When Social Security was first designed it was created to provide a retirement benefit for a very limited period of time. The average lifespan was under 70 years and benefits could be taken at 65. So a person who contributed to Social Security for 30-40 years might collect for 5-10 years. Today many government employees retire in their 50's. If they retire at 55 having worked for 35 years it is not unrealistic to think they will be retired for 30 years or more. It is very difficult for any employer to set aside enough to fund retirement for an employee who may be retired for longer than he or she worked. This is perhaps the most unsustainable part of current pension programs.
Social Security mandates that you cannot receive retirement benefits prior to age 62, that full retirement is 66 moving towards 67, and that individuals retiring at 62 take a 20% or more discount in the funds they will receive. Public employee pensions need to be similarly modified to reflect that it is simply not possible to allow people to retire in their 50's and receive full pensions for life.
Determining how much money needs to be set aside to fund an employee's pension is a very complicated exercise requiring an actuary to determine. Major factors included in the calculations include expected retirement age, lifespan, and return on the investments in the plan. Return on the plan investments is perhaps the most important factor since pension funds for an employee may be invested for 60 years or more! If we assume an employer starts to invest funds at age 25 and funds are set aside for 40 years an 8% rate of return will provide over $400,000 more in capital to fund retirement than a 7% return.
If we create a model we can better see
Early Retirement Impact on Pension
how much of an effect early retirement ages have. Let's pretend there is a public employee who is predicted to work for 40 years and retire at age 65 with a $50,000 pension for his/her lifespan, which we will assume is 85 years. Assuming a 7% average rate of return, about $1,700 needs to be put away his first year to fund his eventual retirement. This amount invested each year needs to increase by 3% to match assumed wage increases. This is all very realistic if he really works for 40 years. However, if he decides to retire after 30 years of work at age 55, the pension fund will be less than half the size it would be 10 years later due to growth of assets and contributions. Having contributed less to the fund and receiving benefits ten years longer, his pension should be about $19,000 annually with only 30 working years. In order to make a $50,000 pension at age 55, the initial investment would have needed to have been over $4,400 per year instead of $1,700. Many public employees are retiring much earlier than their assumed retirement date and, thus, are leaving great shortfalls in pension funds while paying minimal penalties. In reality, this is what is often happening.A look at Washtenaw County's Employees' Retirement System (WCERS) offers a good example of the problem with early retirement ages. In a sampling of seven recent Washtenaw County retirees, six of them were under 60, and a recent WCERS member retired at age 45 with less than 25 service years. With a 2.5% accrual rate, he or she will be receiving $50,000--or over 60% of final average compensation--for probably the next 35 years. When one considers the size of the benefit in comparison to the amount of money and time invested, it's no mystery why Washtenaw County's pension plan is over 20% underfunded with a $55 million unfunded liability.
To remedy this problem, an individual's pension needs to be commensurate with his or her contribution. Raising the retirement age makes people contribute more to their plan. Also, if people choose to retire early, they should not be able to draw from their pension until they reach a certain age, and the amount they receive should be penalized according to how much less was contributed. The extra years of investment really make a difference. If our hypothetical public employee used above still decided to retire at 55 but could not draw from his pension until 65, an annual pension of approximately $44,000 could still be justified.