Pension comparisons

Public employee pension payments are generally dramatically higher than social security payments for similar  earnings histories.  For Massachusetts public employees with a full earnings history, a public pension is computed as 80% of the last three years’ earnings.  Except for very low-income retirees, social security works out to less on both the percentage and the earning components of the computation:  It works out to under 40% of life-time average earnings (which even with indexing will be less than the last three years’ earnings).  

 According to the Social Security Administration, Social Security payments to retired workers in Massachusetts averaged just over $1,000 per month in 2005.  The maximum social security payment was just over $2,000 per month.  By contrast, the median new public employee retirement payment in Massachusetts in 2005 was over $2,000 and 14% of retirees were receiving over $50,000 per year (over $4,000 per month).  In other words, new pension payment levels were roughly twice average ongoing social security retirement payments.   And public employees can often retire several years earlier.   

One could diminish the apparent advantage of public employees by arguing that social security is only one leg of a three legged stool for retirement security — social security, pension and savings.  And further that, MA pensions account for two legs of that stool — pension and social security, since state employees do not receive social security.   (Note that if a public employee also works a private sector job she may contribute to social security, but her eligibility for social security will be sharply reduced by rules that control double-dipping.)  Social security is in some financial planning models intended to replace only 15 to 25% of income.  

However, Bureau of Labor Statistics reports indicate that only 57% of private industry employees in New England have access to any form of corporate pension plan, and only approximately 22% had access to a defined benefit plan.  Only 11% of establishments — mostly larger establishments — offer a defined benefit plan. A slightly more encouraging data point, according to a survey conducted in conjunction with health reform, 71% of Massachusetts employers offer some form of retirement plan. Given limited access and given the low rate of defined benefit availability, perhaps half of private industry workers do not have a substantial pension other than social security — in other words, with pensions much more generous than social security, public workers are likely to be in considerably better shape for retirement than a majority of private workers.  (This is assuming that the third leg of the stool, personal savings, is equally short for both categories of workers.)

One can also diminish the apparent advantage of public employees by arguing that they are contributing a share of their income sufficient to cover the costs of benefits.  Massachusetts employees contribute a much higher share of their income to their pension than do social security participants — Social Security payroll taxes are at 6.2% (plus medicare at 1.45%) while state employees are at 9 to 12% (plus Medicare).  Together with a relatively modest state contribution, these contribution levels suffice to accumulate enough invested wealth for each employee to pay for their pension.  The state contribution works out to just under 1/3 of the employee contribution or approximately 3% — by contrast, employers match the employee’s 6.2% contribution to social security.  (See Generally Commonwealth Actuarial Valuation Report, January 1, 2008, Public Employee Retirement Administration Commission, esp. pages 3 and 34.).  

However, if one combines employee and employer contributions for comparison, as one should since they both go to the benefit of the employee and are a part of economic compensation, both the state and private employers are contributing in the ballpark of 12 to 13%.  The differing allocation between employer and employee contributions slightly affects the comparison of wages across sectors, but does not affect the real economics of the benefit comparison.

The fundamental respect in which public employees are being treated better than social security participants is that they are not being asked to carry the costs of existing retirees.  Each year, in addition to making a relatively small contribution to fund future retirements by current employees, the state makes a contribution to cover costs of retirees who came into the system when employee contributions were too low to cover retirement.  We are catching up on our unfunded liability from prior years.  These scheduled contributions are four to five times greater than the roughly 1/4 of the “normal cost” that is being paid by the state.  In other words, they amount to an additional roughly 12 to 15% of payroll.  (For additional explanation see Commonwealth’s bond disclosure documents.  This amount is greater than the “normal” cost. ) 

In this respect, the Commonwealth’s taxpayers are doing what the national taxpayers are failing to do for Social Security System: The Social Security fund is not receiving taxpayer support to amortize old liabilities.  It is using current employer and employee contributions — which might otherwise roughly suffice to cover the normal cost of a more generous benefit — to pay for previously accrued liabilities, instead of investing those amounts to pay for future benefits.  See SSA discussion and academic discussion.  (Note that state and local retirement systems are able to invest at higher yields than the social security trust which loans only to the federal government.)

State and local pension systems across the country are, like Massachusetts, doing better than Social Security at catching up on previously accrued pension liabilities.  See Letter from Executive Director in 2007 PERAC Annual Report.  This catch-up funding, if annually comparable in magnitude to that in Massachusetts, would be roughly enough to explain the compensation difference between state and local employees and private employees as measured in the National Income and Product Accounts.

Note that Local pension systems within the Commonwealth have generally the same economic shape as the state system.

Published by Will Brownsberger

Will Brownsberger is State Senator from the Second Suffolk and Middlesex District.