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Saving for Retirement

Public Pensions Get an Overhaul

State workers say hello to 401(k) plans and so long to automatic cost-of-living boosts.

In the words of some politicians and pundits, public-pension reform isn't a liberal or conservative issue -- it's a reality issue. Not about politics, but about math. The money's just not there to fund the kind of retirement that state workers have come to expect after a career spent teaching, policing or pushing paper in the municipal building.

SEE ALSO: What Killed Pensions

Reality checks led to a record number of pension-plan changes in 41 states in 2010 and 2011, as lawmakers tried to patch the cracks in the public nest egg. Expect more (and more-aggressive) moves to come. "Many states that have already taken steps are finding that they're still not where they need to be," says David Draine, a senior researcher at the Pew Center on the States.

Overall, state and local pensions are about 77% funded -- meaning that the value of plan assets is enough to cover 77% of promised benefits. That's not bad, since 80% is considered adequate. But there is wide variation among plans. Illinois's plans, for instance, are a little less than 50% funded. The plans in Connecticut, Kentucky and Louisiana are under 60%. And some plans administered by cash-strapped cities and localities are in dire straits. "Even the worst-funded states aren't in immediate danger of not being able to make pension payments. But some localities have kicked the can down the road until they've run out of road," says Draine.

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Whether the wolf is at the door or still decades away, reform is the order of the day. Rhode Island set the precedent last November for the most comprehensive makeover yet. Its new hybrid retirement plan will be part traditional defined-benefit pension and part 401(k)-style savings plan, with employees required to contribute at least 5% of their salaries to the new savings component. Lawmakers also limited cost-of-living benefit adjustments for retirees, made COLAs conditional on the health of the retirement fund and raised the minimum retirement age. The measures will bump the state system's funded status from 48% to 60% right away and save taxpayers about $4 billion over the next 24 years.

None of the general ideas are unique to Rhode Island. What distinguishes the state's reforms is that come July 1, the changes will apply not just to future employees but to current employees, too -- vested and unvested -- as well as to current retirees. "A lot of constitutional, statutory and judicial decisions protect employees from any reduction in benefits, and that's made policymakers hesitant to shift benefit packages for current employees," says Ron Snell, senior fellow at the National Conference of State Legislatures. "Rhode Island has gone further than any other state."

Expect court challenges to the Rhode Island measures. It's too early to handicap the outcome, although lower courts have ruled in favor of COLA limits enacted in 2010 that affected current retirees in Colorado and Minnesota.

Meanwhile, look for some pension-tweaking to be taken up in California, Kentucky, Louisiana, Ohio and South Carolina, where governors or study commissions have made significant proposals.