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Monday, December 17, 2007
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Pension column inspired reaction
by Stephen Butler
Judging from the flood of e-mail after my column last week, I
apparently touched the third rail at one of the junctions where
politics and economics collide.
Do the retirement benefits found in the public sector reflect
sound business sense?
My first pass at an answer was based on anecdotal evidence from
discussions with people who had some experience with these plans.
Admittedly, I had some facts incorrect.
For example, the tax treatment for a retirement benefit qualifying
for disability treatment is only 50 percent -- not 100 percent
-- tax-free. Other e-mailers pointed out that retirement benefits
are rarely the 90 percent that I cited. But I must say that for
every respondent pointing that out, there was one who claimed
to know people who were receiving 90 percent or more.
In one case, a reader pointed out that she overheard a conversation
between two retirees from a Peninsula city government (while waiting
in line for a Commonwealth Club lecture) who were marveling about
how much more they now made in retirement income than they earned
when they were working for the city.
I was wrong about overtime being included in the salary that
is considered for determining retirement pay. However, a certified
public accountant who once audited local municipal plans cited
cases he had seen in which some employees in their last few years
filled in for those who were sick or on vacation. Apparently this
did not qualify as "overtime" and the additional income
counted for calculating future retirement benefits.
The same person also confirmed the 90 percent factor that he
had seen in many cases.
You be the judge.
Shall we believe that these two people sat at their computers
and made up these stories? I could be wrong about the rules, but
what is happening in actual practice?
How easy is it to game the system and jeopardize what should
be a fair deal for civil servants who deserve a reasonable retirement
income?
To drill down through the hysteria on both sides, we need to
understand the key fundamental of "Present Value." When
we promise to pay a stream of income to someone over many years,
what does that stream of payments equal as a cost to us in today's
dollars?
Here's an example to illustrate:
A stream of payments for 20 years, an average retirement benefit,
is an amount of money that we can add up and arrive at in total
dollars. However, if we wanted to determine what it is worth today,
we have to recognize that a dollar spent 20 years from now is
one that we have time to accumulate. We can put a little money
in an investment account now and let it grow to what it needs
to be to meet our 20th-year obligation.
Meanwhile, the payment for next year will cost us the full amount
of the payment because we have to come up with the money now.
To calculate a present value, of all the payments, we calculate
the present value of each year's cost and add them all up. The
total is today's cost of the entire 20 years' worth of payments.
Assuming that we can earn 6 percent on what we invest, let's
calculate the present value of a $60,000 per year retirement benefit
increasing by 2 percent per year for 20 years that has a total
sum of $1.5 million. (The 20th-year benefit is $87,400.) The present
value of that amount, however, is only $820,000, because the 6
percent earnings will help to pay for latter-year payments.
Anyone who is about to start receiving a retirement benefit of
$60,000 per year is someone for whom we should have earmarked
and accumulated $820,000 in a retirement account. The problem
with these pension promises is that when we suddenly lower the
retirement age, or increase the benefit, the present value number
can change dramatically, and the increase in today's present value
cost is never immediately recognized.
Even if a few people understand it, the voters certainly don't.
Don't get me wrong. I am proud to pay taxes to support governments
for the services and protection they provide.
I'm glad I don't have to cruise around wearing a bulletproof
vest.
The spirit of these columns is to ask whether we're making promises
with costs we can't comprehend, much less afford. Are some people
gaming the system and costing us more than they deserve?
These are legitimate questions. Send me more facts and anecdotal
evidence, and I'll share it all in an effort to invite informed
decisions.
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