Understanding pension funding can be hard. And earlier this week, Phoenix city council members Kate Gallego and Daniel Valenzuela showed they haven't quite gotten up to speed on how their city's pension system works.
The issue of the moment is whether a proposed initiative to reform the Phoenix pension system for city employees (non-public safety) would save money, or cost taxpayers more.
We have done our own actuarial analysis of the pension reform act proposed in Phoenix, and have found it could wind up saving taxpayers as much as $1.6 billion.
But according to KFYI News, Gallego and Valenzuela "claimed the change would actually cost the city between $350 million and $600 million between the administrative implementation costs and discontinuing employee contributions to the current pension system." And Valenzuela himself claimed, "people are still going to be drawing their pension. And as they're drawing their pension from this pot of money that we're no longer funding, now do you propose that we do that?"
The first thing here is to point out that pension funding is it is not like social security. The proposed pension reform in Phoenix would put all new employees in a separate system and phase out the current retirement system. But under traditional defined-benefit pension funding rules, those who remain in the old defined-benefit system don't rely on the contributions of future employees.
Second, though, is that Phoenix isn't exactly a traditional defined-benefit system. Last year the city implemented a change that requires future employees to pay half of the cost of pension debt that has built up in the current system. The city has about $1.5 billion in pension debt right now, which is money its promised to pay current employees. Current employees don't have to pay down that debt, but the city has decided to make future employees pay for it.
Third, the text of the pension reform would not stop the city from funding the old retirement system. It simply creates a new system for new employees. The old system continues on as is, its members will get the same benefits, the city has to fund those benefits too until everyone currently an employee of the city retires. Neither would the proposed pension reform would not eliminate employee contributions. Plus, the administrative costs of making the change would be miniscule.
So what do Gallego and Valenzuela have wrong?
- The proposed pension reform would not discontinue employee contributions to the current pension system
- The city will continue funding the system that retirees draw benefits from
- And the pension reform would actually save taxpayers money, not cost them
The one thing they do sort of have correct is that there is some dependence on future employees to help fund the old system because of the recent change to have future workers pay off the pension debt.
However, Gallego and Valenzuela have not factored in that the current system is underestimating its debt by about $700 million.
And the system as it stands is broken: there is no way future workers will want to keep paying off the debt of previous employees. At first it won't be that bad because the cost sharing will be low, but over the coming years the cost sharing could drive future employee contributions above 25% of their paychecks. All to help pay the debt of old employees who contribute just 5% of their pay.
So are Gallego and Valenzuela simply confused on how pension funding works and the problems facing their city? Maybe, but I spoke to the entire City Council in June about this very issue, and if they didn't understand it then they could have asked more questions.
As it stands, there is some clear need for pension funding 101, and maybe the council members need to read the text of the proposed pension reform. Gallego and Valenzuela should look at our full actuarial analysis of Phoenix's current system and the proposed pension reform to get a better education on this important issue for their city.