The voices of Urban Institute's researchers and staff
April 27, 2011

Keeping Older City Workers at Work

April 27, 2011

My last post described an overlooked but pressing flaw in the retirement plan that Los Angeles offers its workers. Like nearly every other U.S. city, LA offers traditional pensions that pay retirees regular monthly benefits until they die. But it penalizes employees who work past their late fifties or early sixties by making them forfeit a month of benefits for each month worked past the retirement age. As I noted, pushing these experienced and skilled civil servants into early retirement will backfire once the economy recovers and changing demographics make younger workers increasingly scarce.

The solution for cities like LA is to switch from traditional pensions to cash balance plans, hybrids combining features from both traditional pensions and 401(k)s. In these plans—first embraced by private firms in the 1990s—employers create retirement accounts for their workers and credit them with a certain percentage of pay each period. The accounts accumulate interest, generally at a rate tied to 10-year or 30-year U.S. Treasury bonds. At retirement, workers gain access to their account balance, which they can collect as a lump sum payment or in lifetime monthly installments. Account balances keep growing as long as workers remain employed, even beyond the retirement age, so nobody gets dinged for staying on the job.

The figure below shows the difference that a cash balance plan would make. For an LA city worker hired at age 25 under today’s plan, the value of future benefits falls each year she works past age 55. Working into her early sixties would reduce her take-home pay by nearly a third. No wonder that city workers in LA and around the country retire so early.

INCREMENT TO FUTURE RETIREMENT BENEFITS FROM WORKING FIVE MORE YEARS, AS PERCENTAGE OF SALARY EARNED (CITY OF LOS ANGELES EMPLOYEE HIRED AT AGE 25)

Pension plans

Consider instead the trajectory of future retirement benefits if the city paid 11 percent of salary into a cash balance plan. As the blue bars in the figure make clear, future retirement benefits climb by a steady 11 percent of pay throughout the municipal employee’s career, no matter how long it lasts.

Restructuring compensation to reward work at older ages is not on the agenda in LA or anywhere else. Instead, the public pension debate swirls around costs and financing—how to trim benefits and require employees to contribute more toward their pensions. That’s the fix hammered out by the Los Angeles mayor and city union leaders last month. The union rank and file had until yesterday to decide if they’ll go along.

Most likely, the City of Angels will continue to be the city of early retirement for now. But there is a way for metros to keep their best civil servants from retiring too soon and taking their valuable skills and experience with them.

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Comments

You need to put a label on your y axis. I think you are comparing the marginal return (to total comp?) of the pension benefit to an additional year worked? Or maybe you are showing the change in lifetime value of benefits? If so, when are you assuming people die?

So, at what age does the cash balance stream decline or become negative? Presumably, at some age the low probability of payment receipt outstrips the value of the benefit stream at a previous age.

Also, in term of work incentives, a person that elects a joint and survivor annuity will have a different payment stream and accruals at later ages (with the traditional DB formula) may have more expected value.

The chart shows the increment to future retirement benefits from working five more years, divided by the cash salary received. The increment to future benefits is the pension accrual. For age 51 to 55, for example, it is computed as the expected present value of the stream of future benefits the worker would receive if she stopped working at age 55, minus the expected present value of the stream if she instead stopped working at age 51.

Many assumptions go into these calculations. I use a real discount rate of 3 percent, I assume that earnings grow at the typical rate for state and local workers, and I use a standard life table to estimate how long the worker is likely to receive retirement benefits. I don't assume a particular age of death. Instead the probability that the worker will survive and receive a pension check falls each year in retirement. So there's a greater likelihood that she'll receive a payment at age 60 than at age 100. But the probability of receipt at age 60 is less than one, and the probability at age 100 is greater than zero. There's no chance that she'll live past 120.