California Initiative Could Switch New Hires to 401(k) Plans

Ed Mendel is a reporter who covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. Find more of his stories at Calpensions.com.

New state and local government employees hired in California on or after Jan. 1, 2019, could receive a 401(k)-style retirement plan under a proposed initiative — but giving them a pension would require the approval of voters.

The “Voter Empowerment Act of 2016” was filed last week by a bipartisan group led by two men who led local pension reforms approved by voters in 2012 in their cities: former San Jose Mayor Chuck Reed and former San Diego Councilman Carl DeMaio.

Their new drive to cut the cost of pensions said to be eating up government budgets is aided by an unusually low number of voter signatures needed to place a state constitutional amendment on the ballot, 585,407, due to low voter turnout in the previous election.

A Public Policy Institute of California poll issued in January last year said 85 percent of likely voters say pension and retirement costs are “at least somewhat of a problem” for state and local government budgets.

“One idea to deal with the situation is to change the pension system for new employees from defined benefits to a defined contribution system similar to a 401(k) plan,” said a PPIC news release. “Asked about this idea, 71 percent of adults and 73 percent of likely voters support it, with strong majorities across parties in favor.”

Previous PPIC polls also found strong support for switching government employees to 401(k)-style individual investment plans that have replaced pensions in most of the private sector.

Employers make an annual payment to the employee’s tax-deferred investment plan, avoiding the long-term debt of lifetime pensions. And the risk of underperforming investments, expected to pay two-thirds of many pension costs, is shifted to the employee.

But critics say the 401(k) was intended to be a supplement not the main retirement plan, often provides inadequate retirement due to low contributions and poor investment decisions, and is vulnerable to big investment losses shortly before retirement that are difficult to replace.

“It’s exactly what we expected,” Steve Maviglio, a public employee union consultant said after the initiative was filed. “It’s fraught with flaws, potential major implications for both existing and future employees and will likely result in years of litigation.”

Maviglio said a legal and financial analysis of the proposed initiative is being conducted, and its “negative impacts” will be pointed out to the public. Details of fatal flaws may not be revealed until it’s too late in the qualification process for a rewrite.

Reed and DeMaio have experience in battling public employee unions that shaped the 3¼-page proposed initiative. It’s said to have been vetted by legal experts in an attempt to avoid lengthy legal battles.

DeMaio estimated that $2.5 million to $3.5 million will be needed for the signature drive, depending on “games” played by unions. In San Diego, signature gatherers at retail outlets were followed by opponents urging voters not to sign.

Reed dropped a proposed initiative last year after state Attorney General Kamala Harris issued what he said was an “inaccurate and misleading” title and summary making voter approval unlikely if not impossible. He said the new initiative was filed early, allowing time, if needed, for litigation with Harris, who is running for the U.S. Senate.

The California Public Employment Relations Board unsuccessfully sued to keep the San Diego initiative off the ballot. The labor-friendly board also has filed lawsuits against the San Jose measure.

The proposed initiative says “government agencies and retirement boards must fully and faithfully implement voter-approved initiatives” on pay and retirement benefits, “whether placed on the ballot by a government agency or voters.”

Former Gov. Arnold Schwarzenegger briefly backed a proposal in 2005 that would have switched state and local government new hires to 401(k)-style plans, until hard-hitting union television ads said death and disability benefits would be eliminated.

The initiative proposed for the November ballot next year says “nothing in this section shall be interpreted to modify or limit any disability benefits provided for government employees or death benefits for families of government employees.”

A key provision of Reed’s San Jose measure gives current workers the option of paying more for their pension or receiving a lower pension. But it was overturned by a superior court as a violation of “vested rights,” and the ruling is being appealed.

Under the “California rule,” a series of state court decisions, one in 1955, are widely believed to mean that the pension offered on the date of hire becomes a vested right, protected by contract law, that cannot be cut unless offset by a comparable benefit.

The proposed initiative is intended to avoid a legal conflict over the vested rights of current workers, forgoing the San Jose option, the San Diego five-year cap on pay used to calculate pensions or other attempts to quickly get major pension savings.

One of the drivers of “voter empowerment” is a court decision that removed a Ventura County 401(k)-style initiative from the ballot last fall. The judge said a county cannot “opt out” of a pension system on its own, needing state legislation instead.

The proposed initiative does not take effect for new hires until Jan. 1, 2019, allowing time for state and local government to decide on a retirement benefit and then, if it’s a pension, get voter approval. A 401(k)-style plan would not need voter approval.

Government employer costs are limited to 50 percent of the total cost of retirement benefits for new hires, including pensions, 401(k)-style plans and retiree health care. The pension reform Gov. Brown pushed through the Legislature in 2012 is different.

His pension reform calls for a 50-50 split between employers and employees of the pension “normal” cost, which excludes the debt or “unfunded liability” from previous years.

So pension contributions from employers, who must cover pension debt costs, are often two or three times larger than the amount employees pay toward their pensions. The initiative would change that, requiring new hires to pay half the cost of pension debt.

How limiting employers to 50 percent of the total cost would affect a 401(k)-style plan is not clear. Some employers match employee contributions to a 401(k) plan up to a certain amount.

In addition to the public employee union coalition, the proposed initiative will be analyzed by the California Public Employees Retirement System and the California State Teachers Retirement System.

“Comprehensive pension reform has already been enacted for public sector workers in California, and it is anticipated to save tens of billions of dollars,” Brad Pacheco, a CalPERS spokesman, said yesterday. “It reduces benefits for new hires, and current employees are now contributing more each month toward their pensions than in the past.”