Pension Fund Contributions Aren’t Enough

The San Diego Union Tribune ran a report on June 17th entitled “Escondido firefighters do contribute to pensions.” Apparently this report was to correct an error from a previous article in which the Tribune stated that Escondido’s firefighters did not make any contribution to their pension. In reality the firefighters contribute to their pension fund an amount, in the form of payroll withholding, equivalent to 9% of their salary.

While it is commendable that Escondido’s firefighters do pay something towards their pensions, considering how many safety employees in California still pay nothing, it is important to place this 9% contribution within the perspective of how much it really costs to fund a “3 at 50” pension.

The following table depicts how much, in terms of percent of salary, an employee will need to have contributed into their pension fund in order to maintain solvency based on various rates of return for the fund.

This table uses after inflation numbers, which makes the returns appear small. In reality, CalPERS, CalSTRS, and most other pension funds, project a long-term rate of inflation of 3.0%. This means that the nearly best case scenarios here, 7.5% before inflation (showing as 4.5% after inflation on the table), are representative of the current official long-term projections used by most pension funds. Based on the official rates of projected returns for pension fund investments, a 30 year veteran, retiring on a “3.0% at 50” pension, will collect 90% of their salary in retirement, and they will need to contribute 32.5% of their pay into their pension fund every year they work. On that basis, 9% is less than one-third what will be necessary to fund their retirement pension. But what if the pension funds return less than 4.5% (7.5% before inflation) per year?

As can be seen, for every 1.0% the real rate of return drops, the required contribution increases by over 10%. That is, if CalPERS can only deliver a 6.5% return (3.5% after inflation), the contribution goes up from 32.5% of salary to 43.4% of salary. If CalPERS rate of return goes down to a 5.5% return (2.5% after inflation), the contribution goes up from 32.5% of salary to 57.9% of salary.

Nobody seriously questions the fact that police and firefighters deserve to be paid a premium for the work they do. But how much of a premium is appropriate? A self-employed independent contractor has to pay the employer and employee share of social security. That means they have to pay 12.5% of every dime they make into the social security fund. And if they are fortunate enough to earn, at the end of their careers, what the average veteran police officer or firefighter makes – let’s lowball that at $100K – they will get a social security benefit, at most, of $30K per year at age 68. This equates to a pension formula of roughly “0.75% at 68” vs. “3.0% at 50.”

Public sector workers, all of them, should consider these apples-to-apples comparisons to the taxpayers in the private sector who support them, when they suggest that 9% is an appropriate or commendable amount for them to be contributing to their pension funds. They should be prepared to explain why they aren’t contributing at least 50% of the cost for their pensions, with that contribution going up whenever projected rates of return for their pension funds go down.

3 replies
  1. Avatar
    Tough Love says:

    Excellent and adequate article … very consistent with my own calculations.

    But lets take this a bit further. I question why the author says that Public sector emoloyers should pay half of their pension cost.

    With “cash pay” in the public sector now equal to or greater than than of the Private Sector (for all but a few highly professional occupations such as doctors and lawyers), there is no justification for ANY (yes ANY) greater (taxpayer paid-for) pensions in the Public sector.

    Most Private Sector employers pay from 3%-8% of “cash pay” toward THEIR employees pensions. There is no justification for taxpayers to contribute MORE than this 3%-8% for Public Sector Pensions. If the Civil Servant wants a particularly rich pension, that’s fine …. but the employee, NOT the taxpayers should pay for all costs in excess of the 3%-8% which Private Sector taxpayers typically get from their employers.

  2. Avatar
    Editor says:

    Tough Love: There has to be a justification for any pension fund contribution by a public sector employer that exceeds 6.25% of payroll, which is what employers are required to contribute to Social Security in the private sector. And you are correct that “lower pay in the public sector than in the private sector” is no longer – with limited exceptions – a valid justification, since government workers now earn current compensation and benefits that are well in excess of private sector averages.

    The point of the 50/50 suggestion was simply that even at that level, most government workers would balk at seeing more than 10% or, certainly, 20%, of their salary being diverted to a Wall Street gambling house (oops, CalPERS or CalSTRS). And since Wall Street’s last, biggest con of this era is almost exposed, that is, since government workers, their union leadership, and the politicians they’ve purchased, are about to realize these promises of 7.75% (4.75% after inflation) long-term pension fund returns are not achievable, we are about to see pension fund contributions for non-safety employees rise to 40% or more, and rise to 60% or more for safety employees. The system is about to collapse. Here are some suggestions:

    (1) There is currently a “stop loss” provision on existing pensioners 2% cap on COLAs, where the 2% cap is lifted once the purchasing power of the pension is eroded through inflation to between 75% and 80% of what it was worth when the person originally retired. Lower this cap to 50%.

    (2) Cap the amount of all non-safety government pensions at 2x the maximum social security payout, and all safety government pensions at 3x the maximum social security payout.

    (3) Along with #2, cap the amount of any government pension at 75% of the average of the retiree’s final three years base salary, not including overtime, sick leave or vacation payouts, or any other non-base form of compensation.

    (4) Require government employees pay at least 50% of their pension costs. If investment returns fall precipitously towards the end of their careers, present them an option of dramatically higher contributions as a percent of payroll, or a reduction in their pension benefits.

    (5) Retroactively eliminate the retroactive pension boosts that were awarded government employees over the past 10-15 years.

    (6) Reduce pension formulas going forward for all currently employed and new employees to levels prior to the benefit increases granted over the past 10-15 years.

    Implementing these steps would rescue the public sector pension system – assuming we have a few years of inflation so step #1 can have the needed impact.

    What’s interesting, and unappreciated by many defenders of pensions as they are, is that the above solution at least preserves the defined benefit, and even preserves a retirement package that still greatly exceeds what social security offers. And the only way this can be justified is if public sector wages and benefits are brought back below the averages for the private sector. All of this will probably happen, painstakingly and incrementally, in bankruptcy courts across the country. It’s too bad the unions can’t embrace a package such as what is proposed here, to avoid all of these bankruptcies, because it is realistic and generous.

  3. Avatar
    Tough Love says:

    Editor, Your suggestions are all good ones. Of course Civil Servants would think otherwise. The 50%-of-cost employee contributions combined with the 2x (3x for safety workers) gets to the right place.

    Whether …”Implementing these steps would rescue the public sector pension system – assuming we have a few years of inflation so step #1 can have the needed impact.” ……….. I doubt it for the worst States/Cities unless all these changes immediately apply to all CURRENT workers, highly unlikely.

    A few like NJ only have 6-7 years before the funds run out. Short of massive taxes increases or a 100+% run-up in assets, w/o a significant benefits-side haircut, little can salvage the Plan.

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