PERA: It’s Even Better Than You Think

Most Colorado (public school) educators know that Colorado PERA is a “good” retirement program, especially compared to Social Security, but often they don’t know just how good it is. Fully exploring this topic is beyond the scope of this blog post, but let me briefly hit some of the highlights.

As part of SB 14-214, the the state of Colorado commissioned three independent studies of Colorado PERA, two of which are particularly relevant to this discussion. The Milliman Retirement Benefits Study, released in January of 2015, looked at how Colorado PERA’s benefits fit into the larger picture of total compensation, and was designed to evaluate the value of PERA compared to other retirement packages offered by other states and by private companies. The executive summary states,

The state’s total retirement compensation package is equivalent to 15.7% of pay (15.4% defined benefit and 0.3% retiree health), relative to the market median of 14.7% (combined sources: defined contribution, defined benefit, social security, and retiree health)

Basically, this says that as part of a total compensation package, Colorado PERA is just above the median benefit paid by states and private companies.

The second study, the Gabriel, Roeder, Smith & Company Plan Design Study is a bit more in-depth and relevant to this discussion. The purpose of this study was to compare Colorado PERA’s plan design and, specifically, the costs and effectiveness of PERA, as compared to other retirement plans offered in the public and private sectors (including the one that affects the most people, Social Security). Again, from the executive summary,

Those are important pieces of background to know, especially when the legislature is in session and various bills are offered regarding PERA. But I want to point out some specific features of Colorado PERA that are particularly relevant to you from an investment and financial planning perspective.

Colorado PERA represents over 500,000 members which provides some significant advantages to you in terms of economies of scale and in terms of investment returns. Because PERA is so large, it is able to both invest at low cost and to invest in areas that are not available to you as an individual investor. Because they are a large, institutional investor, they are able to negotiate investment fees that are lower than what you can typically achieve on your own. They can also invest in areas such as real estate and private equity that are not available to you as an individual investor. Both of these help PERA achieve higher returns (at the same level of risk) than most individual investors.

Perhaps even more importantly, however, is the fact that PERA is the ultimate long-term investor. As an individual, you have a “life-cycle” to your investments. Typically as you get older and then eventually when you are retired, conventional wisdom indicates that you should get more conservative with your investments because you don’t have time to “recover” from a market downturn. But because PERA pools money from over 500,000 members, and because they are essentially investing in perpetuity, in many ways PERA can invest like each one of those investors is an unchanging 35-year old.

While PERA does have to deal with cash flow issues in order to pay benefits, and they certainly have to manage risk and particularly be concerned with sequence-of-returns risk, overall they can truly invest for the long term. Which means that even as you get older, PERA doesn’t have to adjust its investments based on your age, they continue to invest as if you were 35. This allows them to stay fully invested for the long-term at an appropriate level of risk that will generate good long-term returns.

In addition, once you do retire and start drawing your PERA benefits, those benefits are guaranteed for life, including a 2% annual increase to help cover inflation. (Note: that 2% applies to those hired before 2007, and can temporarily decrease following calendar years that PERA investments lose money, which does happen, but not that frequently. For those hired after 2007, it could also be 2%, but it’s a bit more complicated.) Let’s use a specific example to put that into perspective.

The median PERA retiree earns about $35,000 per year in benefits. There’s a rule-of-thumb in financial planning circles called the 4% rule which says that, based on historical results, people can typically withdraw 4% of their investment balance each year to live on and still expect their money to last until they die. While not perfect, the 4% rule is pretty robust, which means that the $35,000 per year in our example equates to about $875,000 in savings. Many career educators will likely qualify for a much higher benefit, maybe $55,000 a year or more, which equates to $1.375 million in savings.

Now, this is a very rough equivalency, as an investment balance using the 4% withdrawal rule has a decent chance of actually growing over time, which means you could leave a healthy inheritance, while your pension income ends when you die (or when your beneficiary dies if you take Option 2 or 3). But I think it still gives you a rough idea of the incredible value of your PERA pension. It really does allow teachers to become millionaires by the time they retire (and multi-millionaires if you invest your own savings wisely).

There’s one other important aspect of this that I think many Colorado educators may not notice. Because this pension income is guaranteed, in many ways you can think of your PERA pension as the fixed income (bonds) portion of your portfolio. This means you can invest your other retirement savings (401k/403b/457 – I’ll write a post soon on retirement savings plans) more aggressively than folks who don’t have a pension plan like PERA, which can ultimately generate a lot of increased wealth and therefore financial security. (I will write a post soon on investment “risk” and how “aggressive” investments are not necessarily more risky for the long-term investor.)

This is one of the main reasons why I think it’s unfortunate that many Colorado educators don’t really start thinking about PERA until they are close to retirement. In reality, the fact that you have PERA as your retirement plan should affect your financial planning from the first day you begin PERA-covered employment. (This is also one of the reasons I decided to start Fisch Financial – after talking with colleagues over the years about PERA, I realized how little many of them have thought about how PERA should affect their financial planning.)

So, how good is PERA? It’s great in-and-of-itself, but it also allows you to be more successful with the rest of your investments as well. Please consider incorporating the affordances that your PERA benefit allows you in the rest of your financial planning.