Public Pension Rip Off: Will It Hurt You?

Last Updated Jul 21, 2009 1:50 PM EDT

The Wall Street Journal ran a great article yesterday on what I would consider a major problem for public pensions, and it's called spiking. Spiking occurs when a public employee substantially increases his or her pay in the year or two prior to retirement for the purpose of locking in a higher pension payment. If you're a public employee, particularly a younger employee, this practice may jeopardize the security of your pension.

How does spiking work?

  • Let's say you're a public employee, you make $125,000 a year, and you intend to retire in two years.
  • Essentially, you work through various loopholes in the compensation system to bump your pay to say $175,000 in your final year.
  • Then you use that $175,000 as a basis for your pension calculation, which has the effect of substantially increasing your lifetime pension payments.
Sounds like a great deal. I mean who wouldn't want to do that? The problem is that it undermines the funding legitimacy of the entire system and puts the pensions of other hard working public employees at risk.

Why? Because when someone spikes their benefit, the pension system most likely has not received enough contributions during that person's working career to support that benefit.

  • Pension contributions are based on your annual income. So if you were making $125,000, then the system has been funding your projected retirement benefit based on that salary. If you spike it in the last year, the contributions are not sufficient to support that higher payout.
  • For instance, a spike of $50,000 in a retirement benefit could cost a public pension system between $800,000 and $1,000,000 depending on the funding formula.
Who Cares. Why would you care? Well, if you're also a public employee relying on a pension, that money for the spiked benefit has to come from somewhere. It's not free.
  • Pension contributions are all pooled in the plan, so one person's spiked payment comes from the entire pool. And if they didn't contribute enough to support that spiked benefit, it can hurt the others in the plan.
  • One of the main problems in public finance today is the cost of retiree benefits. If the systems aren't funded adequately and taxpayers push back on further tax increases to fund pensions, someone may have to take a cut. And it will be easier (legally and otherwise) to cut benefits for those who are still working than to cut benefits for those who are retired.
What Can You Do. If you're concerned about this practice and how it might affect your benefits, you may want to check into whether spiking is happening in your plan. To the extent the data is publicly available, it's in your best interest to pressure those running the system to look into how much spiking is occurring. Shining a light on this issue may go a long way toward correcting the problem.

Bottom line. Pension plans only work if you fund them adequately. When some people game the system, it creates more risk for others.