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A Brief Introduction

Virtually all full-time state and local employees are covered by a retirement plan. In contrast to the private sector, most public employees are still covered by defined benefit plans; however, an increasing number of states have transformed their retirement plans to defined contribution plans, cash balance plans, or hybrid pension plans. One of the most important decisions facing pension participants is how to access their benefits at retirement. This is a one-time decision and that affects annual income for retirees and their surviving spouses. Public retirement plans are not covered by the Employee Retirement Income Security Act (ERISA) and the rules and regulations imposed on private plans by that legislation.

Most defined benefit plans offer workers the choice of several types of annuities including a single life annuity for the retiree or one of several types of joint and survivors (J&S) annuities that continue to provide benefits to surviving spouses after the death of the retiree. In private plans covered by ERISA, the default annuity option is a J&S annuity; however, most public plans do not have a default to a J&S annuity. Thus, retirees are free to select either a single life or a J&S annuity or any other type of distribution offered by the retirement plan.

Very little is known about how public pension systems price various annuity options. In general, defined benefit plans specify a formula that determines a monthly benefit for the life of the retiree. Thus, the formula is used to calculate a monthly benefit that will be paid to the retiree for the remainder of their life. This benefit is usually called the maximum benefit option or a single life annuity. The plans then offer other types of annuity options and the system must decide how to convert the single life annuity to the monthly benefit of a J&S annuity. In most cases, the retirement systems use their own mortality experience to determine the expected length of benefit payments for a J&S annuity compared to that of a single life annuity. To make this tradeoff present value neutral for the system, the system must select an interest rate for these calculations. There is no systematic data on the interest rate used by public defined benefit plans use to make these conversions. Even less is known about the distribution options in other types of plans.

In conjunction with a grant from the Laura and John Arnold Foundation, this research project aims to determine the distribution options offered by large state managed retirement plans covering state employees, local employees, and teachers and how the various options are priced. A key component of the research is to determine how payout methods differ between the traditional defined benefit plans and other plan types such as defined contribution plans, hybrid plans, and cash balance plans.