Looking Twice at Pension Double-Dipping
Should full pensions be allowed if you keep working?
Recent news coverage in USA Today highlighted the public-sector practice of "double dipping" -- receiving pension benefits intended for retirement purposes while drawing a salary with another employer (or in some cases, the same employer).
Pension watchdogs loathe double-dippers, and progressive reformers are now wondering whether something is indeed wrong when retirement benefits are paid to employees who are obviously capable of earning an income. Critics say the practice is akin to doling out farm subsidies for big, successful farmers who are already making good money.
Most notorious are senior management employees, police and fire chiefs, and others who draw six-figure pensions before age 60, and then work for another employer at the six-figure level. Some states are considering legislation to curb what are perceived as abuses.
There are several sides to this issue, and I'll try to provide an objective analysis and provoke a thoughtful debate to encourage suitable and sensible reforms. For starters, I'll suggest that with a few notable exceptions - such as the former California administrator who manipulated his way to a $500,000 lifetime pension - most public employees have earned a right to a decent and modest public pension that assures them a secure retirement. If they work part-time in a second career after toiling for 30 years at $50,000 or less, I have no issue with their work ethic and their right to supplemental income to pay for travel or a new car. That's not what this column is about, however. We're focused here on the highly visible double-dippers who game the system to collect big money from a system that never intended to create pension millionaires and pension aristocrats at taxpayer expense.
Replacement income vs. deferred compensation. Pensions were intended to provide retirement security, not pre-retirement wealth. To provide security, they should provide replacement income in retirement. Replacement income is not dual income. Pensions were not designed to be "deferred compensation" as some would argue. IRS codes provide plenty of arrangements for deferred compensation, including 457 plans common in the public sector which limit the annual contributions and thus the total accumulations that can be withdrawn later. That said, there are some parallels to consider when evaluating the double-dip phenomenon. We should always think about how we would feel if a corporate employee with a 401(k) plan begins to withdraw retirement plan assets while working for another employer. If the net financial result is the same for a double-dipper, then the problem is not with the pension system. Conversely, if a pension recipient receives benefits unavailable through a defined contribution plan, including tax preferences, then suspicions should arise.
A lack of self-awareness. Most public employees feel that they have earned their pensions, but many seem to be unaware of how much earlier they are able to receive substantial benefits than their counterparts in the private sector. It is their entitlement to pre-retirement income that is disputed by the watchdogs. Many of the early "retirees" who double-dip clearly view their pension as deferred compensation and pre-retirement income, not retirement security. They also tend to overlook the gamesmanship that transpires in the pubic pension arena, where workers can transfer service credits from one employer to another and parlay benefits that could never be attained in the corporate world. Portability is one thing; triple-dipping is another.
Double-dipping would be much less frequent if public employees were required to work until Medicare or Social Security age before retiring -- unless they take an actuarial reduction in their pension, just like early retirees under Social Security. Such a system would impose a financial penalty on early retirees which would also reduce the costs of funding the system properly. Then, an employee could supplement her reduced pension with outside income from a second career or a job with a new employer.
Unfortunately, it is difficult to impose such requirements on incumbent employees who view their pension benefits as property rights. Some states have laws making their benefits irreversible once they are vested. However, there are other ways for legislatures to skin this cat, including an excise tax on double-dippers, as I'll discuss below.
For retirees who have reached Medicare and Social Security age, the double-dipping issues are less prevalent. Historically, most workers quit laboring at that point. However, there are new issues that we as a society must face as Baby Boomers reject their parents' shuffleboard retirement paradigm and seek relevance in our society by working in a second career. In most cases, they will downshift to lower-compensated work that gives them personal satisfaction and a sense of involvement with lower stress. What we need to think through is whether the pension should be adjusted in such instances.
Tax the double-dippers? Financially strapped states could impose an excise tax or an income surtax on double-dip income, which would be one way to restore funds to the pension system. For example, states could collect a 15 to 25 percent surtax on income received while earning more than 50 percent of the annual pension, or a similar surtax if combined pension and earned income exceeds the employee's previous five years' average income. The latter arrangement would also address excessive pension ratios.
Low-income retirees and those older than 66 should be exempted, of course. I would prefer to see the tax revenues returned to the pension systems, especially if they are significantly underfunded. This would be an example of a tax that produces in insignificant statewide revenue, but serves as an equalizer for public policy purposes.
Federal law imposes a 15 percent surtax on early distributions before age 59 1/2 in qualified defined contribution plans. I'd say that what is good for the goose is good for the gander and that a similar tax should apply to early pension payments that are not actuarially reduced or reflective of a 30-year career. An excise tax on premature pension distributions could be triggered by excessive supplemental employment earnings prior to Social Security age (for state taxes) and age 59 1/2 for federal taxpayers.
Presently, 10 states do not tax public employee pensions, and some of them will be forced to consider pension income taxes as revenue-raising measures -- including Michigan, which offers the biggest loopholes. I won't be surprised to see legislators and pension watchdogs in several of these states take a hard look at the double-dipping issue when the general tax policy for pension income is reviewed.
Allow a benefit-bump instead. An alternative approach to mitigating the double-dipper syndrome is to reduce pensioners' benefits while they receive outside income, and then permit them to receive a bonus payment later in the form of an increased annuity. The Social Security system has figured this out, so why haven't pension funds? For example, a pensioner entitled to a $40,000 benefit while working a second job could receive $20,000 in a reduced pension while still working, and then receive a pension greater than $40,000 after leaving the workforce altogether. The increased life pension after age 66 would be approximately one-fifteenth of the reduction taken each year, so in this example, a three-year pension reduction of $20,000 annually for double-dipping before age 66 would entitle the her to a subsequent increase of $4,000 annually for life -- thus an enriched $44,000 pension thereafter.
If faced with an excise tax, double-dippers could elect this reconfiguration of their pensions, minimize taxes, and still come out equal actuarially. Some may actually prefer this arrangement because of high marginal federal tax rates on their combined income while they work the second job. In fact, there may be other ordinary pensioners who would prefer to elect a deferral arrangement, which might even include enhanced spousal survival benefits if properly designed by the actuaries. Obviously IRS codes or letter opinions may need adjustment to enable such flexibility, but that will become increasingly necessary as Baby Boomers adopt alternative lifestyles in their retirement years.
We need creative solutions, not finger-pointing. I don't purport to have all the answers here, but our lawmakers and taxing authorities need to address these thorny problems. For starters, we obviously need to raise the regular retirement ages for public pension plans to align them with Social Security, which would eliminate most of the double-dipping. Other reforms such as those suggested above would eliminate the remaining abuses by incumbent employees whose benefits formulas are untouchable. Otherwise public confidence in the public-sector retirement system will continue to erode and future employees will bear the brunt of the punishment for the sins of their predecessors.