This article is written about public pensions in California. But many states face similar issues as well. There is an outcry for reform of the public pension system. It is bankrupting our governments and creating the most egregious disparities between public and private sector workers.
Public employees are retiring in their fifties with fat pension checks, while private sector workers often must toil into their seventies out of financial necessity. At present, public employees can “game” the system by inflating their final year earnings. This practice is called “pension spiking.” Spiking is done by working lots of overtime in the final year. And more disturbingly, public sector employees are able to cash in any unused sick leave accumulated over years of employment. Private sector employees are generally not able to cash in unused sick leave at all. But public sector employees not only get paid out on unused sick leave, but then use the proceeds of this payout to spike their pensions. The pensions of public employees should not be calculated by their final year’s income, but by a lifetime of employer and employee retirement plan contributions and related investment earnings.
Recently a local police chief of a small town retired at age 53 at the very peak of her professional skills and abilities. The loss of her professional skills and experience was to the city’s detriment. But not only that, the police chief received an annual pension of $175,000 per year. At that rate she will be paid over $2 million in pension benefits BEFORE she reaches age 66, the normal retirement age for private sector workers.
When a private sector employee retires, he or she must survive on a combination of Social Security plus their 401(k) retirement savings. Their 401(k) account balance will depend upon three things:
- Employee contributions
- Employer matching contributions
- The investment results on these accounts
When the market tanks, as it did in 2001 and 2008, no-one steps in to make the 401(k) plan investors whole. But with public sector pensions, when the state pension funds lose money in the market, tax payers must cover the gap and make sure that the public sector employees receive the full value of their guaranteed pensions.
Public employee pensions should be designed to replicate Social Security plus the 401(k) plans upon which private sector employees must depend. Workers and their employers would pay into retirement accounts. Employees would retire based on the value of funds accumulated in their retirement savings.
At the point of retirement, the accumulated funds would be annuitized over the expected life span of the retiree. Under such a system there would be equity between private and public sector workers, and no more unfunded public pension liabilities.