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19 November 2012

How Does This Happen?

How do pensions kill businesses?

The purpose of a business is to make money.  We've covered this before (Be sure to read the comments too).

What this means is an employee has to bring more benefit to the table than cost.

Literally.

So if an employee is paid $15 an hour in wages and another $10 in benefits, then what they do MUST generate $25.01 an hour MINIMUM or there's no reason to have them.

By the way, haters, this is why some executives get stupid huge compensation; they generate far more than that for the shareholders.

Now, let's say it costs $75 an hour, total, to keep our employee listed above.  $15 in wages, $10 in benefits and $50 in taxes/overhead.  Yes, Virginia, the rule of thumb is employees cost 3x their compensation.  Look up FICA and employer matching to see the tip of the iceberg.

Let's also say our employee is full time, salaried.  That means we calculate as if it were 40 hours a week but pay a flat rate.  It costs $3,000 a week to keep this person on.  $156,000 a year for their $31,200 salary.  Stunning, isn't it?

Let's say that our employee is an exemplary example and generates 15% more than they cost.  That means the business takes in $179,400 per year and keeps $23,400 of it because that person is in the seat.

Still with me?

Now, our employee does this for 40 years, netting the company $936,000.  To keep things simple, we're going to skip raises and inflation.  They retire with full salary an benefits at 40 years too!  On average our 64 year old retiree will live for another 14.2 years.  There's no overhead anymore so it will cost the company just $52,000 a year to pay their pension.  On average that's $738,400 paid out after retirement.  It's OK because the business still has $197,600 from what the employee made them.

But notice how it changes the return.  Instead of making the company $23,400 a year, they're only making the company $4,940.  Just 3.16% return.

Now, let's add a union into the mix.  They demand that full retirement happen at 30 years.

The same $23,400 is made per year from the employee.  But this time only netting a total of $702,000.  Our employee retires at age 54 instead of 64 and will (on average) live another 24.2 years costing the pension plan $1,258,400.  Now we're in the hole for $556,400!  Our retiree now is costing the company $8.92 for every hour they work.

See how seemingly small changes can have catastrophic effects?  These numbers are also a gross oversimplification of the situation and paint it far more rosy than it really is.

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