A few years ago, my wife went to a garage sale and bought a box of old books for $25. She came home as excited as I had ever seen her. Why? One of the books was a 1831 edition of The Federalist Papers. We searched online and were thrilled to see an estimated value of $500. Those poor sellers had no idea what they had parted with.
Alas, many public employees have a similar experience when they leave their employment too soon. They do not realize the value of what they are walking away from.
At a recent state Association of School Business Officers event, I was talking with a young school business officer, Julie. She shared with me that she had graduated with degrees in finance and accounting and was comfortable with numbers, which resonated with me. I showed her some of our analyses, and she especially liked seeing the total projected distributions from the state pension plan. She asked if I could calculate the total distributions she would receive. I quickly ran her scenario, which projected she would receive $3.9 million over her life expectancy. I saw tears in her eyes and honestly thought she was going to hug me. (I stepped back.) It took her a moment to speak, but when she did, she said she had no idea the distributions would be that significant. She then said she would never quit her job.
Before I had shown her that report, Julie had no idea what the pension system would provide for her. When she found out, it changed how she viewed her commitment to her employer.
Rank-and-file public employees seldom know the total projected distributions from their retirement plan. In most cases, general pension plan participants can easily achieve a million-dollar valuation upon retirement. Showing them their total projected distributions in retirement—and the present value at an assumed rate of return—can help them understand and appreciate their job benefits.
Most people know that defined benefit (DB) and defined contributions (DC) plans are different, but they often overlook one aspect: With DC plans, contributions in the early years are key, but with DB plans, the later years often are more significant due to compounding raises. A DB plan member who leaves early and switches to a DC plan loses the advantage of both plan types. Many public employees, especially teachers, look over the proverbial fence and head to what appears to be greener pastures, unaware of what they will lose in retirement benefits.
For example, consider an employee who works for 30 years with annual 3% raises, has a pension plan based on the final three years of salary, and receives the same percent crediting for each year of service (some DB plans change the percent crediting with different years of employment). If she quits in Year 15, she will have earned only 32.1% of her benefit. In Julie’s case, if she quit after 15 years, her projected $3.9 million of distributions would be reduced to $1.25 million—a loss of $2.6 million in retirement income. (And with 4% raises, the benefit at 15 years reduces to 27.8%, or $1.1 million of total distributions and a loss of $2.8 million.) This loss of income probably could not be replaced even if Julie made the maximum contribution to a 401(k) plan for the 15 years of employment outside of her retirement plan.
This presents at least two opportunities for financial advisors working in the 403(b) and 457 worlds. The first opportunity is to help clients realize the value of their pension plan so that they can make better financial decisions. Many public employees are frustrated with their work and tempted to transition to a different job. Without this critical information, they could be making a life-changing decision without realizing it will slash their retirement income. Well-equipped financial advisors can provide invaluable guidance for such decisions.
The second opportunity is for the advisor to advise HR and business officers on how the school (and other public employers) can leverage their pension plan for workforce retention. Most schools are struggling to retain employees, and they typically welcome employee education that can support their efforts.
Imagine if that family that held a garage sale had been advised about the value of their books. Would they still have sold the box to my wife for $25? Definitely not! I believe the same is true for public employees contemplating a change in their career. When advisors take the time to explain the true benefit of their pension plan, public employees certainly would think twice before switching jobs and missing out on significant retirement benefits.
