Retirement Security in America – A Tale of Two Contracts

Two people walked into a bank, somewhere in California. Both individuals needed to prepare financially for their retirement. Both of them earned about $80,000 per year.

The first individual, Mr. Jones, was presented by the banker with a contract called “Social Security.” The contract read as follows: For as long as you work, you will give us 12.4% of your gross earnings, and we will invest the money. When you retire, we will pay you an annuity for as long as you live. Your annuity will be based on a guaranteed rate of interest – depending on how long you live – of about 1.5% per year, compounded! When you die, you will have nothing left of your investment to pass on to your heirs.

The second individual, Mr. Smith, was presented with a very different contract, called “Collective Bargaining Agreement.” It read: For as long as you work, you will give us 5.0% of your gross earnings, and we will invest the money. When you retire, we will pay you an annuity for as long as you live. Your annuity will be based on a guaranteed rate of interest of exactly 7.5% per year, compounded. When you die, you too will have nothing left of your investment to pass on to your heirs.

Mr. Jones and Mr. Smith had lots of questions for this banker. They both wanted to know how much money they would actually collect each year when they retired.

“How much will I receive?” asked Mr. Jones, who was self-employed in the private sector.

“Well,” said the banker, “if you work for 43 years, and turn over to our bank 12.4% of your gross earnings every year, based on your income of $80,000 per year, I estimate we will be able to provide you an annual annuity of $26,532 when you retire at age 68.”

How much will I receive?” asked Mr. Smith, who worked for the government in public safety.

“You,” said the banker, “may retire at age 55, after working for 30 years, and based on your income of $80,000 per year, I estimate we will be able to provide you an annual annuity of $72,000 per year when you retire.”

Mr. Jones and Mr. Smith did some calculations, and posed a very complicated question to the banker:

“Gee,” they said, “if Mr. Smith is only investing 5% of his earnings in your bank, even if he earns 7.5% on his funds, won’t it be hard for his investment to generate a $72,000 per year annuity if he retires after only 30 years and is only 55 years old?”

“That’s no problem,” said the banker. “We will contribute additional money ourselves to make sure he has enough to retire. Even if we can’t earn 7.5% each year on the invested money, we’ll just contribute more to make up the difference. When all else fails, we’ll borrow money to make sure Mr. Smith gets his full annuity.”

“But where will that extra money required for Mr. Smith come from?” asked Mr. Jones.

“Oh that’s easy,” said the banker, “we’ll take it from you, Mr. Jones.”

“But I’m already investing 12.4% of my gross earnings with you, and only earning an annual return of 1.5%,” said Mr. Jones. “Why should I pay more money to guarantee Mr. Smith’s 7.5% annual return? Can’t Mr. Smith pay more?”

“Well he is,” said the banker, “he’s paying much more these days. We used to pay his annual 5.0% investment for him, and now he’s paying that himself. And we’re even increasing the amount he has to pay. Some of his colleagues are already paying as much as 9%, which is a lot!”

“But I’m paying 12.4%,” said Mr. Jones. “Shouldn’t I get a 7.5% guaranteed return instead of 1.5%? Who will make additional payments to get my annuity up to $72,000 per year instead of $26,532 per year? Why can’t I also retire when I’m age 55 instead of age 68?”

“I’m sorry,” said the banker. “A contract is a contract. We can’t change a contract. That would be unconstitutional.”

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This post is a dramatization intended to make clear the disparity in retirement planning challenges facing ordinary citizens compared to state and local government workers in California. The “bank,” of course, is the government. This post uses numbers and references sources explained more thoroughly (or linked to) in a UnionWatch post published on February 11, 2014 entitled “How Does ‘Zero-point-Eight at Sixty-Eight’ Sound for a Pension Plan?” Subject to the assumptions noted in these posts, they are accurate descriptions of what a self-employed person may expect from Social Security and what a California-based local public safety employee may expect from their pension fund. For more comprehensive information on average pensions for employees retiring from CalSTRS, read the California Policy Center study “How Much Do CalSTRS Retirees Really Make?” and “Comparing CalSTRS Pensions to Social Security Retirement Benefits.” For more information on average CalPERS retiree pensions, read “How Much Do CalPERS Retirees Really Make?“

Ed Ring is the executive director of the California Policy Center.