Yellowstone Financial, Inc.

Public pensions a great deal — for now

Traditional pensions such as Colorado PERA are an incredible benefit. Unlike 401(k) plans, defined benefit pensions pay a fixed income for a lifetime upon retirement. While most private companies such as IBM have phased out their traditional plans, public employers continue to make these pensions available to
their employees.

Imagine a salary for life in retirement. It’s not a free ride by any means as employees must contribute 8 percent of their salary every year, more than the average 401(k) participant invests. Government employers provide more than a 100 percent match with 13 percent to 19 percent of a public employee’s wage going to PERA.

So what do PERA retirees get for all of their (and the government’s) money? Imagine a state employee who finishes their 30-year career at age 60. At the end of their service, this retiree was earning $84,000 a year. They did not take advantage of the options to purchase service credits and other special deals that can increase retirement income.

Starting at age 60, this employee will receive $65,000 a year for life. These benefits will increase most years by 2 percent to help keep up with inflation. Like most PERA beneficiaries, this retiree will only qualify for a paltry Social Security benefit even with 10 years working in the private sector.

While $65,000 a year increased moderately for inflation may not sound generous, in fact it’s far more than most retirees could ever hope to amass. How much would you have to spend to buy this pension? An equivalent immediate annuity would cost over $1 million on the private market, with the cost of living adjustment costing hundreds of thousands more.

Most private sector workers earning $84,000 do not have a seven-figure retirement plan balance.

So how do PERA and other public pensions do it? Government workers and employers contribute much more to PERA than most private sector workers and companies put into their retirement plans. Also, institutions such as PERA do a superior job of investing compared to individual investors, who have a miserable record as a whole.

Yet all of these factors don’t fully explain the full pension benefit.

The truth is that PERA, like most public pension plans today, has more obligations than the current level of plan assets can support. According to the 2011 PERA Annual Report, its pensions are funded from 58 percent to 82 percent of the level needed to support future benefits. Baked into this assumption is that PERA will earn 8 percent per year on its investments, far higher than what private companies can use in pension calculations.

What lessons should we learn from traditional pensions? If you’re a prospective or current employee in a pension-covered position, you should place considerable value on it when weighing job opportunities. In the end, it will likely be worth much more than you would be able to save on your own even if you are a very shrewd investor.

But this appreciation for traditional pensions is tempered by the funding gap.

In Colorado, we have already seen a reduction in the annual cost of living increases. It’s almost a certainty there will be other modifications to pension benefits, even for those who have already retired. If you believe your pension will not be changed, just look at the cities in California that have recently declared bankruptcy in part due to pension costs.

While as a public employee it should be a key part of your retirement strategy, don’t neglect your other savings because, in the end, the pension may not end up delivering what was originally promised.