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Monday, August 19, 2013

PSPRS and pension spiking, part I

The Goldwater Institute, the bĂȘte noire of Arizona's public employee unions, has filed a lawsuit to end the practice of pension "spiking" by Phoenix police and firefighters.  This August 15, 2013 article by Craig Harris in the Arizona Republic details the principal issue of the case, the use of lump sum payouts for unused vacation, sick time, and other deferred compensation to increase (spike) the final retirement benefits of police and firefighters.

The article makes a pretty unimpeachable case that this violates state law.  The relevant Arizona statute reads:
"Compensation" means, for the purpose of computing retirement benefits, base salary, overtime pay, shift differential pay, military differential wage pay, compensatory time used by an employee in lieu of overtime not otherwise paid by an employer and holiday pay paid to an employee by the employer on a regular monthly, semimonthly or biweekly payroll basis and longevity pay paid to an employee at least every six months for which contributions are made to the system pursuant to section 38-843, subsection D. Compensation does not include, for the purpose of computing retirement benefits, payment for unused sick leave, payment in lieu of vacation, payment for unused compensatory time or payment for any fringe benefits. (Italics mine)
While it is fair that employees be compensated for unused time after they leave employment, the Phoenix public safety unions and city officials give no justification as to why this time should be included in pension calculations, especially when it is expressly forbidden.  Nor do they explain how pension spiking benefits Phoenix's taxpayers, who pay city taxes on both rent and food.  The usual arguments about pay and benefits revolve around how they are necessary for retention of good employees.  However, this benefit is being paid to individuals who are leaving city employment forever.  The city and union officials have only made a weak statement about this being a legal, negotiated item that can not be changed until the next round of contract negotiations.   This is a ridiculous defense since a contract can not supersede state law.  After the last few years of conflict with the federal government over several state laws, all Arizonans are probably well-versed on the legal concept of supremacy.

The heart of the issue here is, as always, financial.  Pension spiking bleeds PSPRS and soaks taxpayers because it robs the pension of its most important tool to stay solvent--compounding over time.  A pension contribution at the end of a career raises the final benefit though the contribution did not grow over time.  For example, someone retiring from the Phoenix Fire Department (PFD) today who sold back $30,000 in unpaid time would pay an employee contribution (currently 10.35%) of  $3,105 and the city of Phoenix would make an employer contribution (currently 34.95%) of  $10,850.  If this individual retired at 25 years, he would raise his average three-year high salary by $10,000 per year and boost his pension by $6,250 per year for the rest of his life.  If the combined contributions of $13,955 were to compound daily at 8% annual interest, it would increase to $69,108 after 20 years.  The individual would be paid an extra $125,000 pension benefit over those 20 years.  This would leave a deficit to the pension of $55,892.  This shortfall would need to be made up by taxpayers over the years.

Contrast this financial example with one where the $13,955 had been contributed over the 25 years of his career.  This would translate to approximately $21 biweekly over 25 years.  At 8% annual interest, compounded daily, this steady biweekly contribution of $21 would equal $43,667 after 25 years.  If this $43,667 continued to earn the same 8% interest rate, 20 years later it would be worth $216,246.  This would be more than sufficient to cover the spike in the retiree's pension that he received from selling back his unused time.

These calculations, of course, do not take into consideration the changes in either contribution rates or rates of  return on the PSPRS' investments.  It is only meant to show how damaging end-of-career pension spiking is.  Even a retiree who believes he earned his spiked pension benefits because of all the family and leisure time he gave up while employed must acknowledge that this is not sustainable over the long-term.  Nor is it fair to Phoenix taxpayers who must foot the ultimate bill for the extra costs of spiking. They already pay for a very good retirement for their public safety workers.

While this lawsuit may appear to affect only those PSPRS members who work for the city of Phoenix, there is more to the story of pension spiking, and it affects all PSPRS members.  The next post will cover this issue further.

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