AEIdeas

The public policy blog of the American Enterprise Institute

Subscribe to the blog

Discussion: (51 comments)

  1. Walt Greenway

    Are these workers eligible for Social Security? A lot of government workers are not, so that needs to be factored in for a private to public comparison.

    A $2 million valuation as mentioned in the article isn’t unusual for a defined benefit pension plan and Social Security combined over the 35 years needed to max out Social Security, retiring about 55-years-old, and living to 85-years-old (and can easily be reached with a personal 10% yearly savings rate in an average-pay job over the same 35 years of work at 6% yearly compounded).

    1. givemefreedom

      Walt: A $2 million valuation as mentioned in the article isn’t unusual for a defined benefit pension plan and Social Security combined over the 35 years needed to max out Social Security, retiring about 55-years-old, and living to 85-years-old (and can easily be reached with a personal 10% yearly savings rate in an average-pay job over the same 35 years of work at 6% yearly compounded).

      You are kidding right Walt? First off, the article quote an average of 28 years of service, not 35. Big difference those last 7 years.

      Further where did you come up with 6% yearly compounded? Remember this is a guaranteed pension, so to compare it properly you would have to use a rate of return that they woud get from guaranteed investments, that is 4% or even less.

      Also, they start getting the pension at 55 and social security does not get fully paid until 66.

      Lastly you ignored the fact that 10% savings of what they made when they started 28 years ago was a lot less than 10% of what they are making now due to big wage increases from 28 years ago. Your argument was that if you took 10% annually of what they made using their present salary with a 6% rate of return then $2 million is achievable in 35 years. Well Walt, in 35 years, $2 million is no where near what $2 million is today.

      Go go back 28 years ago using the average policeman and see what that person would have to save for 28 years based on 4% return in order to get a guaranteed pension of $76,440 today and I can assure you that 10% will get you no where near $2 million.

      1. Actually for a pension where the value at death is zero, the yield on an annunity is about 5.56 with no survivor benefits. This is because a piece of the principal is returned every month. Going to an immediate annuities calculator (since that is what a pension is) at 55 the 76,440, represents a npv of 1.4 million. But let interest rates go back up and the NPV of the pension goes down. So one cause of this is the current low interest rates.

        1. Citizen Buddy

          Lyle, as interest rates go up, does not the pension pay out more in benefits for a substantial portion of “retired” government employees?

          So, the npv of a pension will actually go up with rising interest rates, because of the increase in available funds for the pension plan to pay out.

          1. Walt Greenway

            The NPV would be calculated from the perspective of the person paying the pension, so as rates interest rates go up, more interest is available to pay the pension and less principal is needed. Usually the person collecting the pension is collecting the same amount of money regardless of the interest rate (some pensions have COLA). The NPV of $24,000 a year ($2000 per month) at 4% is about $415,000 and at 6% about $330,000. Think of it this way, if you needed a certain amount of money 20 years from now, and put money in the bank earning interest now to collect later, would you need to deposit less or more money now if interest rates were higher?

        2. Citizen Buddy

          “But let interest rates go back up and the NPV of the pension goes down.”

          I don’t think so. The pension fund investments should yield higher earnings, enabling higher payouts. Thus, an increased NPV would be imputed for each recipients pension.

          Also, higher equity values have risen which should increase the pension pool to afford higher pensions.

          1. If you view a pension as an annuity, then the NPV of the pension goes down as interest rates go up. Ignore the fund and as the article does just look at it from the point of view of the individual. There pension is some percentage of the final years of pay times the number of years. Interest rates don’t enter in here at all, the interest rate risk is totally on the pension fund. So if the pension allowed a lump sum settlement, then as interest rates go up the lump sum goes down. Or look at it as how much would it cost you to buy an annuity that provides the same payments as the pension. As interest rates go up, the cost of buying the annuity goes down.
            So while the NPV of the fund goes up (or down, this is why a couple of years ago a lot of pension funds were in big trouble because interest rates went down). However the pensions promised don’t vary with the interest rate environment.

      2. Walt Greenway

        givemefreedom: A lot of people can amass $2 million from various sources in a lifetime of work using pensions, SS, and consistent savings over time. It’s neither difficult or unusual if you are consistent and have that goal. The California police are not unique at the retirement stage of their career as the article suggests.

        Personally, I use 4% as you stated, but I did much better than that from the 1970s to 2010s. Many pensions are using an unrealistic 8% assumption smoothed over 10 years, but 5.79% is widely accepted by many of the leading conservative pension actuaries.

        I agree that a 3% multiplier is higher than usual and would result in pensions being higher than would be necessary to attract people in a competitive hiring environment (1.25 to 1.60 multipliers are usual here). Our pensions, both public and private, range from $1500 to $3000 a month around here from the retired people I know (I know many retired military, teachers, police, fire, and UAW people). Few people here hit 50% of retirement income from our DB pensions started in the 1970s and 1980s (mine is about 38%).

        1. givemefreedom

          Walt,

          My point was that to do a proper comparison of what the policeman in California would have to save on his/her own to amass a $2 million retirement savings that is equivalent to what the article says is the value of their state pension ( and as Lyle states, $2 million might be high, $1.4 million is what you would need for an annuity to pay $76,400 to a 55 yr. old today, but maybe the author is including a health benefits amount), in order to compare it properly you would need to use a risk free rate of return. The officer has a guaranteed pension and takes no personal investment risk to amass the $2 million equivalent amount. The rates you are quoting are rates the pension funds are using to determine their funding requirements. The pension has the risk, not the plan members since if those rates are not achieved the state will have to cover the shortfall, the plan members do not take a hit at all.

          So if you want to compare apples to apples then you must use a rate of return that is a risk free rate when calculating what the office will have to save on their own and 6% is not realistic.

          1. Walt Greenway

            givemefreedom, I accept and agree with your point. My point is that even though the California police had help, their wealth accumulation is achievable by many people that make it their goal.

          2. givemefreedom

            Walt,

            Some people might be able to accumulate $1.4 million by age 55 after saving for 28 years on their own, using risk free investments. But not many.

            The whole point of the article is “how much help” the California police are getting. You said you could do it with a savings plan of 10%. That is implying that their real earnings are only being increased by 10% because of their pension, not the 100% that the author of the article states.

            10% is no where close to the amount. Perhaps the 100% is too high but it is definitely higher than 50%. Add in the health benefits and the 30% more that they make in pure salary over the private sector and you get very close to the author’s claims that police in California are making double what the private sector workers make..

            You have to admit Walt, that is an outrageous amount.

          3. Walt Greenway

            “You have to admit Walt, that is an outrageous amount.”

            The article implies that $2 million wealth accumulation is rare. I admit it is an outrageous pension amount in California while explaining many people can accomplish that goal with planning and consistency over time.

          4. Walt Greenway

            And I would guess that a 3% multiplier is used because the workers are not eligible for SS (Detroit police can’t collect SS), and the higher amount makes up the employers’ SS contribution.

          5. givemefreedom

            Walt: many people can accomplish that goal with planning and consistency over time.

            Yes Walt some do. Few however do it on the salary of a Policeman or a Firefigher. The privately employed people that get to $1.4 million risk free have earnings significantly higher.

            The average person working in the private sector earning what Police and Firefighters earn has no hope of accumulating that amount.

          6. Walt Greenway

            “The average person working in the private sector earning what Police and Firefighters earn has no hope of accumulating that amount.”

            The first million $ is easy with SS, a DB pension, and a 10% savings rate (or 401k/IRA) over 25 to 35 years. The second million $ is more difficult but achievable if you don’t have to start over from mistakes too many times (sell low/buy high)

          7. givemefreedom

            Apples to apples Walt.

            The average person does not have a DB pension plan. The averge person does not retire at 55. The average person does not work for only 28 years before retiring. The average person does not get SS at 55.

            Walt, if someone retires at 65 with $1,000,000, do you know what they had at 55 years old if they had a lifetime rate of return of 4%? The amount is $675,000.

            So even if the average person was able to save $1,000,000 at 65 years old, by 55 they only had $675,000 and the average police and firefighter has more than double that at 55 years.

          8. Walt Greenway

            givemefreedom, again, I agree the Cali pension is high (especially if they get SS).

            $1-$2 million is achievable after a lifetime of work from SS, DB/DC pension, and personal savings for those people who set that as a goal early and stay the course. I have spreadsheets that show different scenarios, but I can’t attach them here.

        2. Note that the payment from a pension includes some return of capital with each payment, if you view it (if you could have gotten a lump sum) as buying an annuity. The payment rates today are 5.6% or so. Once interest rates go back up the rates will return to the 7% range (for 55 year olds), as they were about 7 years ago. Low interest rates make todays NPV values for pensions high. The big thing in Ca is the ability to count overtime in your last year as part of your compensation, allowing the annual salary, to be boosted over the base.

          1. givemefreedom

            Lyle,

            You are correct on the current payment rates for annuities. It does not change the fact though that today you will need $1.4 million to get an annuity of $76,440 if you are 55 years old.

            What I am talking about is what someone without a california police pension would have to do to get $1.4 million risk free. The average 55 year old police officer in California today would have to have saved $1.4 milion in their retirement account to buy an annuity that pays them the same as the pension and that average police officer would have had to save quite a high percentage of their salary over the last 28 years to get there in risk free investments.

          2. Walt Greenway

            givemefreedom, you keep repeating 4% risk-free, which is only market risk, but you can’t ignore inflation risk. Seniors have higher health care costs, so their cost of living increases higher than many age groups. A 5% to 6% COLA with a 4% “risk free return” is a 1% to 2% loss. Historically, equities have higher returns over time, so some mix of equities probably should be included in a portfolio for a 30-year retirement.

    2. morganovich

      walt-

      but they do not have to pay fica, so they had lots more disposable income all along.

      that alone is a helluva deal.

      i would happily not get ss to avoid paying fica even without access to a pension plan.

      these guys are winning on both ends.

      1. Walt Greenway

        morganovich, at this point in my life I agree with you. When I fell off a ladder when I was 35 and had the possibility of not working again, the disability part of SS looked pretty good.

        1. morganovich

          walt-

          it would still have been cheaper to buy private disability insurance with the money you saved on fica.

          it would cost less and pay more.

          regardless, police and firemen get disability that makes SS look like chump change.

          they are getting MASSIVE bang for the buck all around. less pay in, better insurance, better health, and 3 times the pension payouts of SS.

          they are gettign back huge multiples of what they pay in on pension whereas i am (even is SS is not cut) going to get back far less cash than i paid in. i would be better off putting money in a coffee can than giving it to SS. my NOMINAL return is negative.

          1. Walt Greenway

            “i would be better off putting money in a coffee can than giving it to SS. my NOMINAL return is negative.”

            My SS and my employer’s SS contributions from 1971 to 2012 was about $300,000 (this does not include Medicare tax). My SS statement estimates a check for $2500 a month when I turn 66 and 2 months about 7 years from now.

            My hope is to live long enough to get my money back (I realize those who pay in when I collect are the ones who are actually covering the check).

            I agree Cali has a sweet deal, our GM/UAW pension is $48 to $53 a month per year of credited service.

    3. toochrispy

      …can easily be reached with a personal 10% yearly savings rate in an average-pay job over the same 35 years of work at 6% yearly compounded…

      Let’s run some calculations using your situation: 30 years of work experience, 6% compounded returns, $2 million target. For the sake of simplicity, we will assume that salary remains the same.

      In order to reach our target, we need to save $17,947 on an annual basis. If we’re saving 10%, the salary comes out to $179,470 each year.

      These are rough numbers but it is obvious that a person working in an “average-pay job” cannot achieve these numbers unless they are receiving substantial help.

      1. toochrispy

        Sorry for the typo. I actually ran the numbers with 35 years.

        1. Walt Greenway

          The $1 – $2 million I am referring to is valuation on accumulated assets of any pension, SS, IRA/401k, and personal savings. The title of the post implicitly implies “millionaires” are unique–they aren’t.

          1. toochrispy

            I don’t disagree with you in that millionaires are not unique.

            However, I’m arguing that your notion that $1-2 million can be easily generated by saving 10% at an average paying job and with a 6% return is unrealistic.

          2. Walt Greenway

            The $1-$2 million is a combination of the values of all assets (SS, pension, 401k, IRA, personal savings) not including a personal home (not just the 10% savings you mentioned at 6%–the plan is very doable). The problem is too many people think they can’t do it so they don’t even try. Sure, there are sacrifices of consumption now for later, but that’s life.

          3. Walt Greenway

            Here’s one example of a person with a $2000 pension and $2000 SS and withdrawing 4% of a $300,000 nest egg to collect $3000 per month the first 10 years of an early retirement and $5,000 a month from 66 until age 86.

            $720,000.00 Pension $24,000 * 30 years (ages 56-86)
            $480,000.00 SS $24,000 * 20 years (ages 66-86)
            $360,000.00 Savings $12,000 * 30 years (ages 56-86)
            $1,560,000.00 Total

            Savings is 4% yearly of $300,000 IRA/401k/Savings

          4. Walt,

            You have to discount the future cash flows from the pensions/SS to get valuation in today’s dollars. You can’t presume that 24000 30 years from now is the same value as today’s 24000. From using a 6% discount rate, the valuation is around 700k.

            I mean if you’re telling me that someone with above average salary (60k to 70k) wants to save up 700k at the time of retirement via pension, 401k, savings, and other liquid assets, then I would say that the number is reasonable.

            But in your first statement you stated that someone who made average salary (50k) with a 10% savings rate. This person ends up with 2 mil in liquid retirement assets via pension, 401k or whatever. That number is very difficult to achieve.

          5. Toochrispy

            Walt,

            You have to discount the future cash flows from the pensions/SS to get valuation in today’s dollars. You can’t presume that 24000 30 years from now is the same value as today’s 24000. From using a 6% discount rate, the valuation is around 700k.

            I mean if you’re telling me that someone with above average salary (60k to 70k) wants to save up 700k at the time of retirement via pension, 401k, savings, and other liquid assets, then I would say that the number is reasonable.

            But in your first statement you stated that someone who made average salary (50k) with a 10% savings rate. This person ends up with 2 mil in liquid retirement assets via pension, 401k or whatever. That number is very difficult to achieve.

          6. Walt Greenway

            “That number is very difficult to achieve.”

            It’s difficult if you think it is or don’t try. Someone who decides to save $10 a day for 30 years and increases that amount 5% a year and earns 6% compounded interest per year will find themselves with about $550,000 after 30 years. We are just talking about eliminating an expensive coffee and donuts in the morning and a Big Mac meal for lunch to cover that or maybe a few beers (smokers really burn through potential wealth). Throw in another $10 from buying a house with one times your annual income instead of two or three times as is normal and increase it the same 5% yearly earning 6% compounded and you are over your first $1 million. Did you notice I did not mention any SS or employer pension or 401k contribution? There’s your second million when you calculate NPV.

            Income taxes are not included in the calculations, so you will need to adjust for those and any inflation you want to beat for purchasing power.

            The calculations above are just examples. Come on over to the Bogelhead’s blog and pick up some of the Excel spreadsheets we made to run your own numbers.

          7. Toochrispy

            sorry for the repeat post…

          8. toochrispy

            I completely agree that if you try hard enough, you can achieve a $2 million liquid retirement account. But that’s not your original argument. You said a 10% savings from an average salary.

            Your numbers would hold true if for the first year, someone saved $3650 for their retirement account, contributed another $3650 for pension/401k and and paid another $3650 for SSI. Keep in mind that an average salary is around 50k. From the numbers you provided, this individual is saving 20% of their salary in liquid assets. This is a very different situation from your original argument (again, average salary and 10% savings).

          9. Walt Greenway

            I never said an average worker could save $2 million from personal savings at 6% alone. Using common multiple income streams, a $2 million valuation is achievable after 30-40 years’ of work.

            Obviously, a worker without a db pension or 401k employer match will need to cover that from his or her own earnings (second job maybe?). And maxing our 35 years paying into SS would be necessary and optimal. It probably will not happen accidentally, so some type of long-range investment plan is needed (IPS, see below). Most investors biggest enemy is not the market, it’s themselves.

            http://www.bogleheads.org/wiki/Investment_policy_statement

          10. Walt Greenway

            too chrispy, I would appreciate it if you are going to quote and argue with me, that you use the entire statement as I show below instead of a piece of my original statement (the “easily reached” part includes the “isn’t unusual” part of my statement and ALL income streams):

            “A $2 million valuation as mentioned in the article isn’t unusual for a defined benefit pension plan and Social Security combined over the 35 years needed to max out Social Security, retiring about 55-years-old, and living to 85-years-old (and can easily be reached with a personal 10% yearly savings rate in an average-pay job over the same 35 years of work at 6% yearly compounded).”

  2. Walt Greenway

    “City officials have said that in Carlsbad the average firefighter or police officer typically retires at age 55 and has 28 years of service. Using the 3% salary calculation, that person would receive an annual city pension of $City officials have said that in Carlsbad the average firefighter or police officer typically retires at age 55 and has 28 years of service. Using the 3% salary calculation, that person would receive an annual city pension of $76,440.”.”

    A typical teacher/state worker making the same average of $76,440 in Michigan would receive $32,104.80 a year. Using the pension multiplier of 1.5% times years of service. At 1.5%, a state employee would have to work 33.33 years to receive 50% of his or her final salary (the pension multiplier is now reduced to 1.25% for new hires and they must contribute 7% of their salary to the pension fund and work 40 years to get 50% of their final salary). Additionally, all members must contribute 3% for retiree health care.

    1. Good. Michigan taxpayers – what few of them are left – must be thrilled.

    2. mesaeconoguy

      The pension multiplier should be zero.

      Mine is.

      1. Walt Greenway

        “The pension multiplier should be zero.

        Mine is.”

        If you are older and have not saved, you have a problem. If you are younger, you need to get busy saving. Theoretically, if you don’t have a pension or a 401k match, that compensation should be included in your pay to save.

        1. mesaeconoguy

          That’s nice.

          The pension multiplier should be zero.

          Mine is.

  3. chuck martel

    California cops and firefighters that retire at age 55 don’t sit in a rocking chair on the front porch watching the cars go by, they get another job, which then often leads to further retirement benefits, usually from another government agency. In a world in hysterics over unemployment these “retired” public “servants” are being subsidized to take jobs that could be held by the currently unemployed.

    If there was an iota of fiscal responsibility in the country, public employees would have to annually bid for their job, the position going to the low bidder, just as is done with office supplies and furniture.

  4. Citizen Buddy

    “If there was an iota of fiscal responsibility in the country, public employees would have to annually bid for their job, the position going to the low bidder, just as is done with office supplies and furniture.”

    I’ve never heard of this concept but I like it a lot.

  5. When I was in the reserves, I remember one of the sergeants snickering about how he volunteered for extra duty so he could “double dip” his reserve and his government job pay checks. It really aggravated me because it cost me money when I had to skip work for duty.

    One other aspect not mentioned in the post is the security benefit. What is the $ value of not ever having to worry you might lose your job? Also, job security means you can risk investing a larger % of your income in less liquid but potentially high return investments.

  6. Jon Murphy

    One other thing that is a good takeaway from this is how broad the “1%” term really is. It’s not just Warren Buffet and Bill Gates. There are a lot of “ordinary” people in that class, too.

    1. Seattle Sam

      You are in the 1% if your HOUSEHOLD AGI is more than $375,000. That would include a lot of professional couples, lots of doctors, athletes, coaches, news anchors, entrepreneurs getting a buyout, politicians, university presidents, big-ticket salesmen in a good year, elderly people selling stock they’ve had for many years.

      The 1% are everywhere, which makes them difficult to hunt. But we will hunt them down and deliver their punishment. Then when they stop doing those things that make them that much money, the rest of us will be better off.

      1. Walt Greenway

        The 1% wealth and 1% income groups are not necessarily the same group. Many high-income people have no wealth accumulation, and many average to lower-income people have high wealth accumulation.

  7. Back when I was in the reserves, I remember one of the sergeants snickering about how he volunteered for extra duty so he could “double dip” his reserve and his government job pay checks. It really aggravated me because it cost me money when I had to skip work for duty.

    One other aspect not mentioned in the post is the security benefit. What is the $ value of not ever having to worry you might lose your job? Also, job security means you can risk investing a larger % of your income in less liquid but potentially high return investments.

  8. mesaeconoguy

    But but but but….they’re public servants.

    Instead of maintaining and improving infrastructure, we are paying these benefits.

  9. Police officers are fat, lazy, union crybabies.

Comments are closed.

Sort By:

Refine Content:

Scholar

Additional Keywords:

Refine Results

or to save searches.

Open
Refine Content