Jun 15

A few days ago, I saw a tweet that led me to read a CBS article Calif. commish advises teachers give up pensions. The article suggested that the state could no longer afford to pay out on its pension obligations and that changes would have to come. It went on to say that after teaching 35 years, a teacher could expect to get 80% of her salary as a pension each year. Wow! Sign me up, who gets a pension like that in this day and age?

Wait a second. There’s one not-so-minor detail the article conveniently overlooked. These teachers are not in the Social Security system. Another minor oversight – according to a CALSTRS (California State Teachers’ Retirement System) report the teachers still pay in 8% per year of their own money to their pension plan. Now, forgive me, but it’s time to do a little math. In the normal system, one’s employer pays in 6.2% of the employee’s salary to Social Security. Companies’ average 401(k) match is about 3%, but for sake of round numbers let’s assume California puts in a total 8% even, just matching the 8% coming out of the teacher’s pay. So we have 16% per year saved. I pull up a spreadsheet, which will adjust for inflation right till retirement, and enter 16% as the percent saved, a 3% inflation rate, and just an 8% return each year. (Note – Dave Ramsey says I can enter 12% rate of return, but I’ll stick with the 8%) After 35 years, we have 14 times the last year’s income as the amount saved in the retirement account. At 55, an immediate annuity will return 5.82% for a woman (more for a man, we don’t live as long) and to finish the math 14 x 5.82% is…… drumroll…. .816 or 81.6% of final income. No smoke, no mirrors, and just a lousy 1.8% match. My employer gives us 5%, many give more.

What’s ironic to me is that if new teachers simply got this 16% deposited to a private account there’s a great chance they’d actually come out ahead of that 80% income replacement. It comes down to a question of defined benefit vs defined contribution, who will take on the risk? But reflect carefully on the numbers, these teachers aren’t getting a windfall, not by a longshot. Perhaps the author of the CBS article should get, as Paul Harvey says, “The rest of the story.”

written by Joe \\ tags: , , ,

4 Responses to “California Teacher’s Pension Ripoff”

  1. Evan Says:

    I know you know how I feel about the subject but what makes defined benefit systems so amazing to me (AND unsustainable at current levels):
    1) The payment never stops. Even at your numbers if spending stays the same you can run out of money, and be done with it Not with the pension

    AND

    2) It doesn’t matter if you retired in 2000 or 2007 your payment is guaranteed.

  2. JOE Says:

    But Evan, the payment stream is exactly an immediate annuity. So, when you work backwards, a $40K pension is equal to a lump sum of $687K. What I don’t know is how the money (the 16% I referred to in the article) is invested over the years. But, all it needed to do was return 8% compounded. The 35 years ending 2010 returned 11.87%. Even if I look at 35 years ending 2008, post crash, I get 9.26%. See http://www.moneychimp.com/features/market_cagr.htm to play with the numbers. I don’t see the concept of defined benefit as being the issue, in fact, I’d love to see a portable defined benefit plan become the plan of choice. By portable, I mean that anyone can work at any number of jobs over 35 years, but the value would accrue so there would still get the 80% target. It’s a different mindset, but one that passes the common sense test, and “should” replace social security. We should embrace the teacher style plan, remember, it’s in lieu of Social Security, it’s not a handout, or even a perk.

  3. Evan Says:

    Joe

    My point was that you may not have had the 687K if you were to purchase a SPIA or similar product in 2007 vs what you would have had in 2006 or 2000 before pops.

    Also, you can have a portable pension – buy a deferred annuity with a GMIB or similar rider…

  4. JOE Says:

    I understand. So long as the 35 year lookback was above the 8%, even after the crash, there should have been enough. When I run the numbers to end in 2005 before the ’06 15% return, the teacher would have had a lump sum of $1.73M. The seller of the product would not lose money in any 35 year period so far. The teachers are ripped off to varying degrees. The worst case I find is the purchase right after the crash of ’08, the lump sum turns out to be $1.00M, still far above the $687K annuity cost.

Leave a Reply