Perhaps I should stop espousing the benefits and long-term gains of equities and start looking for a public sector job. If I did so, I could evidently “buy” my way into generous pension benefits that appear to far outperform the long-run rate of ret
urn on stock investments. In 21 states, teachers, state or local government employees (or all of the above) are allowed to purchase additional years of service, even if they did not work those additional years. In exchange, they receive more generous retirement benefits than if they had retired short of those additional years. This loophole, referred to as “air time” was first reported in USA Today in December, and then more recently in a commentary by Andrew Biggs at the American Enterprise Institute.Consider this example from the USA Today article:
“Dan Pellissier, a former adviser to California’s previous governor, Republican Arnold Schwarzenegger, paid $75,000 in 2004 for five years of work credit. When he turns 55 in 2015, he will get a California pension of $61,536 a year — nearly $13,000 more than if he hadn’t bought air time. That’s $320,000 extra by the time he is 80.”
There are two ways to look at the rate of return on this amount. Suppose I invested a $75,000 lump sum into my 401(k) plan that would eventually paid me a total of $320,000 for 25 years ($13,000 a year). That is a jaw-dropping average annual return of about 14 percent from the time the $75,000 is invested until the time I retired 11 years later and realized that I had $320,000 waiting for me. However, considering the payout over 25 years at $13,000 a year, the rate of return falls to about 7.2 percent. In both cases, these rates of return far outpace what many experts suggest should be the assumption – the rate on a 30-year Treasury bond, which has hovered around 3 percent.
In 2010, Courtney Collins and NCPA senior fellow Andy Rettenmaier calculated the total pension liabilities for states and cities across the country. The result was that actual pension liabilities reported by states and cities fall painfully short of what Collins and Rettenmaier found. In other words, states are underreporting how much money they need to fully fund their employees’ post-retirement pensions and health care benefits. One of the reasons is that many states
are assuming a rate of return of 8 percent on money set aside today, which is considered too high by Rettenmaier and others who have analyzed pensions.
Yet, states that allow air time benefits are calculating the costs may assume rates that are are closer to 8 percent than to 3 percent. This type of fuzzy math most certainly guarantees that taxpayers will foot the bill in the near future.
If state pension reform is to happen, why not start by picking the low-hanging fruit? Put a stop to air time benefits.