Why public pensions are so rich

Article Highlights

  • Claims that public employee benefits "force them to live in poverty" are misleading

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  • Average public employee receives benefits typically several times more generous than what they would receive in the private economy

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  • There is no good reason why public employees should receive retirement benefits so much more generous than other Americans

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According to government union leaders, their employee retirement benefits are "not lavish by any means." So says Art Pulaski of the California Labor Federation. According to the American Federation of Teachers, public-employee pensions "typically are modest." And the Service Employees International Union asserts that "After decades of full-time work for the state, the sad truth is that far too many retired state employees receive yearly amounts that force them to live in poverty."

These claims are misleading, but reformers have a hard time conveying to taxpayers precisely how generous public-sector retirement benefits can be. That's because government employees typically have "defined benefit" pensions that pay a guaranteed benefit regardless of how the plan's investments may fare. Most private-sector workers hold "defined contribution" 401(k)-type savings accounts that guarantee no specific pension. Complex formulas obscure the fact that public pensions typically are much more generous than 401(k)s, making the situation ripe for misleading claims.

"If government workers were moved to defined-contribution pensions, it would be much easier to ensure fair market compensation in government." -- Andrew Biggs

A case in point is the Illinois Teachers Retirement System (TRS), which insists that, because Illinois teachers don't participate in Social Security, the average teacher's pension of almost $43,000 "cannot qualify as 'too generous.'" One might assume from such a statement that the typical Illinois teacher who retires this year after a full career will collect $43,000 per year. Not so. That average figure reflects the pensions of employees who retired years or decades ago, as well as individuals who worked only part of their careers in public schools.

The 2010 annual report for the TRS actually shows that the average teacher who retires today after 30 to 34 years of service had final earnings of $84,466 and collects a pension of $60,756 a year, plus annual cost-of-living adjustments, providing an income higher than 95% of retirees in Illinois. That's a lifetime value of almost $1.6 million if collected at age 62, and more if the employee retires in his 50s, as many do. In addition, Illinois employees—like many public employees around the country—are eligible for retiree health care that can be worth thousands of dollars per year.

Compared to this, how would a private-sector worker's retirement plan stack up? Private-sector workers typically rely on a combination of Social Security and a 401(k). If the private employee had the same $84,466 final earnings as that veteran teacher, Social Security would pay around $17,750 per year. The remaining $43,000 has to come from elsewhere.

The private worker wouldn't get far to that goal through his employer's contribution to a 401(k). An employer contribution of 6% of pay every year—an amount that only one out of 10 employers exceeds—would generate a guaranteed income of around $3,850 per year in retirement. Benefit levels are low in part because, to replicate the government-guaranteed benefits a public employee receives, a worker with a 401(k) would have to have invested in ultrasafe (but low-yielding) assets such as Treasury securities.

To make up the rest, a private worker would need to save an almost implausible 45% of his salary for retirement. Compare that to the 9.4% of salary that Illinois teachers must contribute toward their pension plan. Many Illinois teachers pay even less because their school districts "pick up" all or part of the 9.4%, a practice that reforms in Wisconsin and Ohio have targeted.

Public employees who don't work full careers fare less well under defined-benefit pension plans, and those with very short careers would do better with a 401(k). But for the average public employee, retirement benefits typically are several times more generous than what they would receive in the private economy.

This comparison illustrates the generosity of retirement benefits for Illinois teachers, but we could generate similar examples for public employees in California, Ohio, Wisconsin or practically any other state where public-sector pay has been a major issue.

As long as the public sector uses defined-benefit pension plans, fair comparisons of benefits will require the kind of detailed calculations presented here. But shifting public employees to 401(k)-style retirement plans would offer greater transparency for taxpayers.

The generosity of defined contribution pensions can't be obscured by complicated accounting rules and benefit formulas. The benefit is simply what the employer puts into the account each year, and that's it. Such pensions also allow for much greater portability, attracting mobile employees who fare poorly under defined-benefit plans and eliminating the "job lock" that keeps burned-out public employees who wish to quit from doing so.

There is no good reason why public employees should receive retirement benefits so much more generous than those of other Americans. If government workers were moved to defined-contribution pensions, it would be much easier to ensure fair market compensation in government.

Mr. Biggs is a resident scholar at the American Enterprise Institute. Mr. Richwine is a senior policy analyst at the Heritage Foundation.

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