Cameron Smith and Gary Palmer: A Small price to pay for public pensions

  This year, public employees in Alabama saw the first part of what will ultimately be a 2.5% increase in retirement contributions in an effort to shore up the state’s retirement systems. The Alabama Education Association (AEA) and Democrat legislators have cast the new contribution requirements as a “pay cut” and launched the common refrain that Alabama’s Republican leadership balances budgets on the backs of teachers and state employees.

  The truth is that Alabama’s taxpayers have increasingly shouldered the burden of public employee pensions for over a decade. Alabamians’ tax contributions to buttress public employee pensions have increased from slightly more than $300 million in 2000 to almost a billion dollars in 2010. These taxpayer dollars go directly into the current and future retirement benefits of state and education employees, benefits far superior to those most Alabama taxpayers have for their own retirement.

  The main reason for the retirement contribution increase is the sad state of affairs of Alabama’s retirement system. According to the Retirement Systems of Alabama, the Teachers’ Retirement System (TRS) is 71.1 percent funded with an $8.17 billion unfunded accrued liability while the Employees’ Retirement System (ERS) is 67.0 percent funded with an unfunded liability of $2.29 billion. But Joshua D. Rauh at the Kellogg School of Management suggests that the real unfunded pension liabilities for Alabama could be as high as $56.5 billion because of the RSA’s overly optimistic growth projections. Like many other state retirement systems, the RSA predicts a minimum eight percent return on its investments, a tough task in the current economy.

  Teachers and state employees should understand the need for changes intended to preserve their pensions. According to the Bureau of Labor Statistics, only about twenty percent of the American workforce has the option to participate in defined benefit plans such as those currently enjoyed by Alabama state and education employees. These defined benefit plans require employees to pay a percentage of their income during their employment in exchange for a guaranteed benefit when they retire.

  Most employees who have a retirement plan participate in a defined contribution plan where the employee sets aside a percentage of his or her wages which are in turn matched by the employer and invested either by the employee or on their behalf. The median employer match in the United States is around three percent.

  A public school teacher starting her career in Alabama at the age of 24, earning an average salary of $46,879, and retiring after 25 years of service is guaranteed an annual retirement benefit of almost $24,000 per year and stands to reap a total benefit of almost $700,000 over the course of her retirement if she lives to the age of 80. Additionally, the public school teacher’s pension benefit is exempt from Alabama state income tax.

  That same teacher working in a private school providing an average defined contribution plan returning eight percent compounded annually would have a retirement account with less than $225,000 over the same 25 year period. To make matters more challenging, this teacher also has to deal with the uncertainties of her investments and the diminishing value of her retirement savings as she needs to withdraw funds over the years.

  Because Alabama’s defined benefit pensions are guaranteed, the state must find the resources to pay for them.

  On the one hand, the Legislature could ask all Alabamians to pay more taxes to fully fund the pensions for public employees, an increase of around $900 per household according to a study done by Rauh and Robert Novy-Marx the University of Rochester. Most taxpayers would surely balk at the notion of paying even more of their hard-earned tax dollars simply to fund public employee pensions.

  Another option would be to simply cut current operational budgets to fulfill benefit obligations. The initial contribution increase from 5 percent to 7.25 percent accounts for almost $180 million in revenue between the TRS and ERS. Using taxpayer funds to cover that additional amount, without a tax increase, could easily eliminate thousands of state jobs or use resources that could improve education or services for taxpayers.

  The final option to preserve the defined benefit system is the one the Alabama Legislature ultimately selected. It requires those benefitting directly from the system to increase their contributions for the benefits they will ultimately receive. Even with this change, the future of the retirement systems remains unclear.

  For the average salaried teacher in Alabama, the 2.5 percent retirement contribution increase (a little less than $100 per month) may feel like a pay cut, but that is a small sacrifice to pay for the significant guaranteed retirement benefit he or she receives later. Notwithstanding their positive contributions to Alabama’s communities, education and state employees whose jobs depend on taxpayer dollars should not be insulated from the economic realities that their contemporaries in the state and around the nation are forced to face.

  If state and education employees really want fairness, they can certainly keep more of their monthly paychecks, reduce contributions to their retirement and switch to a sensible defined contribution plan like the lion’s share of Alabamians.

  About the authors: Gary Palmer and Cameron Smith are with the Alabama Policy Institute, a non-partisan, non-profit research and education organization dedicated to the preservation of free markets, limited government and strong families, which are indispensable to a prosperous society.

  This article was published by the Alabama Policy Institute.