State pension funds, funding, and options
Felix Salmon writes on the question of appropriate pension plans for state systems (emphasis on teacher retirement systems) in Reuters…however, the comment section offers a superb range of thoughts by non-experts on the matter of state pensions as well.
1. Is a 7-8% return reasonable to expect (smoothed over time) in the future?
2. If a different system is used from here on out? what are appropriate transitions?…Felix compares to 401k plans as being totally inadequate but there are other proposals.
3. What about the question of buyouts?
4. Interestingly several of the commenters were using the MA teachers retirement system as an example, which makes it useful for the AB post here.
5. What are the incentives inherent in the current system? (ie. most value is actually ‘accrued’ in the last five (?10) years of acummulated contribution for a pensioner? Not unlike any plan based on yearly contributions over decades.
6. The meme of baby boomers/versus younger contributors was brought forward but without numbers…this also could be subsumed under #2 and #3.
7. What is ‘underfunding’ in this context?
Dan, your first link doesn’t work. After you read this, please delete my comment.
the point about any retirement plan is that you are going to reach a point in your life where you are not going to be able to work. or maybe just not want to work.
it is reasonable to look forward to that and negotiate with an employer to negotiate a deferral of part of your wages to be paid after you retire.
it is difficult for an employer to promise to be able to provide a “defined benefit” over an uncertain future… except in the case of the federal government which can guarantee a benefit as long as the government exists as long as there are taxpayers who understand that their tax “now” is what “guarantees” their benefit later.
a state is in almost the same position. but there are about three ways they can go about arranging the details:
a straightforward “defined benefit” paid out of taxes… just he way current employees wages are paid…
or a “defined contribution” in which case employee wages are paid at a level high enough for the employee to “invest” part of his money in whatever private system he thinks likely to be there when he needs his money back.
or a system in which the state invests the money now… however they think best… in the hope that the “markets” will provide the needed money for the employees retirement… but the state guarantees the difference between what the “market” actually provides, and some agreed upon minimum that the employee agrees to as a part of his pay package.
it doesn’t seem to me that any of these systems is going to be that much different from the others in terms of direct costs to taxpayers. but there are huge differences in the security of the retirement income that will be needed by the retired worker.
the advantage of the pure “market” system is that it is transferable. but it might be wiser if ALL workers, not just public employees.. invested a share of their pay into a pension “fund” managed by “experts” who were employees of the government and therefore having the same interest as the “investors” and not subject to the various evils of private investment firms…
or are we now going the way with retirement that we have gone with medical care… your money or your life, and trust the man in the suit because he cares.
1) is a 7 or 8% reasonable…?
ans. who knows? depends on inflation and growth in the economy. who knows? you are making the assumption that pensions should be handled like bank accounts or stock or bond purchases. that is not necessarily the best way to do it when you have the power to tax. of course if the taxpayers think they can get a better deal by putting the money in the market… more power to them. but what the workers need is some certainty about how much they will have when the retire. the state is in a position to guarantee that. whether the STATE gets the money from the markets or taxes is their call… but should be their risk. if the employees want to take the risk… well, i’d say let em. but i hate stepping over elderly beggars in the street. so some of the pension ought to be guaranteed.
the reason it doesn’t much matter to the taxpayers is that elderly non workers are ALWAYS going to have to be “supported” by the product of the now-workers. whether that comes out of taxes, or out of “interest” that comes out of profits (prices and wages) won’t make a whole lot of difference. except to give whining rights to “taxpayers” vs “employers” vs “workers” vs “customers.” as the corporations always tell you whenever they don’t want a new corporate tax.. it all gets passed through.
the difference is the risk, and of course the ownership of the asset.
the way the employee takes the risk is that the employer says, essentially,
i can pay a thousand a week for this job. it is immaterial to me whether i give you the whole thousand now, or hold back 200 and pay that to you when you retire in then-current dollars, or hold out a hundred now and invest it for you.. at your risk. you could get more than that 200 (adjusted) or less.
since the employee would only expect to live about 20 years after a career of about 40 years, that 200 per week out of wages would become 400 per week in pension.. or a pension of 40%.
of course this would vary with years of service, but not in an arbitrary way.
from what i could see of the state pension plan it was set up to deliver about that level of return at about that level of cost to the state… all carefully confused by “employer share” and “employee share”. more or less depending on the way the workers and the employers struck the bargain.
8% is the return that occurs on the S&P 500 or equivalent since 1871. However if you are a pension administrator you are a fool to put all your money in equities, since they do have down periods of up to 20 years and you can go broke waiting for the market to return to the mean. Fixed income is more in the 3-4% range over the same time period so its a more sensible metric. The other thing is to not include overtime in the pension calculations so its on base salary only or perhaps with a 10% overtime factor. In fact they should consider doing what the UK is doing and moving to a career average formula, not a final average formula.
very possibly. but you realize that what you are arguing is simply a reduction in employee pay.
defined benefit pensions are not complex but do require proper management including…
sane investing with a reasonable target rate
reasonable actuarial and accounting work
a prohibition against gimmicks (last three years pension packing for example)
Many states have not met all of these criteria on a regular basis – that is the problem.
The issue is of course yes the percentages of what makes up total comp change, but one hopes the pension administrators do not go to Las Vegas on Wall Street to invest the contributions. I do recall when I was working that the hourly pension contribution paid by the business units to the fund at the major corp I worked at went up in the 2002/2003 stock market collapse. (Internally the pension charged an hourly charge to the business unit for employee pensions)
Yes I agree rusty. Golden parachutes can actually make a big difference, 2010 numbers will be out in April I believe. Deficits are a tricky item when it comes to politics.
i think i would agree that a defined benefit plan based on stocks and bonds could be made to work. the gimmicks wouldn’t really have to be eliminated, just factored in to the expected costs/benefits.
the thing i am arguing here is that people need to be clear about exactly what a retirement plan is doing: deferring pay. and then they need to be clear about who is bearing the risks. and the people paying the workers… the voters? … need to understand that the pension is not a “gift” revokable whenever times is bad, or they just get a fit of envy. most likely a pension that pays right through the bad times would act as a “stimulus” or at least balance wheel to the economy and tend to limit recessions.
but with anti tax insanity ruling the country you won’t see that discussed in high school economics classes.