Resolving the Pension Problem

October 26, 2012 at 8:05 AM 1 comment

Teacher’s pensions have devolved into a hornet’s nest of woes for government sponsors, unions, and beneficiaries. However, a solution may lie in matching unlikely bedfellows: government pensioners and the richest 1% of citizens who might just be willing to fund their benefits in exchange for tax-free bonds. It is one of the few win-win scenarios available in this picture.

Teacher pensions have created a dilemma for many districts and unions. Traditional pensions for teachers are not portable, so teachers cannot reap benefits unless they stay in one retirement system long enough to reach the 30 year tenure/55 year age threshold. For those who do achieve full eligibility, pension funds often are seriously underfunded.

Alternative plans cannot fix the problem alone. 40lK-type plans offer portability, but any shift of savings to a new plan will create additional underfunding of legacy plans.  In addition, they are too risky for teachers in states that have opted out of the Social Security safety net. Employers will need to enroll staff in Social Security and both will need to make contributions. Regardless, pension sponsors will need a source of low-cost borrowing to meet obligations.

Tax-free bonds have been proposed as a low-impact borrowing source for government sponsors of unfunded pension obligations1. Essentially, the tax-free status will lower the effective interest rate for borrowers while offering tax-sheltered income for the lenders.

I am not often a fan of tax benefits for the rich. However, this is a case of the ends justifying the means. The dual goal of keeping retiree benefits intact while achieving greater equity among teachers in their access to pensions must be served. And who better to do this than the rich who, by the way, need to be co-opted? Otherwise, they tend to be most likely to favor a plan of privatizing education and cutting off retirement prospects for the displaced veteran teachers.

1Joshua Rauh of Northwestern University and Robert Novy-Marx of the University of Rochester via “Solving the Pension Puzzle”

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Entry filed under: The Pension Trap.

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1 Comment Add your own

  • […] The Federal role in the issue could be one of mitigating the financial crisis in pension funding. Changes to the tax code could lower the effective cost of borrowing for sponsors to meet pension obligations. In addition, elimination of the Social Security opt-out would extend the safety net for employees switching to higher risk, defined-contribution pension plans. A prior post discussing this issue can be found here. […]

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