Q. Mike, I am a Tier I retiree and I have left my monies in my deferred compensation plan. That is, I have yet to begin to receive distributions. My wife would like to begin to use this money and I think it is probably time to do so. I plan to withdraw about 4% to 5% per year for the next several years. I have 50% of my money in stable value and 50% in stock portfolios. What do you think will be the return on stocks over the next decade?
A. I believe that you will receive a real (inflation adjusted) total return (dividends plus capital gains) of about 7% over the next 10 years. Now let me qualify my answer. The return on stocks will depend on corporate profitability. Company earnings have recovered strongly since the recent “great recession,” and valuation of those earnings reflected in current stock prices is near its historical average. If companies maintain their profitability, stocks are likely to pay returns that match their historical averages over the coming decade, even if recovery of the economy is weaker than average.
The long-run real return on stocks has averaged approximately 6.5%. This return is the sum of two components, the dividend yield and the real rate of appreciation. For much of the last 60 years, dividends have accounted for most of the real return on stocks. From 1951 to 1994, the average annual dividend yield of 4.6% represented just over one-half of the average real return on stocks. Since then, the composition of real returns has shifted away from dividends toward capital gains. From 1995 to 2010, the average real rate of appreciation of 3.8% represented 70% of the real return on stocks. This shift away from dividends toward capital gains seems to be correcting with dividends now becoming more important to investors, and corporations are responding.
But it will be the magnitude of corporate earnings that will matter most to investors. Currently, stock prices are near 15 times earnings for the Standard and Poor 500 index. These prices offer investors an earnings yield that matches the long-run average real return on equities of 6.5%. Shareholders will tend to receive this return in coming years. I have added an additional 0.5% since I believe that most corporations will continue their current practice of raising dividends.
One of my favorite investment advisors is Vanguard Mutual Fund founder John Bogle. Mr. Bogle believes that the total return from U.S. equities will average 7% a year over the coming decade. One of my favorite investment magazines Kiplinger Personal Finance has a forecast a tad higher at 8%. These forecasts are well below the long-term trend of about 10% annually, but are well above that offered elsewhere.
PASSAGE OF PROPOSITION C: EFFECT ON SUPPLEMENTAL COLA
Q. Mike, now that Proposition C has passed, what is that going to mean for we retired police officers who count on the supplemental Cost of Living Allowance (COLA) to keep our purchasing power even with the ravages of inflation?
A. You correctly state that Proposition C (pension and health care benefits) was passed at the November 8th mayoral election. It passed with a resounding 69% YES vote (Jeff Adachi’s proposition D was defeated with an equally resounding 66% NO vote). The supplemental COLA for fiscal year 2011-2012 will be approved by the Retirement Board at one of its next meetings since the fund earned in excess of 20% in FY 2010-2011. It will be retroactive to July 2011 and will be paid through June 2012. Thereafter, the supplemental COLA will require: (1) sufficient excess reserves (current requirement) and (2) 100% funding of the trust fund (the added requirement). This combination will mean that the supplemental COLA will not again be paid for at least 3 or 4 years (my estimate). The trust fund is now about 90% funded; it will take great investing acumen by the Retirement Board members to grow the fund so that it can once again pay supplemental COLAs.
Vested Pension Rights Doctrine
This change in the formula to determine the payment of supplemental COLAs will now be under intense legal scrutiny. The “vested pension rights” doctrine has decades of case law behind it and violating this legal doctrine maybe the undoing of this portion of Proposition C. The “vested pension rights” doctrine, simply stated, says that a public employer cannot simply demand higher contribution rates or lesser benefits without giving these same employees a countervailing benefit increase. With respect to retirees, the “vested pension rights” doctrine would not allow a decrease in benefits (i.e., the supplemental COLA) once the retiree has begun to receive his/her pension benefit.
The California Supreme Court’s consistent view on public sector pension plans is that for every tweak of a pension plan that results in a current worker’s disadvantage, there must be a comparable, offsetting advantage. Retired city employees are already seeking legal advice regarding a legal challenge to the change in the supplemental COLA – a change for which they received no compensating benefit increase. I am following this closely and will report in later columns as more information becomes available.
Social Security benefits to increase by 3.6%
There is some good news on the COLA front. Social Security checks will rise by 3.6% in January 2012. This will raise the average monthly payout for retirees by $43 to $1,229. This is the first cost-of-living increase for those receiving “old age” monthly benefits since 2009. But many retirees will not see all of the increase because Medical Part B premiums will rise by $3.50 per month to $99.90, in 2012 for most seniors. Those payments are deducted from Social Security checks.
There are some 60 million beneficiaries, including 55 million retirees receiving these monthly benefits. One in two married couples and three in four single people rely on the monthly social security check for at least half of their income. The last COLA increase was 5.8% for 2009 – the highest increase since 1982.
I continue to urge and encourage police officers to get their requisite 40 units in order to qualify for this valuable benefit.
CalPERS and CalSTRS under scrutiny
California Governor Jerry Brown recently released a sweeping 12-point pension reform plan which includes moving new public employees onto a hybrid system and increasing the retirement age to 67. The plan, which the Governor claims will save the State $900 million, also pushes for new public employees to share the risk of investment losses. Under his plan, employees would have to contribute at least half of the total annual cost of their pension benefits. Currently state employees contribute 8% of their salaries into these state pension funds.
CalSTRS which covers California’s teachers currently has a $56 billion funding shortage. Its members currently retire at the age of 62 after 27 years of service, with members receiving a pension that replaces about 60% of their salary (typically a $49,000 annual benefit).
DEFERRED COMPENSATION CONTRIBUITION LIMITS RAISED IN 2012
Q. Mike, I am about 3 years away from retirement and am trying to make maximum monthly contributions to my deferred compensation plan. Will the maximum contribution rate increase in January 2012?
A. The Internal Revenue Service has just announced the cost of living adjustments applicable to dollar limitations for defined contribution plans (IRC 457) for tax year 2010. The limit on elective deferrals will increase to $17,000 for its present $16,500. The catch-up amount for participants aged 50 and above will remain at $5,500. The special catch up provisions (3 years’ prior to the year of retirement) will increase from $33,000 to $34,000.
This is a terrific way to start and build a supplemental retirement plan. With DROP no longer available as of July 1, 2011, deferred compensation remains one of the best ways to supplement your CCSF pension benefit.
Mike Hebel has been the POA’s Welfare Officer since January 1974. He is an attorney and a certified financial planner. He has received awards/recognition as a Northern California “super lawyer” and included amongst “America’s top financial planners.” He represents POA members at the City’s Retirement Board and at the Workers’ Compensation Appeals Board. He also advises on investment matters pertaining to the City’s deferred compensation plan. He is currently a member of the SF Police Credit Union’s Board of Directors. Mike served with the Police Activities League (PAL) as president and long-term Board member. Mike retired from the SFPD in 1994 with the rank of captain after a distinguished 28 year career. He is a frequent and long-time contributor to the POA Journal. If you have a question for Mike, send an e-mail to mike@sfpoa.org or call him at 861-0211.
