One of the biggest apparent misconceptions on the part of those who believe public sector pension benefits can remain unchanged is that somehow there is a difference between 401K plans and public sector pension funds. The only difference is one of scale. Individual citizens save money and invest the money in a 410K plan or other individual retirement account. Public sector pension funds take vast sums of money and invest it in the very same places – primarily Wall Street equities.
While it is true that an institutionally managed, massive and diversified pension fund may be less volatile than an individually managed retirement account, it is also true that massive pension funds are far less likely to enjoy returns that beat the market. They’re too big. So when the market value of stocks and other assets fall, it is impossible for large pension funds to not also see their values also fall.
If you recognize this – the fact that public sector pension funds are just as subject to economic ups and downs as individual 401K funds, and that they are invested in exactly the same things – then comments by defenders of keeping the public pension benefit system unchanged become inexplicable.
President Obama, in a speech last month where he lambasted the nonexistent Republican plan to privatize social security, said “I’ll fight with everything I’ve got to stop those who would gamble your Social Security on Wall Street.” But public sector employee pension funds are themselves gamblers on Wall [...] Read More
It would be easy to condemn as irresponsible the City Council of Vacaville, California, for their vote last week, granting “3% at 50″ benefits to their firefighters. At this point, don’t we all know these are financially unsustainable promises? But on the other hand – isn’t ”3% at 50″ the standard for municipal firefighter contracts? Shouldn’t these firefighters earn pensions at the same level as their counterparts in other cities? Indeed they should. The real question is this – can Vacaville invest 23% of their firefighter’s salaries into a pension fund each year – Vacaville’s current commitment - and expect it to earn a sufficient amount to fund these upgraded retirement benefits? The answer hinges on what real rate of return their pension funds can expect to earn over the next few decades, and what variables will influence these returns upwards or downwards.
In this analysis, we assume a firefighter retires after 25 years work at age 50, which at 3% per year, would mean this firefighter would collect 75% of their final salary throughout their retirement. At various real rates of return on investment, for how many retirement years would this firefighter have a solvent pension fund? In the tables following this post are three cases which I believe use real rates of return – i.e., adjusted for inflation - that might be reasonably projected over the next few decades, 3%, 4% and 5% per year. Depending on which of these returns you choose, surprisingly different funding scenarios ensue, with dramatically different implications for policy.
At a long-term real rate of 3% annual return on investment, with a 23% of [...] Read More