Thursday, October 1, 2015

Teacher Pensions are Well Earned, But...

An article with this title, written by Michael Hiltzik, recently appeared in the Los Angeles Times. In LA Times fashion the article, more an editorial than newsworthy, nonetheless appeared on the front page of the Sunday Business Times. The article caught our attention, not just because of an interest in public pensions, but also for the indispensable work of public school teachers.

In the piece, the writer singles out a teacher with 30 years' experience in the Los Alamitos School District, a small district outside of Los Angeles. The teacher is mentioned by name in the article (presumably to lend credibility) which we won't do here. Our argument is not with the retirement pension of this teacher, or of any teacher in particular. This educator spent 30 years in front of a classroom, made payroll contributions to her retirement plan and is entitled to rely upon that pension income in her retirement.

This case, however, illustrates a point about public employee pensions and those calling for reform. The reform effort, proposed in California for the 2016 electoral ballot, along with local measures passed several years ago in the cities of San Jose and San Diego, do nothing to touch existing retiree or current employee pensions. Rather, the reforms, are effective only for prospective employees, yet to be hired. This simple fact, is what makes the anti-reform efforts of the public unions and editorials like this one in the Los Angeles Times, so peculiar.

But let's go to the core of Mr. Hiltzik's argument. The teacher in question, now 61, will soon enjoy a lifetime annual pension "in the range of $100,000", representing approximately 90% of her highest year annual salary. Mr. Hiltzik goes on to characterize that pension as "decent". Now, if a pension of 90% of salary is considered "decent" in the world of state and local government, then literally millions of private sector workers are living indecently. Saving an account balance through an IRA or 401k that will generate lifetime retirement income of 90% of highest year salary is virtually unheard of in the private sector. 

Mr. Hiltzik, however, continues to justify this level of retirement income by pointing out that the teacher "funded much of her pension from her own paycheck, a contribution that comes to 9.2% of her pay this year". This now reaches to the point of this post. While no one would like to see this teacher's retirement income, so well earned, so well funded and, well so decent, to now be changed. But what we must also consider, is that this lifetime pension of $100,000 per year (adjusted for cost of living increases) must actually be paid by someone, in this case, the school district and the CalSTRS public employee pension system.

But then again, if Mr. Hiltzick's representation that the teacher has funded much of her pension is true, then what's the concern?  Now, this is where we need to drag some math into the conversation. If the teacher's pension is $100,000 and it represents 90% of her highest year salary, then her salary, by simple mathematics would have been roughly $111,000. That would mean her payroll contribution in her highest year, at 9.5%, was $10,555. This would be her contribution, though, for just her highest (presumably last) year of employment. Her average salary over her total employment, we can assume was approximately $60,000. That would imply total pension contributions over 30 years were on the order of $170,000. Investment earnings, to a varying degree, would have been earned on those contributions, so for arguments sake let's say the current value of this teacher's contributions, plus interest are approximately $350,000.

Let's now consider the value of the pension to the teacher and, most importantly for this discussion, the cost of the pension to the public agencies that must provide it. Investment professionals use a rule of thumb for spending in retirement from a 401k or IRA of 4%. Using this metric, a portfolio that produces $100,000 in annual income, would need to be precisely $2,500,000 in size. So, in effect, our teacher is indifferent to an annual lifetime pension of $100,000 or to having been given a lump sum of $2.5 million, from which she can draw 4% per year.

But let's also consider the impact of this one pension on the public agencies that are required to provide it. These public agencies are holding roughly $350,000 from our teacher's lifelong payroll contributions, plus investment income. With a pension liability for the agencies that amounts to $2.5 million, our teacher's pension is underfunded by $2,150,000. Magnify this case, by literally millions of public employee pensions and you can begin to appreciate the enormity of the public employee pension crisis and its impact on local governments and their taxpayers.