Basics About Pensions

It’s important for employees to understand the basic definitions and underpinnings of public sector pensions in California. This overview was written as the public awareness of pension costs and issues was beginning to emerge in 2005-06.

Types of Plans and How They are Funded

In my discussions with many of you, I find that there are a lot of our members who do not understand the nature of our pension system in the public sector. This article is designed to give you a basic understanding of the way defined benefit pension systems work.

Q: What is a defined benefit plan?

A: In my discussions with many of you, I find that there are a lot of our members who do not understand the nature of our pension system in the public sector. This column is designed to give you a basic understanding of the way defined benefit pension systems work and how they are funded. We have 8 WCE chapters, each with a slightly different pension formula, but they follow the same premise—that you will receive a pension at retirement that is "defined" by a multiplier which is based on your age and your years of service. Until the last few years, the formula for most public agencies has been a "2% at 55" formula based on your single highest year of wages. What this means is that if you are employed at least to the age of 50 and retire at age 55, you will have a pension that is based on the salary you made during your single highest-earning year. You won't be entitled to that whole amount, however. What you will be entitled to is the yearly amount times the multiplier. For instance, if you are 55 with 20 years of service, your multiplier will be 40%. So, if your single highest year's salary was $80,000, you would be guaranteed a pension of $32,000 per year. Obviously, the more years you work, the higher the pension, and only if you have been employed in public service for many years will you receive a pension that could be considered large.

Q: How are current plans funded?

A: This type of defined benefit plan is funded by contributions from both employees and employers. Using the typical 2% at 55 plan as an example, the employee contributes 7% of his/her wages to PERS, while the city/county/agency contributes 12% of the employee's salary per year. As part of bargaining, an employer may agree to pay for all or part of the employee's contribution as a component of compensation, but the employee portion has always been required to be paid into the system.

Payment of the employer's share has been a little more complicated. In the lucrative stock market of the 1990's, PERS and other pension plans which were experiencing huge surpluses due to investments, did not require employees to contribute some (or all) of their employer 12% share. Employers for a number of years did not even budget for their pension contribution portion. However, in the past few years, as the investments have declined, employers have been required by PERS and other plans to contribute a larger and larger proportion of their contributions, up to 11% this year. Combine this with enhanced pension plans which have been introduced in certain places—2.5% at 55, 2.75% at 55, or 3% at 60, which require higher contributions—and you have the makings of a problem, at least for the near future.

Political Proposals for Change

The changes described above, and the effect on local governments' finances, have resulted in the move by Governor Schwarzenegger and others to "reform" the public sector pension system to eliminate the defined benefit system and replace it with a defined contribution plan. A defined contribution plan would be like a 401k or a 403b, with the employee choosing to save a certain amount for retirement, accompanied by some matching formula by the employer. A defined contribution plan, however, leaves the investing (and the risk) to the employee and does not guarantee an employee any compensation at retirement. The Governor's proposal, as originally formulated, was supposed to apply only for all new hires as of 2007 (although some legal commentators say that the wording of the some of the initiatives is broad enough to potentially cover even current employees).

On April 7, 2005, the Governor withdrew his support for the pension "reform" proposal, at least for the moment. This was based, he said, on unfounded fears that the new systems would eliminate death and disability benefits for police and firefighters. However, the proposal is not dead—it is only dormant for the moment. And, there are still currently four initiatives "in the pipeline" on this issue, and it will not be known for sure until around June which will qualify for the ballot. You may already have seen some signature gatherers at your local shopping malls. These people are paid per signature by a big-money coalition of businesses and political forces which are trying to drastically change the pension system for all public sector employees.

The initiatives are capitalizing on the mistaken perception that all public employees have huge pensions and that all public pension systems are in dire financial shape. Neither is true. There are financial concerns, but many experts believe that the cost of changing the system is likely to be higher than the cost of maintaining it.

I urge you to think carefully before you sign any petitions aimed at destroying the pension system which public sector employees have worked so hard for. Don't be misled by the claims that these initiatives will only affect state workers, or that they won't affect current employees, or that there's no way they will pass. These initiatives are real, and, if passed, they will have significant effects on all public employees. I hope that all of you will educate yourselves—and your family and friends—about the issues.

Resources for Information

To this end, I am including links to several websites which discuss these issues in more depth. These websites discuss the fact that not only will a change from the defined benefit plan to a defined contribution plan place public sector employees' dollars in the risky stock market as individual investors, but will cost billions of dollars to implement.

Please educate yourself, and feel free to call me if you have any questions.

Websites:

  1. www.calpers.ca.gov—the website of the CalPERS retirement system, with a comprehensive overview of the initiatives and the issues
  2. www.igs.berkeley.edu/library/htPensionReform.html—the library of the Institute of Governmental Studies, University of California, Berkeley
  3. www.lacera.com—the website of the Los Angeles County Employees Retirement Association

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