A few years ago, my wife went to a garage sale and bought a box of old books for $25. She came home as excited as I had ever seen her. Why? One of the books was an 1831 edition of The Federalist Papers. We searched online and were thrilled to see an estimated value of $500. Those poor sellers had no idea what they had parted with.
Alas, many public employees have a similar experience when they leave their employment too soon. They do not realize the value of what they are walking away from.
At a recent state Association of School Business Officers event, I was talking with a young school business officer, Julie. She shared with me that she had graduated with degrees in finance and accounting and was comfortable with numbers, which resonated with me. I showed her some of our analyses, and she especially liked seeing the total projected distributions from her state pension plan. She asked if I could calculate the total distributions she would receive. I quickly ran her scenario, which showed she would receive $3.9 million over her life expectancy. I saw tears in her eyes and honestly thought she was going to hug me. (I stepped back.) It took her a moment to speak, but when she did, she said she had never imagined the distributions would be that significant. She then said she would never quit her job.
Before I had shown her that report, Julie had had no idea what the pension system would provide for her. Seeing the projected distributions changed how she viewed her commitment to her employer.
Rank-and-file public employees seldom know the total projected distributions from their retirement plan. In most cases, general pension plan participants can easily achieve a million-dollar valuation upon retirement. Showing them their total projected distributions in retirement—and the present value at an assumed rate of return—can help them understand and appreciate their job benefits.
Most people know that defined contribution (DC) and defined benefit (DB) plans are different, but they often overlook one important aspect: With DC plans, contributions in the early years are key, but with DB plans, the later years often are more significant due to compounding raises. A DB plan member who leaves early and switches to a DC plan loses the advantage of both plan types. Many public employees, especially teachers, look over the proverbial fence and head to what appears to be greener pastures, unaware of what they will lose in retirement benefits.
For example, consider an employee who works for 30 years with annual 3% raises, has a pension plan based on the final three years of salary, and receives the same percentage crediting for each year of service. (Some DB plans change the percentage crediting with different years of employment.) If she quits in Year 15, she will have earned only 32.1% of her benefit. In Julie’s case, if she quits after 15 years, her projected $3.9 million of distributions will be reduced to $1.25 million—a loss of $2.6 million in retirement income. (With 4% raises, the benefit at 15 years reduces to 27.8%, or $1.1 million of total distributions and a loss of $2.8 million.) This loss of income probably could not be replaced even if Julie made the maximum contribution to a 401(k) plan for the 15 years of employment outside of her retirement plan.
What can we learn from this example? First, employees want to see their own numbers. It meant so much more to Julie, who had a degree in finance, to see her specific value than to study generic numbers and apply them to her own situation. Telling employees that they have a wonderful pension plan (and many do) does not foster the same appreciation as when they see their specific scenario. Having served financial advisors for over 30 years has taught me that people want to see information in a personal, concrete format. The more we tie information to their specific situation, the more they appreciate what is being communicated. Pension plans can be leveraged to help employees understand the value of their years of public service.
Second, DB plan participants need to know what they are leaving on the table when they walk away from their state pension system. Many public employees are frustrated with their work and tempted to transition into a different job. Without this critical information, they could make a life-changing decision and inadvertently slash their retirement income. Leaving the public sector is precisely the wrong financial decision for many people, yet they are not aware of the dangers.
Imagine if that family that held a garage sale had been advised about the value of their books. Would they still have sold the box to my wife for $25? Definitely not! I believe the same is true for public employees contemplating a change in their careers. If employers took the time to explain the true benefits of their pension plan, public employees certainly would think twice before switching jobs and missing out on significant retirement benefits.