The Real 'Income Disparity': Government Employee Pensions vs. Private Workers' Retirement Plans

The Center for Retirement Research at Boston College just released an analysis entitled “Comparing Wealth in Retirement: State-Local Versus Private Sector Workers” to determine the wealth effect in retirement from 1996 to 2006 for former public employee versus the private sector workers at age 65, after adjusting for workers with similar characteristics of education and experience.

“What do we want?” “To protect our income gap!”

The report concluded, “The results show that spending more than 50 percent of one’s career as a state-local worker is associated with 11 percent to 18 percent more wealth at age 65.” The data for the report was produced by a long-term nationally representative study that tracked more than 12,650 people in 7.600 households since 1992, asking the participants questions about financial standing, spending habits, retirement, pensions, and employers.

The Boston College analysis determined that the dominant difference in wealth at retirement turned out to be private sector employees now rely on their self-directed 401(K) defined contribution accounts and Social Security payments, whereas public employees rely on defined benefit pension payments.

At the 2006 conclusion of the study, 78 percent of state and local government employee households in the sample received a defined benefit pension as compared to 59 percent of private sector households. This high proportion of private sector workers with defined benefit pensions shrank dramatically during the study that began in 1992.

Beginning 1980, there has been a rapid shift away from private sector employer-based defined benefit pensions to employee-controlled personal retirement accounts. In 1980, approximately 92 percent of private retirement saving contributions went to employer-based plans; 64 percent of these contributions were to defined benefit pension plans. However, by 1999, about 88 percent of private sector contributions went into defined contribution plans, the vast majority of personal retirement accounts being set up as 401(k)s and Individual Retirement Accounts (IRA).

Private sector workers with 401(K) and IRA personal retirement accounts were advised to invest in the stock market to earn high returns plus a hedge against inflation, while public sector workers’ defined benefit pensions generally guaranteed returns of approximately 10%, including 8% on investments and an on-average 2% cost of living inflation hedge.

Public sector employees, since the peak of the stock markets in 2000, enjoyed the equivalent positive 10% compounded investment return from defined benefit pensions of 235.8%. Whereas, shown after 23.4% loss for inflation in the chart below, private sector 401(K)s suffered real world investment losses of 28.9% from the Dow Jones Industrial Average, 43.2% losses from the broad Standard & Poors Index, and 63.1% losses from the speculative NASDAQ Index.

Bill Gross, managing partner of Pacific Investment Management Company (PIMCO), the largest fixed income manager in the world, recently made brutal comments regarding the current public sector pension strategies to recover their massive real world losses over the last ten years:

In the early nineties, plan sponsors, if biased in their forecast, were generally biased toward conservatism. From 1997 through 2007, expectations, although a bit rosy at times, were largely within the realm of reasonableness. In our view, a long-run equity risk premium of 11% is pure jibber-jabber. It is wishful thinking… Hope is neither a training plan nor an investment strategy.

Given that the return for private sector 401(K) investors, after inflation, has been flat over the 5 years since 2006, the public sector pension plans have artificially increased the wealth of public sector retirees at age 65 by an additional 68% since the end of the study. When added to the existing 11-18% income disparity in 2006, public employees can expect at age 65 to be 77% to 86% richer than comparable private sector workers. Does this really seem fair? Perhaps we should ask the Occupy Wall Street crowd whether this is “equal work for equal (retirement) pay.”

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