As seen from the full post of the STRS announcement, STRS finally came out with their proposed changes to the pension plan. These changes will be presented to the Ohio Retirement Study Council next week in conjunction with the other state pension systems for public employees. These other state pension systems face similar issues as STRS and change within these other pension systems is likely not far behind. It's important to note that state law must actually be changed before these proposed changes can actually be put into force, so there is still considerable length to this process of change.
Change in some form is eminent. Private, non-government pension systems have been vanishing over the last decades because in part because as our life expectancy has continually increased over time, the pensions have had to be paid longer than expected. Pensions put an open-ended liability on the shoulders of the private companies and these pensions and healthcare benefits provided to both employees and retirees hindered companies' ability to compete, as plainly evidenced by the U.S. auto companies. The current recession certainly poured accelerant on the fire of change, but the fire was already burning.
STRS and other governmental organizations are nearly always slower to change than private companies. The sea change experienced in private company pensions and healthcare is now finally making its way to Ohio's pension and healthcare plans. This change will put more responsibility on the shoulders of those who participate in the pension plans. While most people don't like change, procrastination is what will hurt pensioners most over the long term, as they need to accept and plan for the added financial responsibility.
In my opinion the biggest change is the reduction in the cost of living adjustment (COLA). This reduction will be a 33% or 50% reduction, depending on when a pensioner retires with the smaller reduction affecting current retirees. I believe this is the biggest change because it will affect both current retirees and future retirees. All of the other proposed changes affect future retirees. Because of this, I see the COLA issue to be the most hotly contested of them all by pensioner advocates.
The biggest risk an individual faces in retirement is the need to preserve their purchasing power in the face of inflation over their retirement years. STRS and other Ohio pension systems had a 3% COLA, but this 3% was a simple interest adjustment, meaning the adjustment wasn't compounded over time. What this means is that the COLA is solely based on the first year pension amount. So if the pension is $50,000, there would be a $1500 cost of living adjustment each year, yielding $51,500 in year two, $53,000 in year three, and so forth. Yet, if the COLA were compounded the third year adjustment would be 3% on $51,500 for a third year pension of $53,045. While this difference may seem trivial, the compounding affects become steep and very real over time.
For example, suppose a retiree receives a pension of $50,000 per year when she retires at age 60. After 20 years to maintain that $50,000 purchasing power in the face of 3% inflation, the pension needs to equate to $87,675. However, if the pension adjusts at a 3% simple rate, after 20 years the pension would yield $78,500. With the proposed changes to the COLA for those retiring after July 1, 2011, the 3% would be halved to 1.5%. With the 1.5% simple rate, after 20 years the pension would yield $64,250--a whopping 27% reduction from the compounded amount.
It will be interesting to see what proposed changes make it through the legislative process. But again, change in some form is eminent. If you are a participant in one of Ohio's pension systems, you will have more responsibility for your own financial well being. This added responsibility can be dealt with but don't procrastinate in doing so. Utilize your 403b and 457 retirement plans. Evaluate whether or not utilizing the Partial Lump Sum Option (PLOP) will be of benefit to you. Seek the help of a qualified Certified Financial Planner, if you need help with your retirement planning and encourage other pensioners to do the same.