To our long time readers, I think you all are aware that nothing makes my heart race like calculating pension payments and solvency based on contradictory and missing information provided by our illustrious and illuminating State Pension agencies.  So reading through Facebook posts this morning, my blood pressure jumped when I came upon this observation on Sen. Bill Brady’s page from an anxious Brady constituent:

Sen. Brady’s website says that he wants to do away with state pensions and make them “employee owned”. Exactly what does that mean? 401K’s? If so, you will then need to start paying Social Security tax for teachers (which the state does not do currently) and that percentage is higher than what is supposed to be paid to teachers’ state pension fund. That move will cost the state MORE than paying into the pensions.

Which set my calculator into action, with this first point of definition.

The commenter has a decent enough thought, but illustrates a major problem (or vacancy) in Defined Benefits Plans.  The employer pays all the money for the total compensation of the employee.   There is an accounting fiction out there that says employees pay part of their retirement funding, part of their FICA tax, part of the their income tax, which is notational rather than operational. The employer pays the entire compensation package in exchange for the labor of the employee.  The breakdown can come any way that the payroll company wants to write it on a paycheck, but the total amount paid goes out of the employers checking account to various tax agencies, pension funds, with even a few scraps left for the employee. It doesn’t matter that much how you define employer contribution vs employee contribution in the negotiation between employee and employer. What matters is the total compensation.

I’ll leave Sen. Brady’s positions to his campaign team, but I will take a stab at the arithmetic breakout of a defined benefit vs. a defined contribution retirement plan.  Illinois Teachers pensions are funded as follows from the Teacher’s Retirement System Public Information Summary (page 6)

Member Contributions

Active TRS members are required to contribute 9.4 percent of their creditable earnings each year. This contribution is allocated as follows: 7.5 percent for retirement benefits, 0.5 percent for post-retirement increases, 1.0 percent for survivor benefits, and 0.4 percent to fund the Early Retirement Option.  Active members also make an additional contribution to help fund the Teachers’ Health Insurance Security (THIS) Fund (why?). The fund finances the Teachers’ Retirement Insurance Program (TRIP), which is administered by the Department of Central Management Services. For the year ending June 30, 2009, the member contribution rate was 0.84 percent. Members may also make elective contributions for optional service credit and the Early Retirement Option. They may also make elective contributions to upgrade service earned before July 1998 to the 2.2 benefit formula as described under “Benefits,” subject to certain limitations. Employer Contributions TRS–covered employers make employer contribu-tions for teachers paid with federal funds and for the employer’s portion of the Early Retirement Option. Employers also contribute toward the cost of the 2.2 formula change and help fund the Teachers’ Health Insurance Security (THIS) Fund. In addition, the State of Illinois makes employer contributions, as described below

in mind numbing, but fictional detail.  The State of Illinois does not make it’s payment in any regular manner, nor does the TRS pension fund make much of any revenue (in fact it lost money in 2009) on it’s lunatic investment in CDO’s and other feverish schemes.

So to the arithmetic

Given the utter incomprehensibility of the funding formula, I am going to make the very generous approximation that 15% of teachers salaries go towards retirement benefits.  So a teacher making $50,000 year, contributing 15% of their salary towards retirement funding (at 5% return), ends up after 30 years with a fund of approximately $525,000 built up for their golden years.

A reasonable pension payment number to pick for a $50,000 salary is $34,500 plus say 25% for Health Insurance gets you…$43,125 outflow per year.  Keeping the same 5% return, your nest egg of $525,000 nets $42,127 per year (for the next 20 years), or a net loss of approximately $1,000 per year per retiree.

Full Stop

The trouble is the State is not under much of any obligation to save the $525,000 you think you put away.  In fact, they may have been using your pension contributions to fund other operations for the State of Illinois, (or their maniacal investments in CDO’s) or anything else they feel like.    Also, consider that the State actually spends $1,000 more on a retiree’s pension than the pension savings would make throw off in earnings.  That $1,000 has to come from somewhere.

With the legion of irresponsible spenders in Springfield, why in the name of Lincoln’s Ghost would anyone trust our State Government with their retirement funds?  Wouldn’t an average investor has more confidence in their own stewardship than the same people who have got Illinois into a multi-billion dollar deficit condition for the foreseeable future?

It seems reasonable that an investor could pull in around a 5% return from a 30 year Treasury Bond, a pretty safe investment, and use their own good sense as to whether to work till age 60, for instance, rather than age 52.   As an example, if you work till age 60, then you would sock away around $900,000 and have available $72,000 per year for your 20 year annuity.

I know these are only approximations, but they are a starting point to discussing the most pressing financial issue in the State of Illinois.  The Illinois Pension System has a junktruck load of unintended consequences via vote buying, early retirements, and investments pretty much rigged to fail.  There are some very clever people who are teachers and State employees.  I cannot imagine a scenario where the individuals who are smart enough to set up a system where they can retire at age 52 with a $34,500 pension and health benefits, that has incidentally bankrupted the State of Illinois, wouldn’t be able to do better on their own without the ethical peril of selling their votes to our inept Illinois Politicians.

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John Powers is the President of the Chicago Daily Observer and is in possession of a financial calculator.