69 Is The New 65
The President's commission faces up to longevity. When will pension funds?
Last week, the chairs of the President's bipartisan commission on fiscal reform spelled out the drastic measures needed to put the nation on the path toward fiscal sanity. They were immediately denounced on the right for proposing tax increases, and on the left for suggesting curbs on benefits in the Social Security system.
As I suggested in the final column in my recent Social Security and Medicare series last week, the commissioners' proposal to recognize a 5-year increase in American longevity over the past 50 years should not shock anybody. But we still have politicians who will deny and defy the obvious in order to win votes -- even when the affected generations are too young to even vote. Rather than take the obvious step to raise retirement ages now (when younger people can make lifetime plans for their retirement savings), Washington partisans continue to play on the fears of elder citizens who are entirely unaffected by the proposal.
Regardless of whether the next Congress faces up to the inevitable, and phases in modest increases in the retirement ages for full benefits under Social Security and Medicare, I'll focus this column on the much-deeper fantasy world in state and local governments. In past decades, legislators and public pension plans completely ignored human longevity and mindlessly reduced the retirement ages for public employees. Public employers made it easier for their employees to retire earlier with full benefits that often exceed those of most taxpayers -- who will be stuck paying for the bills left behind in underfunded pensions and unfunded retiree medical benefits plans.
A few states have begun to wake up. Illinois passed a bill this year that requires newly hired workers to work until age 67 to receive full benefits. That law does not include public safety or local government employees, but it sets a directional precedent that others should follow. Pennsylvania's legislature last week raised the retirement age to somewhere between 57 and 65 for new hires under a convoluted "rule of 92" formula but backpedaled on the actuarial contributions, so they really just kicked the can on financial discipline despite claims of "reform."
More states will need to align their pension benefits with Social Security, whether or not the federal age limits are increased. Many more state and local governments will need to do the same with their retiree medical benefits (known as OPEB, for "other post-employment benefits").
Let's start with the pensions first. It's almost impossible to change retirement ages for incumbent employees under most states' laws, and in some states sometimes it's unconstitutional at the state level. Morally, I think it's unfair to tell a 54 year old employee who expects to retire at 60 that she now needs to work to 67. It would be far more equitable for employers and legislators in states where such changes are legally permissible to make very gradual increases, and to focus them toward younger workers. Any adjustment of full-retirement ages should not exceed two months for every year between an incumbent's current age and their expected retirement age. (In my example here, a 12-month extension of the full retirement age from 60 to age 61.)
While reforming their plans' full retirement ages, employers should require fair actuarial reductions for early retirement -- just like Social Security, which allows workers to retire at age 62 with a reduction factor. This will allow employees to leave earlier with a fair benefit, but relieves the taxpayers of the burden of providing a full lifetime of benefits to employees who don't work there a full lifetime.
I don't purport to be an expert on the human physiology of police and firefighters, but absent any published medical evidence to the contrary, and given the recent pension fund research showing that they live as long as civilians, it makes sense to me that normal retirement for our first-responders and heavy equipment operators (road crews, etc.) should be somewhere close to age 57, where workers can still find a second career and earn 10 years of Social Security credits even if their public employer is not in that system. That is just a logical age to consider, and having crossed it myself, I know that's about when my marathon-running days ended.
Those who want to retire earlier, at age 52 or 55, can still do so at a fair actuarial discount. This will provide flexibility in the system but avoid the illogical funding structure we have now: workers retiring after 20 or 25 years with lifetime benefits and spousal benefits that mean the public employer could get stuck paying those retired workers twice as long as they worked. For civilians, early retirements after age 57 or 60 with a full actuarial reduction would then be equitable.
Next, we need to re-evaluate retiree medical benefits, and their perverse impact on retirement age. It makes no sense financially to continue the current practices of many states and localities that provide full health insurance benefits to employees who retire before they receive Medicare. In the first and obvious place, few governments can realistically afford to pay this much in the first place. So let's stop promising what we can't afford. Second, there is no competing private-sector benefit richer than this, so this is not an issue of "attracting and retaining" talented workers. Third, the option to retire early with full medical benefits encourages early retirements -- which impairs the pension fund as well. So it's triply stupid from a public-policy standpoint.
Again, some state laws will require that such changes can only begin with new employees. In other states, however, the employers can change the rules for current workers (preferably beginning with the youngest and lowest-tenured). For incumbents whose benefits cannot be changed, the smarter approach may be to charge the employees for half of the full actuarial cost of retiree medical benefits before age 65, and see if they still want the early retirement benefit. When employees are presented with the full cost of their retiree medical benefits, many will decide to scale back to something more affordable. So, the incumbents' choice could be to either (a) pay half the actuarial cost of early-retirement medical benefits, or (b) pay nothing for a Medicare supplement that begins at age 65. This structure will quickly encourage public employees to work longer, approaching age 65, even if their pension benefits are legally available to them at earlier ages.
A smarter design for OPEB. To complement a scaled-back Medicare supplement plan, I'm a big advocate of adding a defined contribution program for retiree medical benefits. This would enable employees to save pre-tax for themselves and their dependents' medical needs, which can include tax-free distributions before age 65. Employers should provide a matching contribution equal to the employees' share. That's the fair and flexible way to provide early retirement medical benefits, and it will be fully competitive with what any employee could ever hope to receive from an employer in the private sector.
The battle over retirement ages has just begun. As Americans debate retirement ages of 65 vs 67 vs 69 for Social Security and Medicare, they will become more resentful of state and local government employees cashing out with full benefits while in their 50s.