Where Will the Money for Your Pension Come From?

What is a pension?

A pension is what you get upon retirement to live on with some dignity. Most of us understand the Social Security benefit as a partial pension; that is it was meant to help the elderly and disabled survive outside the poor house, a place more like a prison than a retirement or nursing home. Big businesses often provided a real pension for employees to honor their years of service and live in relative comfort in retirement. That was more often the case when a “job for life” was the framework for a middle class of workers in a successful economy. Two things changed that framework: job mobility and greed.

Laissez faire government of the economy at the end of the end of the 19th century allowed a few to become very rich—the robber barons. However a burgeoning middle class of managers also rose and began to demonstrate the underside of the capitalist competitive spirit. While the corporations competed for more of the market, the new middle class competed for more of the money being moved around—bigger houses, motor cars and eventually stock holdings. Meanwhile labor workers were experiencing more company debt rather than rising wages, leading to a labor revolt and the rise of unions. Everyone was coping with the changes that were taking place 100 years ago, yet, everyone seemed to see the solution to these situations in terms of more dollars.

The stock market crash, the following depression and the great drought put the brakes on the flow of dollars however, and of course these events hurt those with access to the fewest dollars the most. The scales were now marked, however; life was all about how many dollars one had. So Social Security came into existence to provide “life” for those hard hit in old age. Life was still valued in dollars however, and more was definitely better.

Following the World War II, the three earner sectors emerged to resume their pursuit of the dollar: the fat cats, who had retained vast sums over the course of the depression and then profited from the war; the professional and management classes, who thrived in the war industry’s enormous growth; and the union workers, many of them soldiers, sailors and fliers returning from combat, now manning factory positions, displacing women and negotiating for pensions more lucrative than Social Security.

These three sectors have been competing for dollars ever since. Greed has been sanctioned in all sectors and has led to unethical and even criminal activity to profit on the labor of others. Only one sector actually creates new wealth however, the workers. The other sectors have always used that created wealth as their source of dollars. Hence, any process that holds money in a lower economic sector becomes the target for the sector or sectors above. Those targets include wages earned, pension funds held and taxes used to pay for public services and infrastructure.

 

So what about our pensions?

Because we are public employees, our pensions all originate in taxes: income and sales taxes, property taxes, and various transactional fees. It is public money, paid for infrastructure and social services available to all, often without cost to the user, rich or poor, and collected from everyone, more or less. There are indeed billions of dollars paid in taxes and used publicly which are unavailable for private wealth in theory and in law. However, public money is not the only or the largest part of the pensions we do or will collect.

Just as businesses did when they still valued their life-long workers, money is invested from day-one on the job until the last check at retirement, over 20 or 30 years or more. Generally some of that investment comes from a percentage paid from the employee’s paycheck, and, nationally on average, more comes from a percentage paid by the employer. While wages may have risen considerably over that time, the value of the day-one investment, enjoying as many as thirty or more years of growth, may actually be worth much more than the last deposited investment from the higher wage. What’s more the amount remaining after any pension payout is still earning more as the invested funds continue to grow, failing a serious market setback.

The “de facto contract” made with the employee upon hiring will continue to be paid out and never be reduced through the employee’s retirement. In the case of public school teachers, that contract is generally with the state government, which must therefore find a way to honor that “contract.” One way the state can do that is by increasing the contribution rate from the teachers and/or the schools. The teachers and/or the schools must eat the costs or more money will have to be provided by public sources, e.g. tax funds. The state has no way to control the invested funds as a financial source however. So the contribution from those invested funds can only be decreased, should the markets perform badly or for long, by raising the contributions from teachers and schools. Those contributions can also be raised by hiring more teachers as well, or raising salaries, but these moves shift the burden to the tax base and so are unwelcome.

So your pension’s value is composed of four parts: what you pay out of your check, what your employer pays above that amount, the interest that accrues on those investments, while you’re working, and the interest earned on what remains uncollected during retirement.

The last two fund contributors reside in a pension fund, a single financial account that is managed and invested by a state agency. For Minnesota teachers, except those in St. Paul who have their own fund, that fund is the Minnesota Teacher Retirement Association (TRA) fund, which is managed by the Minnesota State Board of Investments (SBI). Private investments on behalf of individuals also exist of course. Private investments involve an investment broker sometimes, and a fund manager for any mutual fund in which one invests. If one invests independently, say online, there will be a brokerage fee for every transaction. TRA and SBI management are government employees, not insurance company salespeople, fund managers or Wall Street brokers who take much bigger bites from invested dollars.

Public pension sources of revenue, 1987-2016
Compiled by NASRA based on U.S. Census Bureau data

 

So what’s the breakdown?

Well, it looked like this nationally in 2016, but since 2017 has been a very good year for investments, the 61% will be greater. It’s important to understand that these figures are amounts over 30 years and for the whole nation. Notice that on average, the employer (school districts) contribution is more than twice the employee (teachers/administrators) contribution. In Minnesota, those contribution rates are equal.

If one were excited by the competition for more money, one might look at that $4.3 trillion and salivate. Changing the plan from publicly managed to privately managed doesn’t change that dollar figure. It just breaks it into many smaller, more vulnerable pieces. As it is, changes to the plan are managed through public agencies, in Minnesota, that is the joint Legislative Commission on Pensions and Retirement (LCPR). That means it is subject to political influence, but not to the profit of account managers, a perilous trade-off perhaps.

Because it is an important part of the TRA legislative proposal, the ratio of employer and employee contribution rates is worth knowing about. Look at the comparison of the three big Minnesota public employee funds with the St. Paul

Employer and employee contribution rates

teachers’ fund compared to the U.S. average. Why they differ and what it means is certainly more complex than this chart describes. There are two things to consider as you look at this though. The blue column are from the deductions from your paycheck. When this column goes up and salaries are flat, or when retiree benefits (not in this chart) go down, jobs in education look unprofitable and the best qualified new teacher candidates may look elsewhere for jobs. This has an impact for every Minnesotan. Furthermore, for the red column to go up, the LCPR has to propose that change in a bill at the Legislature that must pass it into law over the governor’s signature or a two thirds majority. The cost of that change will come from the same source as teachers’ salaries, the tax base. I will leave you to deduce what this means in our current political climate with elections coming after the next session.

Some states, bearing very high employer contribution percentages, have been encouraged to convert or seriously constrain pensions, thus throwing the more of the cost of retirement onto the employees. Historically, Minnesota’s contribution ratios looked as follows.

Employee/Employer contribution rates 1960-2015

While such contribution equity seems fair, the burden of the contribution falls proportionally more heavily on the employee than on the tax base. Tax payers in Minnesota have been getting a good deal on their investment in the state’s teachers.

 

Wrapping up.

As of September 30, 2017, TRA had approximately $21.78 billion in assets. Of this amount, employee and employer contributions only account for less than one third of the funds’ values. Our (currently) healthy investment markets have been contributing more than twice that portion. The guiding wisdom of saving early and often is certainly born out here. In the 23 years from 1990 to 2013, a period that included two big and one small market setbacks, the TRA invested fund was able to well out perform national expectations.

Minnesota TRA pension fund sources 1990-2013

Discussions will be coming up this year on how Minnesota can stabilize the public employee pension obligations. You may wish to be part of that discussion, or at least make your informed opinion known. Beside this blog post, there is much more information online from state agencies and offices and the TRA. The Committee of Thirteen should also be able to help you understand how this might affect you and what we propose to help your situation. Visit www.committeeof13.org and send your questions to info@committeeof13.org.

Jay Ritterson, Committee of Thirteen

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