Monday, January 6, 2014

Public Sector Pensions vs. 401(k) Plans ... Truth Telling 101

Public sector pensions (and for that matter, private sector plans as well) are widely believed and portrayed as being vastly superior to 401(k) plans for participating individuals.

In fact, that's a falsehood and even in many cases a lie which has been told so many times that it's now accepted by We the People as truth.

Let's set the record straight.

Given the same amount of contributions over a career, and investment of those contributions in an S&P 500 low cost index fund, the annualized return has been ~10% annually, based on more than one hundred years of experience.

Today, most public sector pension plans assume that their contributions will earn less than 8% annually and the reality is that they don't even achieve that rate of return over time.

That's a greater than 2% difference between the annual rate of return on a sponsor's pension plan investments and easily obtained 401(k) opportunities for individuals.

{My Note: Using the compounding rule of 72 which points out that an investment will double when the number of years invested multiplied by the rate of return equals 72, a 10% rate of return over 36 years will grow to twice what an 8% rate return will achieve. 2 X 36 = 72.

Thus, an individual earning what the stock market has earned historically (10%) would have his account grow to twice as much as what he would have achieved if the pension funds had been invested at a return of 8% annually over those same 36 years.

Of course, the managed pension funds don't earn 8% on average and the individual doesn't own his pension account like he does when a 401(k) is in place. Hence, the typical individual with a pension plan instead of a 401(k) plan will end up with 50% of what he likely would have had with a passive and unmanaged low cost 401(k) plan.

In addition, unlike the 401(k) plan, the pension plan participant will have no portability feature if he changes jobs during his working years, and no ownership of an account that he can pass along to heirs at his death. 

Yet the pension plan is deemed safer and better than a 401(k) plan. What a crock of crap We the People have been sold over the years.}


But let's continue.

Using Illinois as an example, since it's the state with the largest unfunded pension liability (~$100 billion and counting), let's see what the big debate is about return on investment for the state's public pension plans. Report questions state pension funds' investment forecast says this in relevant part:

"Amid controversy over a new state law that seeks to rein in Illinois’ huge public pension debt, a report issued Tuesday by the state auditor general . . . urged that state pension systems for teachers outside Chicago, public university employees and state workers all lower their annual estimated rate of return on investments.

The report marked the second year in a row in which the actuarial consulting firm recommended that the three pension systems consider lowering the annual growth rate. None of the boards reduced the rate the last time. Concern over unreasonably high investment expectations has been fueled by the precarious situation for Illinois public pension systems, the worst funded in the nation.

Currently, the Teachers Retirement System, the pension system for teachers outside Chicago, has an investment growth expectation of 8 percent a year, which it changed in June 2012 from 8.5 percent.

The State Universities Retirement System and the State Employees’ Retirement System currently have a growth expectation of 7.75 percent annually, both of which were changed in June 2010 from 8.5 percent. . . . the firm recommended the state employees’ and state universities’ systems lower their anticipated rate of return to 7.25 percent annually. It said documents provided by those two systems showed a high probability that the 7.75 percent rate would not be met."



Public pension plans have not been well funded over the years. This is because the union and government negotiators play games with the way the salaries are increased and the pension promises are funded. One requires cash immediately (salary payment) and the other doesn't (pension promise). That's the negotiating table trick, and it's a sick one at that. Of course, the intended "trickee" is We the People as individual taxpayers.

So if you think a promised dollar is a dollar, regardless of whether it's used to grant salary increases or make future pension promises, you simply don't know how the public pension funding game is being played by your elected "public servants."

The plain fact is that the liability for future pension promises isn't a factor when budgeting for public sector expenditures unless cash payments are required during the pending budget year or years. This is called the cash method of accounting, and unlike the accrual method used by private companies, only cash is counted.

Hence, government keeps salaries within "budget" and then promises out-year pension pay increases, even though those promises often aren't funded and no legitimate plans are made to fund them either.

The result: tax increases sometime in the future to make up the inevitable shortfall in the pension fund down the road to meet the promised future pension payouts.

Got it? If not, consider this. If government agrees to give you one million dollars in five years instead of a raise this next year, the government ignores the million dollar promise in its budgeting unless cash contributions are made. And that's just one more example of how government officials, with the active participation of public sector union officials, have screwed We the People over the years.

And of course, these complicit union officials have relied on the promise of the government negotiators as a promise which can't be broken. What that means is simply that the duped taxpayer of today has placed the future taxpayer on the hook. At least that's the basic idea.

Time will tell just how inviolate this pension promise rule adopted by government and union officials really is. The courts will decide.

In the meantime, We the People need to know who is NOT on our side.

And it's sure not the government negotiators or the public sector union officials. They've been too busy trying to screw us without our even knowing what game they've been playing.

Summing Up

So now you know the real story. Pension plans aren't preferable to 401(k) plans, all things considered.

In fact, they aren't even close to being equal.

401(k) plans are superior in every way, assuming the same contributions are made to each plan for each participating individual plan beneficiary.

If the same contributions are made to 401(k) plans that are supposed to be made to fund pension plans, the performance of 401(k) plans will win by a huge margin over time, assuming they are invested in a diversified portfolio of the shares of America's blue chip companies. In other words, all we have to do is make sure they are invested wisely in something like the S&P 500 Index and that the "experts" aren't involved and charging high management and transaction fees and expenses to the individual accounts.

See how simple this could be if we had real public servants and less government and high priced union representation and other investment 'expert' assistance?

It's a no brainer.

Thanks. Bob.

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