Guest Commentary: Time to Replace Pensions with 401ks

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pensionsBy Jeff Boone

Another name for a pension is a “Defined Benefit” (DB) retirement plan.  DB plans provide a pre-determined payment to retired employees despite the performance of the underlying investments. DB plans are employer-owned.  In 1979 about 28 percent of all workers participated in a DB plan, but today only 2 percent participate.

Conversely, Defined Contribution (DC) “401k-style” retirement plans are employee-owned investment accounts that appreciate along with the choice of the underlying investments.   Today about 50 percent of all employees participate in some type of DC plan.  DC plans have become the predominant choice for providing employee retirement benefits… except when it comes to government employees.  Today 86 percent of all government employees are still enrolled in DB retirement plans.

Some will point to this discrepancy as being reflective of a private-sector “race to the bottom” for employee benefits.   While there is no denying that business profits have played a part in the decisions for conversion from DB to DC plans, there are many reasons why private industry has adopted DC plans as their best-practice method for providing retirement benefits to employees (see below).   Unfortunately the public sector not only lags behind, but stubbornly refuses to let go of their DB plans even as those plans create a giant financial mess at all levels of government.

According to the Public Plans Database, in Fiscal Year 2014, only 39% of state and local governments made their full pension contributions.

Reliably, those with a vested interest in the status quo deny the scope and scale of the problem.  For example CalPERS, the giant pension fund supporting the State and City of Davis retiree and employee pensions, projected a 7.5% return (after being adjusted down from a more aggressive 7.75% return); even as the report from the gleaming new CalPERS Sacramento campus for the current fiscal year is a measly 0.61% return.

From a survey by the National Association of State Retirement Administrators, government pension funds estimate they will earn an average 7.6% a year on their portfolios and then report that our national pension funds are only $1 trillion short.  But assuming all pension funds were required invest and project at the current “riskless rate” of around 3%, that total liability becomes over $3 trillion.

Most objective analysts denounce pension fund projections as grossly overly optimistic.  They foretell a looming collapse without significant greater payment into the system.  They say the government pension system is in a deep crisis.

The immediate problem we face is first acknowledging the crisis and admitting that DB plans are financially unsustainable.  Next, we need to start doing something about it.

Davis is a government company town, and many residents will likely bristle at any suggested change to their employee retirement plan.  It is an understandable defensive response, but one lacking complete understanding of the risks and missed opportunities:

  • Retiree protection risk– Since DB plans are clearly in crisis and unsustainable, they will eventually fail and existing retirees will have their benefits reduced or eliminated.
  • Job security risk– As governments see their budgets turn more red attempting to fund employee retirement plans, more of them will become financially insolvent, declare bankruptcy and lay-off employees.  DC plans help improve job security since there are no unfunded long-term liabilities (from under-performing pension funds) to wreck government budgets.
  • Job satisfaction opportunity – A percentage of all people starting a career will determine at some point that a change in career is desired.  Since the DC plan account balance is owned by the employee and not the employer, they take it with them.  Employees would not be held captive in a job they dislike only to wait to receive their DB plan benefits.   In addition, by helping unhappy employees quit and pursue other careers, the overall work culture would improve being filled with a higher percentage of employees happy in their work.  This would then contribute to greater job satisfaction for those remaining employees.

These days even a mid-level government job can be like winning the lottery in retirement benefits.  The present value of a DB retirement plan for a mid-level professional or management employee at retirement will be several million dollars.   We may feel good rewarding our public servants this way, but it actually causes them other risks and other lost opportunities.  Lastly, DB plans are simply grossly unaffordable.  They are destroying budgets at all levels of government.  They are clearly kicking the fiscal can down the road to future generations.   It is time to make the switch to 401k-style plans for all government employees.

Jeff Boone is a professional manager with extensive experience in employee benefits.  He is 40-year resident of Davis and Co-Managing Director of California Statewide CDC. 

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Disclaimer: the views expressed by guest writers are strictly those of the author and may not reflect the views of the Vanguard, its editor, or its editorial board.

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47 thoughts on “Guest Commentary: Time to Replace Pensions with 401ks”

  1. Tia Will

    Jeff

    Thanks for an interesting read. Retirement has been much on my mind of late as I make my final preparations. I am reading this from a hotel in Oakland where I am attending probably the last of my annual Kaiser conferences, this one highlighting Atul Gawande.

    Some will point to this discrepancy as being reflective of a private-sector “race to the bottom” for employee benefits.   While there is no denying that business profits have played a part in the decisions for conversion from DB to DC plans, there are many reasons why private industry has adopted DC plans as their best-practice method for providing retirement benefits to employees (see below).”

    I would like to address your idea of the benefits other than profit and your assertion that DC universally represents “best practice”. You have stated three benefits, but not discussed their downsides. And you have not mentioned even the possibility of alternatives.

    1. Retiree protection risk – This risk presupposes the the government entity will fail. Certainly you can provide examples of which this has happened. But there are many, many other examples in which it has not. Also you have not mentioned the possibility of collapse of the entities in which the 401 K is invested. Nor did you mention that there is still the possibility with either a DB or a DC for the employee to choose to invest some of their funds themselves as a hedge against investment failure.

    2. Job security risk – I see no greater risk from government insolvency than I do from private company insolvency or closure from some other reason. You, know, what you have in the past called creative destruction, which you have stated you consider a “good thing” and I have stated depends on your perspective. There is nothing “creative” about the loss of a satisfying job, especially when there is no equivalent job to move into.

    3. Job satisfaction opportunity – I think that we can both agree that this exists only when there are equally good jobs to move into. This has not been the case for at least the past 10 years and probably more like the past 20 counting not only the recession but when major automation improvements displaced factory workers, compounded by the movement of manufacturing to countries where it could be done far more cheaply, changes from a production to an information/service based economy, and I am sure you could name much more than I can.

    So what other alternatives could be considered.

    1. A hybrid in which a certain amount is placed into a pension plan, while participation in a 401 K is also incentivized. This is the Kaiser model for doctors ( I don’t know about any one else’s plan). It provides for the benefits and safeties of both types of plans without putting all of  “one’s eggs in one basket”.

    2. What I favor however, as you all know is a UBI. The benefits of this approach would be:

    – Job satisfaction security – would be existent throughout one’s life span. Students would be free to pursue whatever career their individual set of talents and interests allowed. The same would be true for all workers. This would also apply to those of retirement age who might not want to retire but are essentially pushed out ( with loss of institutional memory) in favor of younger ( and often less expensive workers.

    – A more level playing field so that every individual does indeed start out with the advantage of enough to eat, a roof over their head, clothing and medical care, regardless of whether or not their parents have been able to secure those basics for them.

    – Recognition that “work” is much broader than we have chosen to define it. Those who must stay home to raise children, or care for the infirm or elderly would not have to worry about how to perform these essentially full time tasks while maintaining the basics of life for themselves and their families.

    1. quielo

      Tia,

       

      A UBI would just create a perpetual underclass. “Recognition that “work” is much broader than we have chosen to define it.” Then this would also include consumption of cheap wine, MM, and “Artisanal  Amphetamines” ?

    2. Ron

      Tia:  “A hybrid in which a certain amount is placed into a pension plan, while participation in a 401 K is also incentivized. This is the Kaiser model for doctors ( I don’t know about any one else’s plan). It provides for the benefits and safeties of both types of plans without putting all of  “one’s eggs in one basket”.”

      I believe that the federal government already uses this approach, for its employees.  Risk is therefore “shared” between employees and employer, thereby offering some protection for both.  (As you put it – not all of “one’s eggs are in one basket”.)

      https://www.opm.gov/retirement-services/fers-information/

    3. Sam

      “This risk presupposes the government entity will fail. Certainly you can provide examples of which this has happened. But there are many, many other examples in which it has not.”

      I am sure a lot of college students are going to go out tonight and find someone at the bar and have unprotected sex with them. If they don’t get an STD or pregnant does that make it a good idea?

      Most pension plans horribly underfunded and a good number of them have become insolvent already. So much so that the Pension Benefit Guaranty Corporation, a government insurance agency, will be broke any year now too. But I guess we should not change anything until most plans are unable to pay retirees?

       

      1. Tia Will

        Sam

        But I guess we should not change anything until most plans are unable to pay retirees?”

        I don’t see how you got from my post that I thought that we should not make changes. I merely pointed out that I thought there were more alternatives than Jeff had mentioned.

         

        1. Sam

          Tia- As a medical professional, if there was a dangerous health hazard like AIDS in the 80’s and you read and understood all of the medical research available and came to the conclusion that AIDS was being transmitted when people shared needles. You then try and tell everyone, “Please stop sharing needles, you are all transmitting the AIDS virus to each other and you are going to die!” Then an accountant comes along and says “Don’t worry about it, not everyone that shares a needle is going to die”. “Don’t people deserve to share needles?” “Why are you being so mean not letting people share needles?”

          Wasting time trying to debate options is not going to help anyone.

          Pensions are as unsustainable as sharing needles in San Francisco in 1982.

      2. hpierce

        For the record, it was the large PRIVATE pension plans (GM, other big auto, etc) that have depleted PBGC, not public pensions.  In, fact, PBGC ONLY applies to private plans.

        %-age wise, almost all public systems have been better funded than the private sector plans were, ever.

         

    4. Delia .

      Jeff, thanks for taking the time to outline your opinion.

      Tia, I agree w/ you.

      Tia, I wish you much happiness in your retirement.

      Jeff, I wish the same for you, in the future.

      Frankly, you both deserve it.

    5. Jeff Boone

      Tia – I have some interest in continued exploration of UBI.  My problem is the law of unintended consequences.  There does not seem to be any past or present model for this that demonstrates it is a good idea.  Maybe you can research this and write a piece on it.

      However, doing away with the thousands of benefits programs that distort the true cost of the entitlement industry does sound like a good idea to me.

      I do NOT agree with a hybrid DB/DC retirement plan.  If we want to enrich retirement benefits to our public-sector employees then the money to do so needs to be accounted for upfront.

      One more thing to consider: without the double hit of employee pay increases causing a huge increase to the pension cost (give an employee another $100 per week that is expecting a 90% pension, then we must increase the pension funding to cover $90 per week for the rest of that employee’s post-retirement life), with a DC plan, pay raises would tend to be easier to justify when needed.  The end-result might be city employees feeling better about their pay and their resulting lifestyle and a willingness to stay on the job longer (assuming they like their work) and that in-turn helping to save on the cost for hiring and training new replacement employees.

  2. Tia Will

    quielo

    A UBI would just create a perpetual underclass”

    You mean other than the one that we already have ?  Why is providing those, including children, with enough to eat, a home to live in, clothing and medical care in a direct, non complicated fashion rather than the patch work of inadequate governmental support through a plethora of programs haphazardly augmented by charities that we currently have any
    worse ?

    I also take exception to your use of the word “just”. The creation of a permanent underclass is neither the inevitable outcome, nor the only outcome of a UBI. You are neglecting to consider those children who being supervised by an adult instead of having both parents working ( or out of the home for other reasons) would not be out getting into trouble and might be furthering their education or learning skills of use to society. There are many possibilities beyond “just”.

    Then this would also include consumption of cheap wine, MM, and “Artisanal  Amphetamines” ?”

    We have that right now. In his own words Mr. Rees states that he is unable to get to the office to obtain SNAP benefits for his children because it is too inconvenient for him.

    This is what we have with our current system which has been in existence for decades. Why not try something streamlined, carefully overseen, and non punitive ( for the children if not their derelict parents) ?

     

  3. hpierce

    For anyone [who favors the DC approach] who can answer… (or have informed opinion)…

    What is the max %-age and/or $ amount can an employee have set aside towards their 401(k), 403(b), or similar DC plan, from their salary?

    If gov’t employees are switched to a DC plan what should the min/max contribution be from the gov’t employer?

     

     

     

    1. Sam

      For a government employee the maximum contribution would be $18,000 in a 403(b) and $18,000 in a 457 plan. There are some provisions for catch up contributions that can increase those amounts.

       

      1. hpierce

        Thank you for your info on the contribution limits.

        Am assuming that, saying nothing about employer rates, the only employer contribution will be to SS, with 0% to the DC.

        God help an employee who entitled to a DB pension AND SS.  Their SS benefit will be reduced, $ for $, by any gov’t DB pension they are entitled to…

        1. Sam

          Employers, like the City of Davis can fund the DC plans just like they fund the pensions. They could even continue doing the same amounts they are now. They just wouldn’t have the liability in the future like they have with pensions.

    2. Jeff Boone

      hpierce – For a 401k, if you are 50 or older and have not previously maxed out your aggregate individual pre-tax 401k withholding limits (very few people have), you can withhold $18,000 (the current standard limit) and then another $6000 in “catch-up”… for a total of $24,000 withholding per year.

      Another benefit to this that I failed to cover in the article is the income tax benefit.

      Say you make $100,000 per year in taxable income.  If you are able to and withhold $24,000 from that, your taxable income would shrink to $76,000.  This would likely put you in a lower tax bracket and result in more money in your pocket every month.

      The other “limit” is the employer contribution.  This is currently $53,000.

      A government 401k will be a 403b… which has some differences under ERISA and IRS.  I think the investment limits are the same or similar.  However, there are some differences.

      For example, under ERISA a 401k can be either a Safe Harbor or Top-Heavy-Tested plan.   A top-heavy plan is one that has rules for how much of a difference in benefits go to higher-paid versus lower paid employees.   One reason for this is to prevent owners from using the 401k to pay themselves outside of what would otherwise be taxed as ordinary income.  The other reason is that 401ks are suppose to be for the benefit of all employees.  Basically the end of year top-heavy test would result in IRS-levied fines if the contributions to highly-compensated employees exceed a ratio-limit compared to the benefits given to the lower-compensated employees.

      A Safe Harbor plan is one where is a bottom guaranteed company contribution (usually 3%) to ALL employees.  And whatever the company decides to contribute, ALL employees get the same percent.

      The employer contribution part of the plan can be structured different ways.  The most popular is a matching-style plan that encourages employees to individually contribute.  Matching has a maximum limit of 25%.

      One more limit is the amount of compensation that can be factored when determining the company contribution.  The IRS sets that limit.  Currently it is $265,000.   So if a highly compensated executive made $300,000 and the Safe Harbor company contribution is 10%, that employee would have a limit of $26,500 in company contributions.

      Most of the IRS limits are to prevent highly compensated people from escaping from paying income taxes.  The government knows that most of its income tax revenue comes from the wages of highly compensated people.

  4. Topcat

    Good article.  Overly optimistic projections of future investment returns has been a big problem for our current retirement scheme. Equally troublesome is the future of Social Security which many people believe is headed for big trouble in the future.

  5. Carson

    We are whistling past the graveyard with the MAIN reason municipalities especially should NEVER participate in a DB plan.  No ability to forecast cost.  With a dc plan, I know exactly to the penny what the cost of an employee will be. period. per year. no question.  With a DB plan, we are screwed with whatever our state overlords tell us, with endless contributions we cant afford.  The reason the private sector went away from it, is as people stopped dying at 60, the numbers dont work, cant work.  Even the DB plans where the employee “contributes” are woefully underfunded.  Contributing a couple hundred bucks a month for 20 years to recieve a couple thousand  am month for 20-30 years… no investment in the world squares that circle.

    It is absolute malfeasance that new employees are being put into DB plans…

  6. Carson

    average age of death in 1950 for a white male(the predominant working/target retiree population in private DC plans by my guess at that point) was 65.6, 1998 it was 10 years longer.  in 2010, a male, just to keep apples to apples, was 79.  It’s a cruel joke… and the Calpers types keeping this zombie going by sucking in new employees know full well, that there wont be any money for them in 40 years.  they are in the red every year NOW

  7. Stephen Douglas

    You are overlooking the obvious. Most “reform” ideas floating around for public pensions are not reforms so much as they are reductions.

     

    It’s fairly typical, at least in the major states, for a full career (35+ years) employee to receive a DB pension of eighty percent, or more, of final salary. At a cost to the employer (taxpayer) of fifteen to thirty percent of salary. (Thirty percent would be for police and fire, who typically retire younger.) These were the costs even before the 2008 recession.

     

    Proposals for DC plans usually limit to a five percent employer match. Ten percent for safety employees. You can see the substantial savings there.

     

    But there are still huge advantages of the DB plan over DC. Longevity risk sharing is the biggie. Several major pension experts and, I believe, the Society of Actuaries, say that, for the same employer/employee contributions, a DB plan can deliver as much as twice the pension of a DC plan.

     

    The downside… all the major econometric studies show that, on average, public workers earn twelve percent less than equivalent private sector workers. If one reduces the typical public DB pension to about half of final salary, current wages would need to increase to compensate. Of course, wages would also need to increase if the government entity goes to a DC system.

     

    1. Jeff Boone

      Thanks for this.

      Do you have any cites for these points?  I am not aware of any recent agreement from the Society of Actuaries or any other think tank saying that DB plans are twice as efficient as are DC plans.  Certainly the performance of both over the last decade does not support that theory.

      I also don’t think you are correct that public sector pay is 12% less than equivalent work in the private sector when factoring all of the non-retirement benefits provided.   I think that data is very stale… certainly before the Great Recession.   I am basing this off my work reviewing federal BLM data.

      I do agree that we should consider the pay level of public sector employees if we make changes to the DC plans.   There is no statutory limit of 5% matching.  It can be more or less than that.  Typically 3% is the bottom floor.

      Keep in mind that 401k employee contributions are pre-tax.  So a larger contribution would reduce the employees taxable income, put them in a lower income tax bracket…. and in essence give them a raise.

      1. Stephen Douglas

        This is not exactly an unqualified endorsement, but a general statement. And not an “official” position.

         

        Move to Defined

        Contribution Plans:

         

        Bad for participant

         

        Bad for plan sponsor in the long run

         

        Bad for society in the long run

        ————————————————-

        A better alternative would be to make less risky investments in the DB plans:

         

        Good for shareholder value

         

        Good for participants

         

        Good for society

         

         

        https://www.google.com/url?sa=t&source=web&rct=j&url=https://www.soa.org/Library/Newsletters/Pension-Section-News/2005/January/psn-2005-iss57-ruloff.aspx&ved=0ahUKEwiMmtvWxq3PAhVG2WMKHfXWBgwQFggkMAA&usg=AFQjCNHUKhpMfyUmjdFVk9UTmj5zxGESHw&sig2=2IBRqbaphmqA3n3pN4V2CQ

        ————————————————

        Here is a modest endorsement of DB plans:

         

        https://www.towerswatson.com/en-US/Insights/Newsletters/Americas/us-finance-matters/2013/Defined-Benefit-Plans-Outperform-Defined-Contribution-Plans-Again

         

        And a more robust endorsement;

         

        “All told, defined-benefit plans cost about half as much as defined-contribution plans to provide the same level of benefit due to these effects, according to research by the National Institute on Retirement Security.”

         

        https://www.google.com/url?sa=t&source=web&rct=j&url=https://cdn.americanprogress.org/wp-content/uploads/issues/2012/02/pdf/defined_benefit.pdf&ved=0ahUKEwj5sLGJy63PAhWBJiYKHe9rCDAQFggyMAk&usg=AFQjCNGq-1xsvcMdakB7LJdEeymAM36tPQ&sig2=mKoydHrTBDrkhAqPB0n0dQ

      2. Stephen Douglas

        “I also don’t think you are correct that public sector pay is 12% less than equivalent work in the private sector when factoring all of the non-retirement benefits provided.   I think that data is very stale… ”

         

        Somewhat stale. Data from approximately 2007-2012. When I say 12%, I am referring to salary only. And I am talking AVERAGE salary. There is a huge caveat hidden there. There are three or four major studies from that period showing that, considering salaries only, public workers earn much less, and when pensions and benefits are added in, public workers (on average) have total compensation roughly equal to, or slightly lower, than equivalent private sector workers.

         

        The one study I highly recommend is

         

        Overpaid or underpaid? A state-by-state ranking of public-employee compensation – American Enterprise Institute

         

        Biggs and Richwine, 2014.

         

        This is the outlier of the major studies I mentioned. It agrees on the generally lower salaries of state workers, but, through using a lower discount rate, judges that public workers end up with a ten percent overall advantage (national average… states like California, Illinois, New Jersey, have a 23%, or more, advantage. According to Biggs.)

         

        Yes, stale data. I don’t know how relative salaries have changed, but there have been significant reforms (reductions) in state and local government pensions since 2012.

  8. Stephen Douglas

    ” For example CalPERS, the giant pension fund supporting the State and City of Davis retiree and employee pensions, projected a 7.5% return (after being adjusted down from a more aggressive 7.75% return); even as the report from the gleaming new CalPERS Sacramento campus for the current fiscal year is a measly 0.61% return.”

     

    Nonsense. CalPERS showed an overall 18.4% return on investments for the year that ended June 30, 2014. That’s compared with a 10.4% average annual return for the last three years. The rate of return far exceeded the fund’s official 7.5% goal set by the CalPERS board.

     

    To rely on these larger returns is also nonsense, to a point. I think most experts recommend an expected long term return around five and a half to six and a half percent. Yes,  “Past performance is no guarantee of future results.” But I, as a CalPERS retire would feel much more secure if CalPERS hoped for the best and planned for the worst, with a presumed ROI of five percent, or less. Then, if returns exceeded expectations, they could raise the discount rate in the future, after they have reduced their unfunded liability and built up a reserve.

     

    The trouble with that plan is that the higher contributions required would be an immediate shock to most local governments. Perhaps a fatal blow.

     

    But forget about the “measly 0.61% return”. That’s a red herring. It could as easily have been a  0.61% loss, without materially affecting the long turn average.

     

    1. Matt Williams

      Stephen, is there a particular reason why you chose June 30, 2014 rather than (or in conjunction with the June 30, 2015 and June 30, 2016 periods, which are both available (see CalPERS announcement)?

      The June 30, 2016 return on investment according to CalPERS was 0.61%

      The June 30, 2015 return on investment according to CalPERS was 2.4%(see CalPERS announcement)

      The June 30, 2014 return on investment according to CalPERS was indeed 18.4%(see CalPERS announcement)

      The June 30, 2013 return on investment according to CalPERS was 12.5%(see CalPERS announcement)

      The June 30, 2012 return on investment according to CalPERS was 1.0%(see page 23 of CalPERS presentation)

      The following article in the LA Times quoting CalPERS’ Chief Investment Officer brings those highly variable returns into perspective CalPERS posts worst year since 2009, with slim returns

      That is “the rest of the story” that you left out in your citation.

       

      1. Stephen Douglas

        @Matt Williams

         

        “Stephen, is there a particular reason why you chose June 30, 2014 rather than (or in conjunction with the June 30, 2015 and June 30, 2016 periods,…”

         

        No sir. If you are implying that I was cherry picking data to make a point, no, I am not. I am actually a big fan of “the rest of the story”. The point of my post is that it doesn’t make sense to look at a 0.61% and imply that a defined benefit is unsustainable any more than it would be logical to point to the 18.4% ROI in 2014 and say, “Hell yeah, let’s give everyone an increase.”

         

        I chose 2014 as a counterpoint to the 0.61% return. Neither is indicative of the long term average return.

         

        The beginning line of the (0.61% quote) paragraph in the article states “Reliably, those with a vested interest in the status quo deny the scope and scale of the problem.” I say, those with a vested or ideological interest in ending DB pensions exaggerate the scale of the problem.

         

        A 0.61% gain is definitely not good. A 27% loss in one year (2008) is much worse. Not to mention, unprecedented. Still, it’s the long term return that matters. Not a 0.6% gain or an 18% gain.

         

        Here is the recent history of CalPERS returns: (page 5)

         

        https://www.google.com/url?sa=t&source=web&rct=j&url=https://www.calpers.ca.gov/docs/forms-publications/facts-at-a-glance.pdf&ved=0ahUKEwjj5OKa9q3PAhUDYiYKHdjNA8kQFggbMAA&usg=AFQjCNEZdPqqxWWsk8W2HI6LqqnfjY5Llw&sig2=2OXhuwtMQn3QWA3U7YRwdw

         

        I am certainly not an investment expert. I have a modest IRA, and I let Fidelity® handle that.

         

        Most pension experts agree that CalPERS 7.5% expected ROI is too optimistic. I don’t disagree. As I said, I would be more comfortable with a 5.5% goal. I understand CalPERS is planning to reduce the discount rate (slowly) to the 6% range, and change their asset mix accordingly. I am just saying that any one year gain or loss should not be cause for undue concern.

         

        1. Jeff Boone

          Stephen – Do you know what the cost impact to the Davis city budget will be if CalPERS delivers an ROI of 5.5%?  Remember that Davis has a $50 million general fund budget and an aggregate $650M long-term unfunded pension liability already… and it is growing.

          Maybe Matt will respond to this.  If I am not mistaken, going from $7.5% to $5.5% ROI would cost the city another $20 million per year just to cover the funding of the existing payments to CalPERS.  So if that is your preference you are advocating to bankrupt the city.  Unless you are also advocating to cut pension benefits for existing employees and existing retirees.

        2. Stephen Douglas

          Jeff Boone:

          ” So if that is your preference you are advocating to bankrupt the city.  Unless you are also advocating to cut pension benefits for existing employees and existing retirees.”

           

          Not at all. As I stated earlier:

          ” But I, as a CalPERS retire (sic, retiree) would feel much more secure if CalPERS hoped for the best and planned for the worst, with a presumed ROI of five percent, or less. Then, if returns exceeded expectations, they could raise the discount rate in the future, after they have reduced their unfunded liability and built up a reserve.

           

          The trouble with that plan is that the higher contributions required would be an immediate shock to most local governments. Perhaps a fatal blow.”

           

          So, no,  they literally can not demand the contributions that a 5.5% discount rate would require.

          CalPERS is now between a rock and a hard place. I don’t know about the specific budget in Davis, but if it is like most other local governments,  nearly half, or more, of their costs are for unfunded liability, not for normal annual costs for present employees.

           

          Due to PEPRA and perhaps other negotiated concessions,  normal costs for today’s employees have definitely decreased, but even if pensions were completely eliminated… neither DB nor DC, the already existing debts will be a huge drain on Davis budgets, as well as the state or other local governments.

          (Note, I accidently hit the “report comment” button. Didn’t mean that.)

        3. Matt Williams

          Jeff Boone said . . . “Stephen – Do you know what the cost impact to the Davis city budget will be if CalPERS delivers an ROI of 5.5%?  Remember that Davis has a $50 million general fund budget and an aggregate $650M long-term unfunded pension liability already… and it is growing.

          Maybe Matt will respond to this.  If I am not mistaken, going from $7.5% to $5.5% ROI would cost the city another $20 million per year just to cover the funding of the existing payments to CalPERS.  So if that is your preference you are advocating to bankrupt the city.  Unless you are also advocating to cut pension benefits for existing employees and existing retirees.”

          Jeff, The $20 million figure you cite isn’t the incremental annual expense.  It is the instantaneous increase (reported on page 84 of the CAFR) in the Unfunded Liability the City would have for its Pension Liability if the ROI% went from 7.5% to 6.5% (the actual amount is a bit over $23.5 million.  Going to 5.5% would add another $28.4 million, for a total of $52 million.  Those numbers only cover the non-Safety employees. Safety (Police and Fire) are extra.  They also do not include OPEB for any employees.

          What that would mean for the annual CalPERS expense is much harder to tease out of the CAFR, but the October 10th meeting of the FBC will be devoted to an indepth dialogue with the City’s actuarial consultant.  Understanding the impact on the annual budget will be one of the many dialogue threads at that meeting.

  9. Stephen Douglas

    Jeff Boone:

     

    ” I am not aware of any recent agreement from the Society of Actuaries or any other think tank saying that DB plans are twice as efficient as are DC plans.”

     

    Not exactly, no. And I am sure you will hear that the National Institute on Retirement Security may have a liberal or pro government bias. But, for what it’s worth, read:

     

    “Still a Better Bang for the Buck

    An Update on the Economic Efficiencies of Defined Benefit Pensions”

     

    “For a given level of retirement income, a typical individually

    directed DC plan costs 91 percent more—almost twice as

    much—as a typical DB plan.”

     

    For a more conservative “think tank” see the California Policy Center, Ed Ring, Executive Director:

     

    “Hence there are two distinct virtues to defined benefit plans, both based on the fact that these plans allow large numbers of participants to pool their risk. This means that even though some participants may live longer than average, their income is secure their entire life, because by definition whoever collected more from the plan by living longer than average had their higher than average withdrawals offset by those whose lifespans were shorter than average. And because risk in a defined benefit fund is shared across generations of workers, during eras when investment returns are low, existing workers guarantee extra cash coming into the plan to keep it solvent, and during eras when investment returns are high, surpluses are fed into the pension fund that can also be used to make up the shortfall during lean years.”

     

    “Saving Defined Benefits Requires Lower Pensions for Existing Workers and Retirees”

     

    DECEMBER 6, 2012 ·

     

    To be sure, Ed Ring supports dramatically lowering the level of pensions (therefore dramatically lowering the cost, of course.) But does not endorse changing to a DC system.

     

     

    1. Jeff Boone

      You are correct.  I would not quote the National Institute on Retirement Security.  Here is their board of directors:

      Board of Directors

      Gregory Smith, NIRS Chair and Executive Director, Colorado Public Employees’ Retirement Associati

      Meredith Williams, NIRS Vice Chair and Executive Director, National Council on Teacher Retirement

       

      Hank H. Kim, Esq., NIRS Secretary/Treasurer and Executive Director and Counsel, National Conference on Public Employee Retirement Systems

       

      Mel Aaronson, Board Member and President, National Conference on Public Employee Retirement System, Chair, Teachers’ Retirement System of the City of New York .

       

      Dana Bilyeu, Board Member and Executive Director, National Association of State Retirement Administrators 

       

      Laurie Fiori Hacking, Board Member and Executive Director, Minnesota Teachers Retirement Association

       

      Richard Ingram, Board Member and Executive Director, Teachers’ Retirement System of the State of Illinois

       

      Gerri Madrid-Davis, Board Member and Director, Financial Security and Consumer Affairs, State Advocacy & Strategy, Government Affairs, AARP

       

      James Sando, Board Member and Trustee, Pennsylvania’s Public School Employees’ Retirement System

      But the California Policy Center quote is interesting.  Do you have a link to it?  This organization tends to be pretty clearly against the current practice of public sector pensions… at least these pensions in their current form.  But they do seem to be walking a line of not directly calling for their abolition… only reading between the lines:   For example:

      The problem with defined benefits is not that they exist. The problem is that we have set up a system where public employees operate under a set of retirement benefit formulas and incentives that are roughly four times better than what private sector workers can expect. Yet these private sector workers pay the taxes to fund these pensions and bail them out when the investment returns falter.

      http://unionwatch.org/average-full-career-calpers-retirement-package-worth-70000-per-year/

      1. Stephen Douglas

        Of course:

         

        https://www.google.com/url?sa=t&source=web&rct=j&url=http://unionwatch.org/defending-defined-benefits/&ved=0ahUKEwju8u-Vn67PAhWC4D4KHaDfA4cQFggdMAE&usg=AFQjCNFTE5Aymhd7i2-ztTfRYGuZUfi7kQ&sig2=AB_I5nolVKZxX5XlL_k5QA

         

        It should be clear even from the title that their problem with DB systems is not the system itself, but the level of benefits. Currently the state of California contributes over $5 billion a year to CalPERS, and the various cities and counties much more. In gross terms, if one could reduce the level of benefits by half (I think that would please Ed), the cost to the state and local governments would decrease accordingly. And still retain the advantages of the DB system.

         

        Costs would not be cut in half, exactly, because much of the costs now are not for current normal costs, but are to pay down the unfunded liability.

        ———————-

        You don’t have to quote the National Institute on Retirement Security, but don’t completely discard their work. It may be biased, even exaggerated, but not completely useless. I don’t agree with Biggs entirely, but his study is eye opening and, in many regards, agrees with the compensation comparisons of more liberal organizations. I hardly ever agree with Ed Ring, and I have read opinions by others in his group of organizations who do advocate switching to DC pensions.

  10. Carson

    All this talk about cost this and benefit that is using the published benefit and cost schedules for DB plans.. Newsflash, that only works as long as localities and state gov is willing to constantly shovel $ down the hole that is our pension nightmare. NONE of these pension funds are viable without massive ongoing infusions and increases in payments.  That is a joke.  If they were even close to solvent, we could have these discussions about performance for retirees etc… but they arent.  When state workers and teachers start getting massive haircuts in 10 years, they will wish they had had the option to “suffer” in a DC plan like the rest of us.

     

  11. Stephen Douglas

    Jeff Boone

    September 25, 2016 at 11:02 am

     

    “Say you make $100,000 per year in taxable income.  If you are able to and withhold $24,000 from that, your taxable income would shrink to $76,000.  This would likely put you in a lower tax bracket and result in more money in your pocket every month.”

     

    Tia Will

    September 24, 2016 at 7:08 am

     

    “– A more level playing field so that every individual does indeed start out with the advantage of enough to eat, a roof over their head, clothing and medical care, regardless of whether or not their parents have been able to secure those basics for them.”

     

    Stephen Douglas

    September 26, 2016 at 11:21 am

     

    “I am talking AVERAGE salary. There is a huge caveat hidden there.”

    ——————————————-

     

    If I may try to tie these three statements together… Please, before you abandon DB pensions, or make any other material changes, take that word “AVERAGE” out of the picture. Including the average 12% salary disadvantage I quoted for public workers. Some time ago another poster pointed out to me that the average Californian has one ovary and one testicle. In many cases, “average” is useless. In many other cases, it is worse than useless.

     

    “Say you make $100,000 per year in taxable income.” I’m not complaining (much), but in my best year, my salary was a little over $50,000*. And that was ten to twenty percent better than many of my co-workers (CalTRANS maintenance).  For many of those workers, especially with families, there is no tax advantage. CalPERS automatically withholds ten percent of salary (non-optional). It is tax deferred, but many of these workers don’t pay income tax anyway. (Some actually earn EIC, or receive SNAP or other subsidies, but that’s another story.)

     

    *The average public sector salary in California is approximately $70,000

     

    That’s the bad news. Here is the good news (or worse news, depending on your bias).

     

    I can’t strongly enough recommend the Biggs and Richwine study I cited elsewhere. It was an epiphany. When Biggs calculated an overall nationwide ten percent advantage in total compensation for state workers, ALL that  “average” advantage came from these lowest paid workers. This and all the other studies typically contain some statement like “lower educated, lower skilled public workers, when counting pensions and benefits, earn more than similar lower educated private workers.” (Safely make that “much” more.) And higher educated public workers (professionals, PhDs, doctors), even with their higher pensions and benefits, earn less than their private sector peers. (MUCH less.)

     

    Biggs and Richwine quantify this phenomenon, at least on the national data.

     

    So, Tia, when you consider the “more level playing field”, that is what you find in the public sector. Compensation is much more egalitarian there than in the private sector. There is a virtual “floor” on public compensation below which the lowest janitor does not go, and a ceiling on the highest paid. With very few exceptions, you will find no public sector doctor, lawyer, or mid level manager over $300,000 a year, including the value of pensions and benefits.

     

    At this point in my tirade, I usually like to quote Juvenal, a frequent poster whom I have never met:

     

    ” you are just wrong about the comparison of public sector and private sector total compensation (except at the level which requires no education–sorry for giving them benefits other than Medi-Cal).) ”

     

    He is (obviously) much more succinct than I.

     

    As far as the “more level playing field”, in other debates, to make a point, I suggested that for “fairness” the obvious solution, considering the Biggs data, is to take the pensions (and retiree healthcare) from the public sector janitors, clerks, and laborers, and distribute those funds to the public sector doctors, lawyers, etc.  You guessed it? Someone actually agreed that would be more “fair”, even if it means that the lower level public workers ended up on the public dole. The Wal-Mart -ization of the public sector. For the record, the fact that lower educated public workers earn more, and the higher educated earn less than the private sector, simultaneously occurs, as far as I can tell, in every state in the union, and in almost every OECD Member country.

     

    Largely due, apparently, to public pensions and benefits. This may be a good thing, or it may be a bad thing. Who am I to judge?  (It’s not a bad thing.)

     

    All I ask it that you understand the dynamic before you make drastic changes to the benefit situation.

     

  12. Jeff Boone

    All I ask it that you understand the dynamic before you make drastic changes to the benefit situation.

    A few points here.

    1. The dynamic of a complete lack of financial sustainability is already well documented.

    2. Something missing from many of the total compensation studies is the value of paid time off benefits for public sector workers, and a great big one… the value of retiring several years earlier than those in the private sector.  I will work on that analysis to publish something later.  But I have already looked at this for example Davis city employees.  Employees that get 6-8 weeks of total paid time off per year and that can retire in their 50s, for comparison sake would need to add back the compensation required to hire other employees that can back them up.  If you make $100 per day and are given 6 weeks of paid time off, you are paid $3000 more in value than someone in an equivalent job with no paid time off.  If you retire at age 57 making $50,000 per year and your peers retire at 65, then you make $400,000 in additional compensation that should be spread throughout a 30-year career to level the “value” of this benefit.

    So unless the studies cited control for the value of paid time off and retirement age, they will significantly understate the total compensation of the public sector worker that generally get a lot more paid time off and retire many years earlier than do their private sector cohorts.

    3. Lastly… if DB plans were better than DC plans, more private companies would provide DB plans.  Especially all those progressive tech companies that are working so hard to retain talent.

    1. Stephen Douglas

      From the Biggs, AEI study, page 40:

       

      “Paid leave encompasses sick time, vacation days, paid holidays, and personal leave. On average, paid leave is almost precisely the same in the private sector as in state government, with values of 11.11

      percent and 11.06 percent of wages respectively. There are variations from region to region, with some governments providing more paid leave than private employees and others less. Overall, however, differences between the public and private sector are quite small relative to other fringe benefits. It is unusual for the value of state and private paid leave to differ by more than 1 percent of wages.”

       

      BLS concurs: for private sector workers,  paid leave equals about 6.9% of total compensation. For public workers it is 7.2%

      ———————————-

       

      It is true. Some public workers can, and obviously do, retire at age 50. In fact, there are many former employees who worked long enough to vest, then went on to private sector jobs. They can begin to draw a pension at age 50. The typical formula is about 1% at 50, so a worker with 20 years public service would get about 20% of final salary at 50 (with no health benefits. ) while still working their private sector jobs. But some obviously retire much over age 60.

       

      The average?  about 60. Except safety workers who generally retire younger.

       

      http://m.ocregister.com/taxdollars/strong-478051-age-retirement.html

       

      “For public workers in California, however, the average retirement age is about 60, according to a recent Legislative Anaylst report. It drops as low as 50, and varies greatly by job:

       

      California Highway Patrol officers have an average retirement age of 53.

      For local police and public safety workers, the average retirement age is 55.

      State prison guards and firefighters hold on until age 60.

      And other state and local employees in the California Public Employees Retirement System — many city and special district office workers et al — have an average retirement age of 60 to 61.

      Teachers, who are in a different public pension system, retire at age 62.

      And the academic faculty members in the University of California system hold on the longest — until age 63. But UC’s professional and support staff check out sooner, at age 59. (Insert joke here about who drives who crazy.)”

       

      Guess what the average retirement age is for all American workers? Since 2000, the average retirement age has been….  60. Before that it was late fifties. In the last two years, it has been increasing,  in both sectors.

       

      http://www.gallup.com/poll/16375/retirement-age-expectations-realities.aspx

       

       

      1. South of Davis

        Stephen wrote:

        > For local police and public safety workers,

        > the average retirement age is 55.

        Don’t forget that for MANY public safety workers you can “retire” from your first job and get a $100K “pension” and then get another $100K “job” in another department and these “second” retirements (with second pensions) push up the “average” retirement age.

        I have a friend that “retired” at 48 as a battalion chief of a Bay Area district (by buying “air time”) and got his first “pension” of  $162K/year (90% of $180K) and then got another job as fire chief of a district in a different pension system making over $200K.  If he works to 65 (with an average of his two “retirements” at 57) he will have a SECOND $100K+ pension.

        I just ran in to a guy I went to High School with at a funeral of a (56 year old) mutual friend.  I remembered that the guy went to the CHP academy after Sac State and asked if he was still with the CHP.  He said he “retired” at 50 (with his CHP pension) and was now living and working as a deputy sheriff in the Sierras (were he will collect a second pension when he retires).

        I don’t know if the former Davis Fire Chief and her husband got new jobs (in different pension systems) but the site below says they are getting over $200K (more money than a guy I know in town brings in from the ~$5mm of free and clear Davis rental homes and duplexes he inherited from his grandparents)…

        http://transparentcalifornia.com/

        P.S. When talking “average” pensions and “average” retirement age it is interesting to look at the difference between the “average” pension and retirement age of “all” retired people in the state and the “average” of the people that retired “last year” (the differences are often pretty big)…

      2. Jeff Boone

        BLS concurs: for private sector workers,  paid leave equals about 6.9% of total compensation. For public workers it is 7.2%

        Since total compensation is higher for these government workers it does not make sense to use percentage of total compensation to try and make a case that they are equal.

        From BLS: http://www.bls.gov/ncs/ebs/benefits/2015/benefits_leave.htm

        State and local government jobs and private sector employers both provide 15 days of paid vacation after 5 years.  What is missing from this is the paid vacation given at 10, 15 and 20 years of service.  Because that is where there is a larger gap given the fact that most private sector business stop increasing vacation benefits while the public sector employers keep adding more days.

        Per BLS after 5 years state and local government gives 12 days compared to 6 in the private sector.  And there are 11 paid holidays to the median of 8 for the private sector.

        Now in good ol’ wealthy Davis we give our employees a lot of paid time off.  See here http://cityofdavis.org/city-hall/human-resources/memorandums-of-understanding-mous

        Take an employee with 16+ years of service… they will get 28 days of paid vacation.  And if a manager (a lot of our employee are since we are a bit top-heavy)… well they get another 10 days of paid management leave per year.    Oh.. and if they don’t take that management leave they can get paid in cash for it.    Now sick leave.  They get 12 days of paid sick leave.  And paid holidays… they get 14.5 of those.   So a 16+ year management employee with the City get a whopping 64.5 paid days off.  That is about 13 weeks.  Might as well be a teacher and get those summers off.

        And for the retirement age, well you are off a bit there too.  First, you are not counting those that retire after 25 or 30 years and then go back to work.  They get to double-dip… retire twice if you can believe it!

        “In most cases, public employees with several years of service become eligible for a pension benefit at age 50—even though the employee may be able to earn a greater pension benefit if he or she delays retirement until a later age,” the LAO says.

        But from where you got some of your information: http://www.ocregister.com/taxdollars/strong-478051-age-retirement.html

        And today’s workers expect to retire at age 66, according to a new Gallup poll.

        For public workers in California, however, the average retirement age is about 60, according to a recent Legislative Anaylst report. It drops as low as 50, and varies greatly by job.

        And…

        Put it all together and, in the state’s three largest public pension systems, the average worker retires at about age 60, the Legislative Analyst said.

        So that government workers gets a 6-year end of career paid vacation that the private sector workin’ stiff does not get.  Let’s add up those benefit dollars along with that aggregate increase in paid time off and include in in the total compensation calculation.

        Does not seem fair nor right no matter how you spin it.

        1. Stephen Douglas

           

           

          “And today’s workers expect to retire at age 66, according to a new Gallup poll.”

           

          And…

           

          “Put it all together and, in the state’s three largest public pension systems, the average worker retires at about age 60, the Legislative Analyst said.”

           

          Ergo…

           

          “a 6-year end of career paid vacation that the private sector workin’ stiff does not get.”

          ——————————————-

          Ho Lee Crap. Are you kidding me?

           

          If you don’t read the newspaper, you’re uninformed. If you read the newspaper, you’re misinformed.

           

          I can’t really blame Teri Sforza for the statement: “And today’s workers expect to retire at age 66, according to a new Gallup poll.”

           

          1). I don’t know if she was intentionally misleading

          2). The statement is technically correct. True-ish, as far as it goes.

          3). The “rest of the story”…one more time:

           

          http://www.gallup.com/poll/16375/retirement-age-expectations-realities.aspx

           

          The key word is “expectations” people expect to retire at 66, but polls asking retired people at what age they actually did retire say 60. Although actual retirement age has increased in the last few years.

           

          May be public workers …should… earn more than the private sector. May be they are just plain smarter.

           

          Say good night, Gracie.

           

           

        2. South of Davis

          Jeff wrote:

          > Oh.. and if they don’t take that management leave they can

          > get paid in cash for it.    Now sick leave.  They get 12 days of

          > paid sick leave.  And paid holidays… they get 14.5 of those.

          Any idea if the people working for the City of Davis can still get paid cash for the healthcare they don’t use added to paychecks (if a spouse has a family health plan at work) or if workers in the city of Davis can cash out vacation or unused leave before retirement (a cousin recently retired from the SFPD at 53 and got a check for just under $250K for his “unused vacation”)…

  13. Jim Frame

    I didn’t read everything posted above in detail — some I read, some I skimmed — but there are a couple of items I didn’t see addressed:

    1.  Looking at national averages, or even state averages, doesn’t do much for a rational analysis of the Davis budget.  My sense is that Davis has historically (not sure about new hires now) paid a very high level of salary and benefits compared with the regional private sector, going back at least 10 years.

    2.  I don’t dispute the contention that a DB plan can provide a higher level of benefits for the investment, but one significant problem, at least locally, is that changes in the annual percentage benefit and retirement age are effectively off-budget and therefore not transparent to the taxpayers.  That makes them tempting targets for politicians looking to curry favor with employee bargaining units, and it’s what got us in trouble in the early 2000s.

    3.  Regarding public-versus-private compensation levels, one item not addressed is the very real difference in the way that public and private firms handle revenue downturns.  Public corporations generally try hard to avoid layoffs, even when doing so means cutting programs or raising taxes and fees, often without regard to workload.  Private firms are much quicker to lay off staff of reduce hours in order to match expenses to revenues.  That difference amounts to compensation that doesn’t show up when comparing public versus private salaries and benefits.  (The severity of the 2008 recession forced a lot of public agencies to go to layoffs and furloughs, but I don’t expect that mindset to persist in government.)

     

    1. Jeff Boone

      Good points.

      My father in-law retired from Davis law enforcement and he read this article and was, of course, not in favor of DC plans.   But when I explained that the system is unsustainable and will collapse and take his pension payments with it, he agreed that something needed to be done.

      1. South of Davis

        Jeff wrote:

        > when I explained that the system is unsustainable and will

        > collapse and take his pension payments with it, he agreed

        > that something needed to be done.

        Like any “Ponzi Scheme” the current pension system only “worked” with massive growth.  We are still paying the bills only because the population of Davis has had exponential growth over the past 50 years with the population doubling about three times.  Unless we have another 50 years of “exponential growth” (doubling three more times will bring the number of taxpayers in town up over 500,000) we won’t have enough people paying in to the system (designed by “politicians” not “mathematicians”) to pay what was promised.

        http://www.huffingtonpost.com/dave-pruett/the-myth-of-exponential-growth_b_4037025.html

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