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Civic Report
No. 40 November 2003

Defusing the Pension Bomb: How to Curb Public Retirement Costs in New York State


  1. High public pension costs also contributed to the New York fiscal crisis of the mid-1970s, prompting legislative efforts to rein in pension benefits in 1976 and 1983, as reviewed on pages 4–5.
  2. “Local governments must plan again to make contributions of at least 12 to 16 percent of payroll as a normal pension cost,” Comptroller Alan G. Hevesi said on Sept. 8, 2003.
  3. The precise costs would depend on the level employees choose to contribute, since the employer contribution would be made on a matching basis. See pages 10–11 for details.
  4. The projected employer pension contribution for New York City and New York State and local government workers other than police and firefighters is at least 12 percent of salary for fiscal years beginning in 2004.
  5. This is based on the state actuary’s expectation that approximately 50 percent of newly hired retirement system members terminate employment within 10 years.
  6. The average length of service for members of the New York State and Local Employee Retirement System is 24 years, according to the state actuary.
  7. The $100 billion, 944,500-participant New York State and Local Retirement System alone is the second largest in the country, after California’s massive “CalPERS” system.
  8. Most New York State government employees also qualify for subsidized post-retirement health insurance. However, retiree health benefits are treated as a current expense; they are not financed out of the pension fund but out of the “general state charges” line in the budget’s general fund. While subject to collective bargaining, they are not part of the pension system or the constitutional pension guarantee.
  9. Article 5, Section 7 of the Constitution mandates that “membership in a retirement system shall be in the nature of a contract, the benefits of which shall not be diminished or impaired.” New York is one of only five states to provide this maximum level of security for government pensions.
  10. For most current government workers, final average salary (FAS) is the average of wages earned during any 36 consecutive months when earnings were the highest, subject to certain limitations.  For members of Tiers II, III and IV, the wages in any year used in the FAS calculation cannot exceed the average wage of the previous two years by more than 10 percent.
  11. On average, Social Security benefits are 40 percent of average annual earnings over a worker’s entire career.
  12. For example, a 40-year state employee retiring at 62 with an FAS of $50,000 (roughly the average for all state workers as of 2002) immediately qualifies for a state pension of $37,500 and Social Security benefits of $12,948, yielding a total of $50,448. Since the pension payment is not subject to federal payroll tax or to state and local income taxes, which can approach 10 percent, the effective difference between retirement and working incomes is even larger than it appears in this example.
  13. The average age at retirement in the New York Police Department in recent years has been 43. New York City police pensions date back to the 1850s and were the first of their kind in the United States. Retirement at half pay first became an option in 1878.
  14. In 2002, newly retired members of the state’s police and fire system received an average pension of $48,456 a year, according to the system’s annual report.
  15. Statement of Steven A. Kandarian before the Subcommittee on Select Revenue Measures, Committee on Ways and Means of the U.S. House of Representatives, April 30, 2003.
  16. Unions campaigned against the switch, and the time window was limited. With a wider window and a marketing campaign that did a better job of informing workers, more might have switched.
  17. In addition to the state, four large Michigan counties and the capital city, Lansing, have moved from DB to DC pensions plans.
  18. “The New Choice in Retirement Planning in Florida,” state guide posted at .
  19. In making the move, state retirement officials expressed concern that 90 percent of investments were directed to only three of 11 available funds, principally a conservative “default” option. These statistics did, indeed, highlight a known weakness in the DC system. Left entirely to their own devices, many participants in such plans tend to overly cautious in their investment decisions, as reflected in sub-market rates of return for 401(k) accounts in recent years. However, rather than reforming the manner in which funds are invested under the existing DC plan, Nebraska officials appear to have been distracted by goals of “competitiveness” with public DB systems and by a consultant’s recommendation to the effect that only a pension duplicating the worker’s pre-retirement standard of living could be called “adequate.”
    Under the new plan, the employer will guarantee employee account balances and annuities at retirement. Responsibility for investment decisions (and all the downside risk) is shifted under the cash balance plan to a state-run Investment Council.
  20. Guaranteed pension benefits for post-1984 Federal Employee Retirement System members accrue at the rate of 1 percent of salary per year—only half the level available to New York State employees.
  21. Pay Grade 6.
  22. It’s assumed the employee’s first 10 years were in Pay Grade 14 and the last five were in Pay Grade 18.
  23. It’s assumed this employee progressed from Grade 14 to Grade 18 after 10 years, and then to Grade 23 after 15 years.
  24. This would be “Option 0,” the single life allowance, which does not provide for payments to a beneficiary after the retiree’s death.
  25. This is consistent with the recommendation by most financial planners that workers adopt a more conservative investment mix, with fewer stocks and more bonds, as they approach retirement.
  26. The return on each worker’s corporate bond portfolio was equal to the average return on all corporate bonds rated in this period by Moody’s Investor Service. The return on each worker’s stock portfolio matched the composite returns on the S&P 500 as reported by Ibbotson Associates in its 2003 Stocks, Bonds, Bills and Inflation Yearbook. This index reflects the returns on “large cap” corporate stock and this is a relatively conservative number; the historical composite returns on “small cap” tend to be higher.
  27. Annuities were calculated by entering accumulated savings as “deposits” on the site, which generates an average annuity estimate from 16 companies.
  28. The state actuary assumes underlying annual inflation and wage growth averaging 5.8 percent.
  29. The IRS limit on pre-tax employee contributions to 401(k) accounts is $12,000 as of 2003. Contributions above that amount are taxable.
  30. For example, the Microsoft and IBM pension savings plans match only 3 percent of employee pay contributed to 401(k) savings plans, while General Electric matches up to 3.5 percent of pay.
  31. As in all DC plans, the employee’s portion of the account, including all investment gains, immediately is considered the employee’s property.
  32. This is the minimum age at which the IRS allows penalty-free withdrawals from qualified retirement savings plans.
  33. Under the current system, Tier IV workers with less than 10 years of service can withdraw only their own contributions, with interest of just 5 percent. After 10 years, there is no right of withdrawal.
  34. “What’s Driving New York City’s Growing Pension Burden?”, Independent Budget Office, Inside the Budget, Number 119, Aug. 13, 2003.
  35. Andrew G. Biggs, “Personal Accounts in a Down Market: How Recent Stock Market declines Affect the Social Security debate,” Cato Institute Briefing Paper No. 74, September 10, 2002, p. 2.
  36. See Gary Burtless, “Social Security Privatization and Financial Market Risk,” Center on Social and Economic Dynamics, Working Paper no. 10, February 2000, Figure 4, p. 28.
  37. Sarah Holden and Jack VanDerhei, “Can 401(k) Accumulations Generate Significant Income for Future Employee Benefits,” Employment Benefit Research Institute Issue Brief, November 2002. The EBRI model is based on an average contribution of 9.3 percent of pay, which is less than the maximum recommended for New York. It also assumes levels of funding withdrawals that would be restricted or prohibited altogether for participants in the proposed New York plan.
  38. EBRI’s 401(k) model (Ibid.) found that a three-year bear market immediately before retirement could depress the level of pre-retirement income replacement by 13 to 17 percent. By comparison, inflation between 1978 and 1981 eroded the value of a dollar by 25 percent.
  39. The distribution of worker longevity on state government payrolls can be viewed as a pyramid, with most workers clustered near the base, in bands with least experience. In 2001-02, from 40 to 44 percent of the general employees (excluding police and firefighters) in New York City and in others towns, cities and counties had spent less than 10 years in the public pension system; more than 80 percent had less than 20. The state government’s workforce is older and more senior on average; at the state level, about 33 percent of employees had been in the pension system less than 10 years, and 68 percent had been in the system for less than 20 years.
  40. Statement quoted in Press Release from the Office of New York State Comptroller Alan G. Hevesi, Sept. 8, 2003.
  41. Ibid.
  42. State of Wisconsin, Retirement Research Committee, “2000 Comparative Study of Major Public Employee Retirement Systems,” Staff report No. 83.
  43. U.S. General Accounting Office, Report to Congressional Committees, “State Pension Plans: Similarities and Differences between Federal and State Designs,” March 1999, GAO/GGD-99-45.
  44. Other large companies including GE and IBM offer similar stock purchase options.
  45. Congressional Budget Office, CBO Memorandum, “Comparing Federal Employee Benefits with Those in the Private Sector,” August 1998, p. 9.
  46. Weighted survey data from the March 2002 supplement to the Current Population Survey. These averages compared only public and private DB plans and did not include income from 401(k) accounts, Individual Retirement Accounts and other savings-based retirement plans commonly found in the private sector.


Center for Civic Innovation.


CR 40 PDF (155 kb)

Skyrocketing employee pension costs have been a major factor in the fiscal crisis affecting every level of government in New York State. The defined benefit (DB) pension plans used by governments guarantee employees a fixed percentage of retirement income based on their peak salaries and career longevity. This requires those governments to invest money each year to cover future pension payments. As a result, the DB system is crisis prone because earnings during bull markets cover employer contributions, while losses during bear markets force governments to drastically increase contributions. This study shows how greater fairness for taxpayers and better retirement benefits for most government employees can be achieved by switching from the current DB pension plan to the defined contribution (DC) model used by the vast majority of private companies.


Executive Summary

About the Authors



Figure 1. Falling Revenues, Rising Costs

Figure 2. Heading Off the Charts

The problem with public pension plans

The right solution

The financial plus for taxpayers


Trail of “tiers”

Carving out special benefits

Police and fire

Pensions as a security blanket


Michigan leads the way

Florida Follows Suit

Federal pension reform

Higher education precedent


Early-career workers

Investment and Return Assumptions

Dramatic differences

Figure 3. Annual Retirement Benefits for Early-Career State Workers

Long-term workers

Figure 4. Annual Retirement Benefits for Career State Workers

Pension bias


Advantages for Workers

Advantages for Employers and Taxpayers

Criticisms of DC Plans

Special Issues


Costly return to the “norm”





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