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The Great Wealth Switch

There has been a massive switch between public service employees and private sector employees in the realm of finances. The wealth of private sector workers has declined significantly, while the public sector worker has seen a large increase. Wealth here is referring not to assets, but to financial security. The main reason for this wealth switch can be found by examining the state of the pension system.

Say you have two people — one person in private industry, and one in the public sector, both making say $75K/year so that they could retire and have $50K-60K for all their years of good service and hard work.

Until about 5 years ago, it used to be that a private industry person retiring with that $50K-$60K/year plan in mind could actually retire on that. The sum of his portfolio that would enable him to retire with that much per year would be around $1 million – $1.5 million. That person could reasonably concluded that he is set pretty well for life; if his portfolio earns 5-6% a year, he could pull out that earned $50-60K a year (5-6% on a $1 million worth) or even upwards of $90K ($1.5 million at 6%), and still have the principle ($1 million – $1.5 million) left to pass on to the kids. Not bad.

In a similar way, a public service worker or union making the roughly the same money would have roughly similar expectations — a $60K yearly pension. The relative value you could put on it would be $1 million. However, there is a large difference between the public pension and private pension. When the public pensioner dies, that pension ends; the money is gone; that is, there is no principle because there is no personal “investment portfolio” in the same manner that a private sector pensioner has. The public pension is funded from the larger investment pool within the public service industry.

Fast forward to the present day.

The last five years has made the pension and investment situation for retirees quite untenable. Interest rates remain sluggish, yielding only around 1-2% a year. That becomes only about $20K in returns for the private industry person. Now the pensioner can’t live off of the returns from the million in his portfolio. It’s not going to give him the retirement he planned or the inheritance he saved and thought he could pass on.

The situation is different for the public service person. He still gets his $60K a year, regardless of whether or not the return is actually only 1-2%. His defined benefit plan promised to pay him a set amount every year until he passes away. When these plans were funded, the adminstrators were only putting away enough to have $1 million worth per person, and banked on yearly investment returns of 5-8%.

In order for the public service pension to get funded as promise — that $60K — the public service pension pool must pay it. Though the plan may have been worth $1 million, now that the pool has to cough up the difference in funds do to low investment performance (1-2% when 5-6% was necessary). That pension now becomes the valued at $2-3 million, because more funds must be added to it in order to maintain the promised payments.

The government must come up with that extra $1-2 million supplement to sustain the promised benefits to the public service person. Multiply that by for every person for which there is not enough money set aside in these pooled retirement funds to pay for them. Where does that money come from? The employer? No, the taxpayer.

Here’s the kicker. When the public sector and unions earmarked that $1 million for the employee, they hoped it would be enough to cover it. Within the private sector over the last decade or two, business owners began to understand the fiscal instability and risk inherent in such defined benefit plans. Refusing to make such a commitment, most private sector employers have abandoned such plans completely. Not so with the public sector.

When the public service sector started seeing the fissures in the system, they did something different. They started to negotiate to keep their benefits as good as possible. They negotiate with politicians, not the people who fund the retirement pool — the taxpayers. It is easy to make promises when there is truly little accountability.

So what has really happened with these public and private retirement plans? Those public service persons with the $60K retirement plan saw the value of their retirement jump from $1 million to $2-3 million. From an accounting point of view, it’s money going into the assets of the public service employees, while the other side is a debt born to all the taxpayers for the benefit of a few.

This is nothing more than a huge wealth transfer. When the public sector and unions made deals with municipalities, these were cozy sweetheart deals, a trojan horse, a poison pill. There were no provisions made to handle the possibility of a low-interest rate society; they took their chances and their fallback is to suck money from the taxpayer by raising taxes to cover budgeting shortfalls.

Now the private sector pensioners are bearing the brunt on two fronts — their own retirement plans are performing poorly and their portfolios are dwindling while their taxes help to fund the gross negligence of the public sector. All taxpayers are feeling the pinch.

The failure of the public service groups to be responsible in their fiduciary responsibility to the taxpayer means that now more than ever, vast amounts of wealth are being given over merely to band-aid this broken system, mask the true debt, and avoid real reform. Ultimately, this wealth transfer is a perfect example of legal plunder.

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