On the other hand, private sector employees frequently are covered by variable defined contribution or 401k plans. Unlike public employees, private sector workers are guaranteed no prescribed annual retirement benefits.
In the end, private sector employee taxpayers are on the hook to pay for the public sector employees' guaranteed lifetime retirement benefits.
Taken as a whole, this arrangement is nonsensical.
President Obama says that he is fighting for the middle class. Republican presidential hopefuls say that they are fighting for the middle class, too. If everybody is fighting for the middle class, then why are so many people, including middle class taxpayers, taking it on the chin?
Why Public Pensions Are So Rich argues persuasively that public employee pension plans should be converted into 401k plans. The article points out the misleading characterization by government union leaders of today's situation:
"According to government union leaders, their employee retirement benefits are "not lavish by any means." So says Art Pulaski of the California Labor Federation. According to the American Federation of Teachers, public-employee pensions "typically are modest." And the Service Employees International Union asserts that "After decades of full-time work for the state, the sad truth is that far too many retired state employees receive yearly amounts that force them to live in poverty."
These claims are misleading, but reformers have a hard time conveying to taxpayers precisely how generous public-sector retirement benefits can be. That's because government employees typically have "defined benefit" pensions that pay a guaranteed benefit regardless of how the plan's investments may fare. Most private-sector workers hold "defined contribution" 401(k)-type savings accounts that guarantee no specific pension. Complex formulas obscure the fact that public pensions typically are much more generous than 401(k)s, making the situation ripe for misleading claims.
A case in point is the Illinois Teachers Retirement System (TRS), which insists that, because Illinois teachers don't participate in Social Security, the average teacher's pension of almost $43,000 "cannot qualify as 'too generous.'" One might assume from such a statement that the typical Illinois teacher who retires this year after a full career will collect $43,000 per year. Not so. That average figure reflects the pensions of employees who retired years or decades ago, as well as individuals who worked only part of their careers in public schools.
The 2010 annual report for the TRS actually shows that the average teacher who retires today after 30 to 34 years of service had final earnings of $84,466 and collects a pension of $60,756 a year, plus annual cost-of-living adjustments, providing an income higher than 95% of retirees in Illinois. That's a lifetime value of almost $1.6 million if collected at age 62, and more if the employee retires in his 50s, as many do. In addition, Illinois employees—like many public employees around the country—are eligible for retiree health care that can be worth thousands of dollars per year.
Compared to this, how would a private-sector worker's retirement plan stack up? Private-sector workers typically rely on a combination of Social Security and a 401(k). If the private employee had the same $84,466 final earnings as that veteran teacher, Social Security would pay around $17,750 per year. The remaining $43,000 has to come from elsewhere.
The private worker wouldn't get far to that goal through his employer's contribution to a 401(k). An employer contribution of 6% of pay every year—an amount that only one out of 10 employers exceeds—would generate a guaranteed income of around $3,850 per year in retirement. Benefit levels are low in part because, to replicate the government-guaranteed benefits a public employee receives, a worker with a 401(k) would have to have invested in ultrasafe (but low-yielding) assets such as Treasury securities.
To make up the rest, a private worker would need to save an almost implausible 45% of his salary for retirement. Compare that to the 9.4% of salary that Illinois teachers must contribute toward their pension plan. Many Illinois teachers pay even less because their school districts "pick up" all or part of the 9.4%, a practice that reforms in Wisconsin and Ohio have targeted."
Why isn't public employee pension fund money invested in stocks? Would it make a difference how it was invested, and if so, to whom?
Of course, public employees don't care about such investments because their retirement benefit is fixed and therefore unaffected by how, if at all, adequate funds are invested to pay the fixed benefits upon retirement. That's the taxpayers' responsibility to make sure benefits are paid as due.
Thus, it makes a difference to taxpayers how and if public pension funds are invested. That's because taxpayers are the only people who have to make sure the public employees' retirement benefits are paid in full.
To repeat, taxpayers bear the ultimate responsibility to pay public employee pension promises in full. Of course, taxpayers are not on the hook for private sector worker retiree benefits.
So private sector workers pay their taxes and guarantee public employee pensions but receive no such guarantee for their own benefits. They make contributions to privately financed company 401k plans instead.
Our country's world leading general level of prosperity resulted from private sector risk taking and the resulting wealth creation therefrom. In turn, profitable wealth creation requires entrepreneurial risk taking and competitive success. That's how free markets work. Winners get paid well.
Of course, with opportunity sometime comes failure. However, success is well rewarded when achieved. Risk and reward at work.
In that vein, 401k plans will do well if (1) companies do well and (2) participating 401k employees invest in stocks of those successful companies. Why own stocks?
Well, on average stocks have outperformed bonds by ~4.5% annually (in real terms) over the past century. While bonds have averaged annual returns of 2+% in inflation adjusted terms, stocks have earned real returns of nearly 7%.
That means, applying the "magical" compound interest rule of 72, that $1 invested in stocks 100 years ago would have doubled in real inflation adjusted value approximately every 10 years and be worth ~$1,000 dollars today. On the other hand, a similar amount invested in bonds would be worth ~$8 in real terms today.
That simple stocks versus bonds decision, over the long term, would generate 125 times more ending value by choosing to invest in stocks instead of bonds. The magic of compound interest at work. But first, there has to be money saved and then invested properly.
If every American understood that straightforward piece of investing history, it would make a huge difference with respect to how we choose what to do when saving and investing our own money for retirement purposes. And for Social Security purposes as well.
The whole point is that taxpayers should insist that retirement funds for our public employees and social security recipients (1) exist and then (2) be invested in a broad portfolio of American blue chip stocks and not government bonds. So why aren't they?
Probably because the government has no such money to invest for the long haul. And that simple fact should cause us to pause and reflect.
Social security payroll taxes are used largely to pay current benefits to the already retired. It's likely the same story for many public employee pension payments as well. Maybe that's not a Ponzi scheme, but it's awfully close.
Middle class taxpayers should rebel. So should everybody else.
And future middle class and all other taxpayers should be livid!
But then, these future generations of taxpayers don't vote yet, do they? By the way, who's fighting for them?
Here's what needs to happen.
Public employee pension plans should be converted to 401k plans and their retirement funds should be invested in stocks to achieve stock market rates of return over time. And then taxpayer support for guaranteed fixed payments would end, as it should.
This simple change would save taxpayers lots of money. Meanwhile, public employees would receive better retiree benefits over time as investments in stocks proved once again to be a better choice than investing in "safe" bonds.
Meanwhile, private sector workers and public employees would share the same opportunities and risks with respect to retirement pay opportunities and uncertainties. Social Security recipients, too.
The above is only logical. And it's only fair. And it's worth fighting about, too.
Perhaps someday union leaders and politicians will start telling us the truth about all this. Until then, let's tell it to them.
To really fight on the side of the middle class, people need to encourage the success and profitability of U.S. private sector companies, because our country's prosperity is wholly dependent on the private sector's wealth creation process.
Maybe someday the fighting politicians will get it. Then we can quit fighting and start supporting each other.
Wouldn't that make sense?
Thanks. Bob.
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