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.
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%.
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.
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Ed Ring is the president of the California Policy Center.