By Jennifer Baker and Dave Earl Carpenter
A hot topic of discussion of late, public pension systems have been under intense scrutiny and unwarranted attack by legislators and candidates alike. Much of the talk has been centered around the sustainability of defined-benefit retirement pensions, such as CalPERS and CalSTRS.
Steve Poizner and Meg Whitman — both running for governor of California — are becoming increasingly vocal in their opposition to defined-benefit plans, arguing a need to switch public employees from their current defined-benefit retirement plans to 401(k)-type defined-contribution plans. The candidates claim that the switch to 401(k) systems would be more cost-effective for the state. But in actuality, the reverse is true. To deliver the same level of retirement benefits to an individual — a decent, livable wage — a defined-benefit plan saves almost half the cost of a defined-contribution plan (see sidebar).
Historically, defined-benefit plans are much more efficient, secure and predictable vehicles of retirement than 401(k) contribution plans. Defined-benefit systems are able to pool resources to maximize investment returns, while defined-contribution plans leave individuals burdened with administrative fees and many hidden costs. Research shows that many individuals struggle with the task of managing money through a 401(k), either drawing down funds too quickly and running out of money, or holding on to funds too tightly and enjoying a lower standard of living as a result.
Gov. Arnold Schwarzenegger recently took sides in the debate through the actions of his economic adviser, David Crane, who commissioned a study conducted by students at Stanford University that calls for a switch of public employee pensions from a defined-benefit plan to a 401(k) plan. The study throws away decades of investment and accounting practices, and concludes that the rate of return assumptions for California’s pension systems should be close to 4 percent — almost half of their current levels, which have been achieved over time, despite the economic downturn.
The real purpose of the study is to create an alarmist perspective that running a defined-benefit plan is simply too costly and must be eliminated in favor of a defined-contribution plan. The governor should be seeking ways to ensure that all Californians have a secure retirement.
Instead of commissioning students to study eliminating retirement benefits, they should instead study what the cost will be to provide for the hundreds of thousands of seniors with a 401(k) who may soon be facing the unfortunate predicament of lacking the resources to retire.
On the legislative front, a Senate committee met in May to discuss SB 919 (Hollingsworth), which was recently introduced as a measure sponsored by the governor. The bill seeks to create a two-tier retirement system for public employees who utilize CalPERS by significantly reducing the current benefit structure for new employees. It would require school employees to work an additional 10 years to age 65 in order to receive the standard 2 percent formula.
These tactics create a divisive atmosphere and penalize individuals for deciding to enter into a public service career.
Public employees have been working diligently with their local government counterparts to find ways of cutting costs, which have resulted in salary cuts, furlough days and a multitude of other creative cost savings. SB 919 would bypass the local government process in favor of perceived short-term gain that is not actuarially proven.
The issue of securing an adequate retirement for educators will be an ongoing discussion as politicians seek new ways to cut state costs at the expense of its workers. CTA is diligently working on behalf of educators — along with a broad coalition of labor organizations including teachers, nurses, firefighters, police, correctional officers and state workers — to protect the secure and fair retirement of public employees.
Defined-benefit plans are more cost-effective
The cost of a defined-benefit plan is 46 percent lower than a defined-contribution plan that provides the same level of retirement benefits.
Longevity risk pooling
Maintenance of balanced portfolio diversification
Superior investment returns
Source: “A Better Bang for the Buck: The Economic Efficiencies
of Defined-benefit Pension Plans” by Beth Almeida and William
B. Fornia, FSA — 2008.
Example of CalSTRS retiree payout:
Final average salary:
Years of service:
Monthly retirement benefit:
($24,000 per year, replacing 48 percent of final average salary)