As some readers might recall, I wrote a series of posts based on a model of how much the pensions initially promised to New York’s public employees should have cost, how much they were underfunded based on excessive investment return assumptions, and how much some of the major pension enhancements (among the dozens) of the past 15 years and pension spiking have added to the cost. I found that most of New York’s public employees were promised pensions that, properly funded, would have cost 11.8% of their pay, with 8.8% paid by taxpayers and 3.0% by the employees themselves. For those in physically demanding jobs, the total cost would have been 16.2% of pay, with 13.2% paid by taxpayers; for police and fire it was 29.6% almost all paid by taxpayers. Subsequent deals and pension spiking have (just deals I’m aware of) more than doubled the expected taxpayer cost of pensions for teachers and those benefit from the “traditional pension incentives” repeatedly offered, while also drastically increasing the cost for workers in other categories.
Let’s say, however, that you are not a person who is in a position to live decades without contributing any thing to anyone else, and force other people who are worse off to pay for it, the way the public employee unions and politicians have? What does the model say about your retirement, assuming retirement for you will mean what it has generally meant historically – a few years of leisure at the end of a long working life? To answer that question, I have added a “reasonable” retirement scenario to the model, and find that you had better be saving 10.0% of your salary or more, assuming you are paying for your entire retirement yourself (or almost all of it).
I’ve reattached the spreadsheet. Clicking on the reasonable tab, let’s go over the model. It assumes a historically reasonable investment rate of return of 4.0% over the inflation rate, assuming that asset prices are reasonable to begin with. This is a very generous assumption, given that the dividend yield on stocks is 2.0%, the interest rate on 10-year U.S. Treasuries is under 3.0%, stock prices are high relative to earnings, and earnings may be inflated by having massive federal debts (temporarily) keep the debt-funded consumer economy alive. When I created this model, the expected inflation rate was 1.8% based on the spread between 10-year U.S. Treasury Bonds and 10-year inflation-adjusted U.S. Treasury Bonds. That spread has since shifted to just 1.3% expected inflation, but for now I’ll use the old number.
In the model, you can adjust two data points – the inflation rate, and the percent of your pay that is put into a retirement savings account. The goal is to adjust the savings rate until the amount of money left at age 80, the presumed death date of oneself or one’s spouse, is around zero, based on building up enough by putting money in so you have enough to take out later.
New York City and state pensions pay half of one’s final year salary at the full retirement age, and more if you retire later. With rising life expectancy, and deals to make the full retirement age earlier, this has provided the beneficiaries with more years in retirement that ever before. Far from having “worked hard all our lives,” those benefitting from the pension deals would probably have worked for a smaller share of their lives than anyone in history, other than slave owners and those living off inherited wealth.
(One might object that the situation is more like indentured servitude that slavery, because it part of a contract. But the contract was between the public employee unions and the state legislature, exchanging richer pension deals for political support, and those who will be forced to pay – everyone else – was not involved in or aware of the transaction).
The “reasonable pension” scenario does not promise any specific retirement age. Instead, for most workers it provides for retirement at half of peak pay at whatever age, on average, people have ten years left to live – age 70 in the model. For those doing physically demanding work, it provides 15 years in retirement. If life expectancy goes up, retirement would have to be later, but if it goes down (not impossible given that younger generations are poorer and more obese), retirement could come earlier.
In the pension plan proposed by the model the payout is in real dollars, fully adjusted for inflation. New York’s public employee pensions are partially adjusted for inflation when inflation is high, but rise by more than inflation when prices and taxpayer wages are stable or falling, as in the deflation scenario that is a real possibility.
Now let’s go through a typical work life, as shown in table number one.
This model assumes that since a worker is funding their own retirement, they are not in a position to start doing so until age 41. Before that they may have student loans to pay, a house down payment and home repairs to save for, time off from work to care for pre-school children (my wife and I both worked part time in those years), and required savings for children’s education (following the institutional collapse of public education due to teacher pensions, more may have to pay for private school as well if their children are to be educated).
The model assumes that, other than keeping up with inflation (which not all workers do) the prototypical worker gets one real wages increase during their main career before reaching a plateau at a quite generous $75,000 per year (in today’s money). After 25 years of saving 8.7% of pay (or about the same amount as the City and State of New York would have had to pay in under the pensions most recent retirees were promised), a total of $247,500 would have been accumulated at age 65.
But that isn’t enough to get by from age 65 to 80, so the model assumes the worker chooses (or is forced) to take a lower paying job earning about $40,000 per year to defer retirement to age 70. With that lower pay, no additional money is saved, but investment returns are reinvested. But the worker has presumably paid off their mortgage and is living rent free. The worker actually retires after age 70, withdrawing about $41,000 from the retirement savings account in year one, about the same as was earned in the lower paid second career job, with more withdrawn each year to age 80 to account for inflation. Assuming a paid off house (or downsizing to a smaller paid off housing unit with low maintenance costs), that should be enough to live reasonably well relative to one’s standard of living while working.
A couple of points. First, with regard to the unfairness of public employee pensions, the problem is not the 25 (years worked), it’s the 55 (age of retirement), with 25 years in retirement. It is reasonable to earn or save for a pension in the 25 years that constitute one’s main career, but it isn’t reasonable to be “retired” at 55 and have one year (or more) paid for nothing for each year worked. That isn’t “retirement;” there should be another word for it.
Moreover, while it is reasonable to say one shouldn’t be required to work at the same place doing the same thing for 45 years, it is also not reasonable to say people can’t go do something else someplace else. Most private sector workers have no choice. Most public sector workers, in fact, “retire” young to other jobs, getting paid twice. The value of that second paycheck is hidden from the public when they are working for the government (“I’m underpaid!”) and not taxed by New York City and State after they are gone.
Second, during the housing bubble Alan Greenspan said it was rational for young people to build up debt when they were young and were earning less, to “even out their standard of living over their lives.” That is absolutely not true and completely irresponsible. Despite low pay, young people prior to having children have more disposable income than they may ever have again, and should be saving as much as they can stand, rather than upsizing their lifestyle only to face the pain of downsizing it later. There is always some long-term cost that has to be set aside for – home purchase, parenting, education, retirement. Those who fail to do so, and reach old age with little savings and no paid off home, will be poor or worse. Living larger on the credit card when young, or extracting home equity for some lifestyle enhancement after age 40, in financial suicide.
(Unless you assume that Social Security will be means tested and taken away from those who save, leaving them no better off than those who earned just as much but spent it all).
Now the first table is a very optimistic scenario. The third table, also assuming a typical (not physically demanding) worker, is more realistic. The worker gets downsized at age 55, and can’t get another job at anything like their former pay, because employers are reluctant to add older workers who will increase the cost of their health insurance. (Or they don’t get health insurance, have to pay for it themselves, and have less left over for other things). So in this scenario, there is only 15 years of saving for retirement, and the lower paid second career starts after 55. In that case, it requires an 11.4% savings pace to get half peak pay for the last ten years of one’s life, after making sure the savings are not touched until then. This, however, assumes positive investment returns. We may in reality be heading for a second lost decade.
There is also the question of what happens if one lives past the average death age, and what if investment returns plunge when one is in or near retirement? A traditional pension plan provides insurance against these possibilities, as those who die young offset those who live longer, and those hit with low returns near and in retirement can be offset later by younger people who will get better returns by buying assets for less. But if you aren’t in one, you’ll have to that buy insurance yourself by purchasing an annuity from an insurance company. I have no idea what that costs, but I guesstimated 2.5% of your savings balance per year (in the form of a lower rate of return on that savings once you purchase the annuity).
As tables 4 and 6 show, if one is going to purchase an annuity to pay when they have ten years of average life expectancy left, to pay the equivalent of a guaranteed pension for their remaining years, they’d better contribute 9.9% of pay of you assume you’ll be saving for 25 years to age 65, or 12.8% of pay to account for the possibility of being pushed to a lower paying second career at age 55.
On the other hand, given that asset prices are still inflated and wherever you put your savings someone is trying to make you take investment losses that have already occurred but not yet be admitted, perhaps that 5.8% average investment return is a little high for the foreseeable future. So putting in 20.0% of your pay, and cutting your lifestyle accordingly, seems more reasonable. Note that most NYC public employees with seniority put in little or nothing, and what you will be paying in taxes for their retirement was, to take the example of NYC teachers, equal to 28.0% of pay and going up.
In purchasing an annuity, moreover, one runs the risk that an insurance company will use optimistic assumptions about its own rate of return and future life expectancy to justify a higher share of its assets going to higher executive pay, rather than being reserved for future payouts. And then, if those optimistic assumptions do not come true, not having enough to pay what was promised. State insurance regulators are supposed to prevent this. But like actuaries, accountants, appraisers, bond raters and others hired supposedly to tell the truth to prevent those with a conflict of interest from exploiting people, they can sometimes be convinced to see the truth another way, and decide there is so much money available that more can be taken out. Particularly those regulating an annuity provider in trouble, such as AIG in the fall of 2008.
With Social Security reaching age 75, and now the ONLY retirement benefit most people will be getting, there has been some talk of raising the retirement age, as an alternative to the “screw the saver” means testing mentioned earlier. One objection is that those with physically demanding jobs will be hard pressed to work until age 67, the current full retirement age for Social Security, let alone 70 or (if life expectancy continues to rise, no sure bet) later. But very few jobs require physically demanding work, now that we have machines. And once again, just because you don’t have the same job doesn’t mean you are incapable of doing anything for anyone else, unless that had been your attitude all along. A construction worker, for example, could move to a second career at Home Depot, while advising young homeowners who do work themselves on the side.
Table 2 provides such a scenario. A worker works at a relatively high skill, high pay manual occupation for 25 years from age 30 to 55, moves to a second career earning less, and then stops working at 65. With more years drawing on retirement savings, this scenario requires more savings up front, with 9.9% of pay put in on a straight calculation and 11.8% accounting for the need to purchase an annuity.
Note that the manual worker has to start saving at age 30 rather than age 41 to make this scenario work. On the other hand, such workers could (and perhaps should) enter the labor force years earlier, since college and grad school are not required, and have less student loan debt (though not zero since the “college, college, college” mantra has been associated with less community support for vocational training, which is generally private and not free).
It appears, therefore, that private sector workers should be putting aside about the same share of pay for themselves that they would have been paying in taxes for public employees (other than police and fire), if hugely costly, retroactive, pension sweeteners had never been legislated. And they should expect to retire later. After all, nobody owes them a living, regardless of the value they provide in exchange, and they can’t make people pay up front whether they like it or not.
Which leads to one more point. Some have claimed that instead of complaining about all those retroactive sweeteners, private sector workers should instead demand that their bosses give them similar pensions. Well, those bosses are in no position to provide similar pensions, because if they did their costs would be higher, their prices would be higher, and public employees and retirees would shop elsewhere for a better deal, leaving the employees out of a job. (A far from theoretical scenario). Where is the money for those enriched public sector pensions coming from? From lower profits by government agencies? They don’t make provides. From “the bosses” in lower wages for government managers? Nonsense. It is coming from those worse off in higher taxes and diminished services, and it is only possible because people have no choice but to pay.
How about raising New York State taxes high enough to give all private sector workers the same tax-supported pensions government workers with pension incentives get? To match the 25/55 NYC teachers with seniority got under the 2008 deal, just add 22.0% of your pay to your state tax burden, over and above the state and local taxes you are paying now, and that could work. Consider that the average total state and local tax burden in FY 2006 equaled 10.9% of personal income in the U.S., 15.9% in New York City, and 13.4% in the rest of the state. So for everyone to get the same pensions, another 22.0% would be added to that. Federal taxes are also in addition. Somehow, I wouldn’t bet on getting a tax-funded 25 year retirement unless you are in on a special deal at other people’s expense.