How much interest do we pay a year on our Pension Obligation?June 9, 2016
We have received inquiries regarding interest paid on the City’s pension obligations. I would first like to provide a brief overview of the nature and structure of a pension plan.
- A pension plan is an agreement in which the employer provides employees with a defined or estimated retirement benefit in exchange for current or past services. Pension benefits are paid from a pension plan to retired employees on a periodic basis. The pension plan is essentially an investment portfolio structured to provide enough funds to provide retiree benefits.
- CalPERS offers a defined benefit plan where retirement benefits are based on a formula, rather than contributions and interest earnings to a savings plan. Retirement benefits are calculated based on a member's years of service credit, age at retirement, and final compensation (average salary for a defined period of employment).
- A citizen has asked how much interest does the City pay on our pension obligation. The amount of annual interest accrual is typically not called out in any of our pension reports that we receive from CalPERS. However, the typical practice is to equate the interest expense rate at the same rates as the expected rate of return on the investment. The rate of return in effect at the release of our 2015 financial statements is 7.50%. So, while the Pension Plan may incur interest expense at that rate it also invests to make income at or above that rate. As long as the plan is functioning properly, theoretically future pension interest expense will always be offset by investment income.
- Additionally, in 2010 the City essentially refinanced the pension obligations that had accrued to that point in time. The interest paid on these bonds will total $893,000 during fiscal year 2015-2016.