Public Pension "Air Time" Is an Absurdly Generous Perk
January 20, 2012
USA Today reports that 21 states currently allow government workers to take advantage of an obscure perk known as "air time." It allows public employees to essentially purchase credit for extra years of work that are applied toward their pension benefits. Here's an example provided by USA Today, says Andrew G. Biggs, a resident scholar at the American Enterprise Institute.
- A Michigan State Police analyst makes $56,000 each year.
- He retires after 27 years of service, but before doing so, he pays $30,365 (an amount determined by the pension's actuaries) to purchase five years of work credit.
- This credit gives him retirement benefits equivalent to a 32-year worker instead of his actual 27 years.
- This will add around $6,825 to the worker's annual pension, boosting lifetime benefits by around $170,000.
Government officials and the pension actuaries alike respond to the charge that this is an overly generous payout by emphasizing the careful calculation of the air time price. Essentially, actuaries estimate the total payout per year over the course of the worker's lifetime, and discount the payout with a given interest rate, usually around 8 percent.
Yet it is not the calculation itself that makes this perk extraordinary, but the assumptions beneath it. By discounting future payments at a given interest rate, state governments are essentially offering a guaranteed return on a worker's investment at that rate. Now, returning to the use of 8 percent, it becomes clear why this option is obscenely beneficial for the worker, as a comparable option is unavailable anywhere else.
- Guaranteed U.S. Treasury securities currently pay less than 3 percent.
- Annuities issued to federal government employees by the Thrift Savings Plan have an underlying interest rate of around 2.25 percent.
- In the private sector, guaranteeing an 8 percent return on a mixed stock/bond portfolio over 25 years would cost around 133 percent of the portfolio's original value.
Furthermore, this 8 percent rate is also used to calculate necessary worker contributions for pension plans in general, meaning that many workers receive an 8 percent return on all contributions. State governments should revisit their investment assumptions and bring pension benefits in line with private-sector rates.
Source: Andrew G. Biggs, "Public Pension 'Air Time' Is an Absurdly Generous Perk," The American, January 13, 2012.
Browse more articles on Tax and Spending Issues