Sacramento's "Secure Choice" Pooled 401K – Too Frugal for Public Workers

In a move of breathtaking hypocrisy, California’s legislators have unveiled a financially sustainable retirement security program for private workers, while keeping financially unsustainable pensions for public workers.

What private sector employers and private sector workers need to ask, more than anything, is if this new retirement security scheme is so great, why aren’t public employees going to also adopt it?

That’s a really good question. And the answer is simple:  The pensions they’re already getting, paid for by taxpayers, are far. far better. Way better. Out of this world better. Crazy better. Goofy better.

Take a look at the official recommendations made on March 28, 2016 to the California Legislature. In this document, on page 53, there is a table showing “income replacement” based on years paying into the system at various contribution rates. At a contribution rate of 5%, after working 30 years, a participant can expect income replacement in retirement of 13.8%. That is, if they made $100,000 per year in their final year of work, they would get a “pension” of $13,800 per year.

Wow.

If you normalize “Secure Choice” plan’s proposed contribution rate to 10% of payroll, comparisons to public pensions are possible. Because 10% is a good rough number to use for public sector employee contributions via payroll withholding. Teachers and bureaucrats pay a bit less than 10%, members of public safety pay a bit more than 10%. Here are the comparisons:

Public sector:  Teachers/Bureaucrats, 30 years work  –  pension is 75% of final salary.

Public sector:  Public Safety, 30 years work – pension is 90% of final salary.

Private sector:  “Secure Choice,” 30 years work – pension is 27.6% of final salary.

There are two reasons for this gigantic disparity. First, public pension funds collect far more than 10% of salary. While the employee rarely pays more than 10% via withholding, the employer – that’s YOU, the taxpayer – typically kicks in another 20% to 40% or more. Second, public pension funds assume a “risk free” rate of return of 7.0% per year. How much will the “Secure Choice” plan assume? Refer again to the official recommendations, this time page 16:

“Senate Bill 1234 will allow the Board to: Establish managed accounts that would be invested in U.S. Treasuries for the first three years of the program…. After three years, the Board should begin to develop investment options that address risk-sharing and smoothing of market losses and gains.”

The 30 year T-Bill is currently paying 2.69%.

Let’s recap:

Public sector:  The “risk free” annual return for their pension funds is ” 7.5% per year.

Private sector:  The “risk free” annual return for their “Secure Choice” is 2.69%. per year.

Ah, but wait! The attentive reader may wonder what may happen after three years. Because the recommendations specify that “investment options” shall be “developed” after three years of investing in T-Bills. Which brings us to the second monstrous hypocrisy – the “Secure Choice” pooled 401K funds will be managed by those same private sector investment firms that defenders of the pension funds routinely demonize.

How much money? If 50% of California’s 6.8 million eligible private sector workers participate, using the U.S. Census Bureau’s median income estimate for California’s private sector workers of $45,000 per year, at a contribution rate of 5%, you’re talking about $7.6 billion per year. Not much compared to the $30 billion that gets poured into California’s state/local government pension systems each year, or the $45 billion per year that those systems actually require to remain solvent, but nonetheless it is a huge chunk of change.

The sad irony amid all this hypocrisy is that the “Secure Choice” program has the virtue of being far more financially sustainable than public sector pensions. With lower risk investments, modest benefit formulas, and the built in capacity to adjust benefits to ensure solvency, this pooled 401K – which could also be termed an adjustable defined benefit – is a system that can be offered to all citizens without blowing up. There are many problems, the employer mandate and the “opt-out” provision are two obvious ones, but at least it is an attempt at creating the so-called three legged stool of retirement security: Social Security, supplemented the “Secure Choice” program, supplemented by individual retirement accounts.

Concerned citizens may argue endlessly about whether or not the state should offer any sort of retirement security – Social Security, “Secure Choice,” or whatever. But if the state is going to have these programs, they should be offered to every worker according to the same set of rules and offer the same set of benefits. Government workers should not be getting deals far better than private workers.

So here’s the deal, California legislature:  Mandate that every state and local government worker, effective immediately, begin participating in Social Security and the “Secure Choice” program, and encourage them to supplement that with individual 401K retirement accounts. Mandate that all retirement benefits they earn from now on are limited to those three programs. So work out the bugs. Then, and only then, sign us up.

 *   *   *

Ed Ring is the president of the California Policy Center.

11 replies
  1. talltalk says:

    db plans should have been converted to dc plans starting 30 years ago. this is long overdue.

    the people “serving” …they are doing it for the pension….meaning they are not doing it to serve.

    db plans are scams, ponzi schemes, they always have been and always will be…..

  2. S Moderation Douglas says:

    Public sector: Teachers/Bureaucrats, 30 years work – pension is 75% of final salary.

    Public sector: Public Safety, 30 years work – pension is 90% of final salary.

    Private sector: “Secure Choice,” 30 years work – pension is 27.6% of final salary.
    ———————————————————-
    Military sector: 30 years work – pension is 75% of salary with NO employee contribution. (Can retire with 50% of salary as early as age 37.)

    Is the military pension a ponzi scheme? Should it be replaced with a defined contribution system?

  3. Tough Love says:

    Ed, Quoting …

    “Public sector: Public Safety, 30 years work – pension is 90% of final salary.

    Private sector: “Secure Choice,” 30 years work – pension is 27.6% of final salary.”

    That relationship looked odd because ….. if the 27.6% of final salary for the Private Sector worker was generated from a level annual 10% of pay, it would imply that the 90% of final salary for Police would arise from a total (ee + er) level annual contribution of (90%/27.6%)x 10% = 32.6% of pay …. but that appeared quite low for a 90% COLA-Adjusted pension, because many of my own calculations (using an interest rate more consistent with Private Sector pension plan valuations …. around 4.5%), suggested a total level annual contribution requirement of from 50% to 60% of pay.

    So I did some calculations………

    While I have my own spreadsheets, I used YOUR Excel Pension Analysis Spreadsheet so that you would easily be able to duplicate my results.

    Inputs:

    Life Expectancy = 80
    Age at Retirement = 55
    Age began working = 25
    Final Average Salary = $100,000
    % of Salary to Pension = 10%
    Pension Formula/yr = 0.92% (from 27.6%/30 years)
    Pension COLA % = 2.0%

    Then I used a test-value for the input “Fund Return %” and Excel’s “Goalseek” function (rather than trial-and-error test values) to determine what “Fund Return %” would result in exhausting the fund balance at the end of the 30 year payout period. Using Excel’s “Goalseek” function it quickly zeros-in at 6.4373%

    That explained it rather quickly.

    First, I confirmed the Police contribution of 32.6% as follows:

    I left the resultant 6.4373% (from above), changed the input “Pension Formula/yr” from 0.95% to 3% (the Police pension formula-factor), and used Goalseek to solve for the input “% of Salary to Pension” that exhausts the fund balance at the end of 30 years. As expected, it came out to 32.6%.

    HOWEVER ……

    Continuing on from the last calculation above, I changed the input “Fund Return %” from the 6.4373% to 4.5% (a rate consistent with that used today by many Private Sector pension Plans) and used Goalseek to solve for the input “% of Salary to Pension” that exhausts the fund balance at the end of 30 years.

    The result was 54.162%, right in the middle of the 50% to 60% range I have been stating as the REALISTIC cost (appropriately reflecting the inherent risks of equity market investments) of the extraordinarily generous CA Police pensions.

    It important to note …. that when using the SAME interest rate that the US Government REQUIRES of Private Sector Plans in their Plan valuations, CA Police pensions (for those that retire after 30 years) a level annual total 54.162%-of-pay (per your spreadsheet) is necessary to fully fund the promised pension over the working career of the officers. …. and that 54.162% appropriately should be compared to what the typical Private Sector worker gets in retirement contributions from his/her employer …. rarely more than 3% to 4% of pay into a 401K Plans plus their employer’s 6.2% of pay into Social Security on the workers behalf.

    Certainly doesn’t seem fair, reasonable or appropriate.
    ——————————-

    FWIW, I’m guessing that the Secure Choice modeling used the stated treasury rate only for the first 3 projection years and then assumed a considerably higher return (being equivalent to a level annual 6.4373%).

    Also, I tested the above calculations using a life expectancy of 85 (30 year retirement instead of 30) and the results do not materially change (i.e., the 6.4373% would instead be 6.77%).

  4. john moore says:

    When I was in the military, monthly salaries were so low that if we had received 100%, it would not have amounted to much. Comparable salaries is an important variable.

  5. S Moderation Douglas says:

    E 6 with 20 years is $3,800 mo. Half of that, starting at age 37 with COLAs for life is way better than a poke in the eye. O 3 (lieutenant in Navy) is $6,448 for $3,224 pension at age 37 or $4,836 pension after 30 years service. AND if you’re smart, the first four years is them paying you to go to college AND paying your tuiton, housing, and books.

    That’s not the main reason I brought up the military, though.

    There is a reason I mentioned military pensions earlier. When discussing military pensions, there is never the argument about discount rates, unfunded liabilities, risky investments, etc. Why? Because there is a difference between a pension and retirement savings. With individual retirement savings, the worker puts back, ideally, 10% to 20% of earnings, or more, and invests according to his risk tolerance. (He could put it in a coffee can buried in the back yard, it’s up to him.)

    But a pension is a contract. It is deferred compensation. The employer tells you if you work 35 years, when you are 65, I will pay you 50% of your salary for life. Not, “I’ll pay you 50% IF my investments work out.” In the military, it is a pay as you go contract no investments or investment losses involved

    “It’s like a mortgage!!!” (Stop me if you’ve heard this before.)

    No, not because “it’s not all due tomorrow”. More like, if you buy a $300,000 house, and you happen to have enough cash on hand to pay it off now, but you can get a 4% mortgage and feel confident that you can invest your cash and earn 6-7% you can make a contract to pay off the house over 30 years at 4%. If, after fifteen years, however, you find your investments are not quite making the 7% you anticipated, (or, somewhere along the line you used part of your $300,000 on sports cars and Viagra). It’s “underfunded”. Not because the house cost too much, or the interest was too high, but because you weren’t prudent. You still have a contract. It is still due.

    That seems to be the newest meme. “Affordability”.

    First all the pundits were pointing out the $100,000 club. Most people who paid attention soon found out that was a very, very small percentage of retirees.

    Then was the “exorbitant pay”!! As in, “In the eighties, public workers were paid less than the private sector, so they needed pensions to attract workers, but now public workers make more in wages than the private sector!!”

    And the survey says…. Not true.

    The latest talking points seem to be “sustainability”. Not necessarily that pay is too high, or pensions too high, but that we just owe so much money we will never get caught up. That may indeed be true in many cases, where cities or states went for decades without paying the full ARC. Pennsylvania, as I recall, payed less than 50% for the last ten or more years. New Jersey is even worse. And Illinois. As Leo Durocher said: “You’ve got third base so screwed up nobody can play it!”

    http://www.nytimes.com/1994/03/08/opinion/observer-eptitude-not-awesome.html

    “It’s the math!” They say. “When there’s no money left, the contract is useless!!” They say.

    “DON’T PAY THE BILLS, THE DEBT GETS LARGER”

    Says Mary Pat Campbell. (And “80% is NOT adequate pension funding. Public or private.)

  6. Tough Love says:

    Quoting SMD …….

    “But a pension is a contract. It is deferred compensation. The employer tells you if you work 35 years, when you are 65, I will pay you 50% of your salary for life.”

    Well, yes it’s a “contract”. But was it an honestly negotiated at-arms-length contract, with EACH side looking out for THEIR best interests ….. or was it the result of the Public Sector Unions BUYING the favorable votes (to grant such grossly excessive, unnecessary, unfair, and unaffordable pensions) of our Elected Officials with campaign contributions and election support, and was ANYONE (yes, ANYONE) at that “bargaining table” looking out for Taxpayers’ best interests?

    Oh please …..

    Such “contracts” should NOT be honored.
    ——————

    And as to military pensions, they don’t hold a candle to the ongoing thievery in CA’s Public Sector.

    The latest from “Transparent California”….. Palo Alto’s top ten (2014) COLA-INCREASED PENSIONS …..

    $197,447
    $189,292
    $177,896
    $174,930
    $172,457
    $168,234
    $162,015
    $161,098
    $156,768
    $155,838
    —————————

    And as expected, you conclude with more of your classic “smoothing”, again claiming that the pension mess is due to the lack of full funding, while ignoring the ROOT CAUSE of the problem, that being the grossly excessive pension promises in the first instance ….. which RESULTS-IN huge, impossible-to-fund ARC requirements.

    We BOTH know that the lack of full funding is not the CAUSE of the pension mess in which we now find ourselves, but the CONSEQUENCE of the real root cause …. grossly excessive pension “generosity”.

  7. Tough Love says:

    Quoting SMD … (again)….

    “The employer tells you if you work 35 years, when you are 65, I will pay you 50% of your salary for life.”

    Oh if the Taxpayers were only so lucky that only THAT was “promised”.

    While THAT is still a DB pension (which few in the Private Sector are still accruing benefits under today) it is FAR less generous than the TYPICAL Public Sector pension.

    FIRST…. On what planet do Public Sector workers have to work for 35 years and to age before the can retire without ANY reduction in the formula-calculated payout?

    SECOND……… And if they do work for 35 years, their pensions would (on the LOW end) be 75%-of-pay and for some, perhaps even OVER 100% of final pay.

    THIRD, A FAR more accurate description of the very TYPICAL CA NON-Safety pension would be …

    “The employer tells you if you work 3o years, when you are 60, I will pay you 75% of your salary COLA-increased for life.”

    And a FAR more accurate description of the very TYPICAL CA Safety worker pension would be …

    “The employer tells you if you work 3o years, when you are 55, I will pay you 90% of your salary and COLA-increased for life.”
    ——————————-

    And while your ORIGINAL QUOTE might have accurately described the Private Sector DB pensions of 25+ years ago (but WITHOUT any COLA increases), the current Non-Safety pensions (I described above) is 2 to 4 time greater in value at retirement than that granted a comparable and similarly situated (in pay, years of service, and age at retirement) Private Sector worker … and with that 2 to 4 times rising to 4 to 6 times for the even MORE generous Safety worker pensions.
    —————————

    Your Endless “smoothing” with all of the misinformation, mischaracterizations, distortions, and omissions of pertinent facts fools VERY few.

  8. S Moderation Douglas says:

    Is that libel, or slander? Or do you have even a shred of proof?

    You and I do not “… BOTH know that the lack of full funding is not the CAUSE of the pension mess in which we now find ourselves….”

    That’s your shibboleth, not mine.

    Speaking of “smoothing”….

    ” It important to note ….” “…….a level annual total 54.162%-of-pay (per your spreadsheet) is necessary to fully fund the promised pension over the working career of the officers. …. ”

    Is untrue. To paraphrase Mr. Ring, it is far, far untrue. Way untrue. Out of this world untrue. Crazy untrue. Goofy untrue. Wow.

    And…

    “We BOTH know that…”

  9. Tough Love says:

    So SMD………

    I guess that mean ….. that you have no good answer to the Public Sector pension/benefit thievery …do you?

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