No pension? You may still owe $30,000 on one

Many economists think the US's debt, aging population and slow ecnomic growth spell disaster for pensions.

By MSN Money Partner Nov 8, 2011 4:35PM

This post comes from Jack Hough at partner site SmartMoney. on MSN MoneyPension accounts for state and local government workers are underfunded by $4 trillion, according to one recent analysis. If America's households were to split that tab today, each would have to kick in $34,000.


Don't have that kind of cash on hand? Another option is to chip away at the shortfall over 30 years starting now. That would cost households $1,400 a year beyond what they pay in taxes today.


A pension, for those who aren't familiar with one, is like a 401k plan in reverse. With a 401k, or defined contribution plan, a worker knows how much he socks away, but not how much he will have at retirement. That part depends upon investment returns. With a pension, or defined benefit plan, a worker is told how much he will receive in retirement. It's up to the pension to put aside enough today. To do that, pensions guess about future returns. The higher the returns they assume, they less money they must save today. And therein lies the problem.


Most states assume a yearly return of around 8%, says Kil Huh, who manages fiscal research for the Pew Center on the States, a think tank. "In past decades, when investment markets boomed, they were able to achieve those returns," he says. "Now they're not even coming close."


Indeed, whether states and local governments have a funding problem under current rules depends on what markets do in coming years. Pensions have two-thirds of their money invested in risky assets like stocks, real estate and hedge fund positions. If the next 20 years could be counted on to resemble the 1980s and 1990s, when stocks returned double their historic yearly average, then states would be flush today.


But plenty of market forecasters expect just the opposite -- for America's burdensome debt, aging population and slowing economic growth to reduce stock returns to a crawl. If they're right, states and cities are vastly understating what they owe.


Future stock returns shouldn't enter into the math, says Joshua Rauh, a finance professor at Northwestern University. He and Robert Novy-Marx of the University of Rochester have proposed a new treatment for pension benefits. Post continues after video.

"You'd never say to your bank, 'I'm not going to make my credit card payments because my stock returns will take care of that,'" says Mr. Rauh. "That's what state and local pensions do."


What they should do, say the professors, is to treat pensions like debts that don't allow for default. That would call for math that uses a default-free investment rate, like the rate on U.S. Treasury bonds. Even the longest-maturity Treasury bond pays barely 3% at the moment, or less than half what pensions are assuming for their returns. "The only reason to use a higher rate is if you allow room for future defaults," says Mr. Rauh.


Pension abuses by workers might have have helped create the problem. "Nearly every fire house in the country saves the overtime pay for the guy who's about to retire," says Mr. Novy-Marx. That's because pensions often base retiree benefits on the highest year's pay workers achieve.


Some municipalities have adopted so-called anti-spiking rules to prevent such abuse. "But those only affect new workers," says Mr. Novy-Marx. "It's going to make things cheaper 40 years from now but it's not going to do anything now."


A bigger problem than pension-gaming, however, is "ignoring your bill, and that's what pensions have done," says Mr. Huh.


Not everyone agrees that there's a pension funding crisis. In June, the National Conference of Public Employee Retirement Systems, a trade group for pensions, published survey findings showing that plans were "solidly funded." Among more than 200 funds that participated in the survey, the average had achieved average returns of 8.2% a year over the past 20 years and was now assuming a 7.7% yearly return in its funding math.


Over the past five years, however, the Standard & Poor's 500-stock index, a benchmark for U.S. stocks, has returned 0.25% a year. NCPERS did not respond to requests for comment.


"At the end, what you have is a distributional problem," says Mr. Novy-Marx. State and local governments say they're $1 trillion underfunded, but the truth is closer to $4 trillion. All of the discussion should be about how to distribute that pain."


Possible recipients of that pain, he says, include taxpayers, who could pay more or get less in services; workers, including future hires and retirees, who could have benefits cut; and municipal bondholders, who could suffer defaults if local governments can't pay what they owe.


States are already working on changes. Illinois has raised its retirement age and capped the salaries used in calculating benefits. New York has proposed similar changes. California's governor proposed a shift toward a defined contribution plan. But most of the changes don't apply to current workers.


"Right now everyone is trying to foist the problem on new workers," says Mr. Novy-Marx. "That's politically painless but it has little effect on shortfalls." Retirees account for about half of pension obligations.


The "day of reckoning" won't come for 10 to 15 years, says Mr. Rauh. By then pension accounts will be low on assets and municipal bond markets will react, he says. "As we know from the European debt crisis it's hard to predict when bond investors will panic," he says. "We've known about Greece for a long time, but its bonds imploded only recently."


To prevent such a fate, pensions will have to decide soon how to distribute the pain. "Most of it is going to go to the taxpayers," says Mr. Novy-Marx, "because they're the only ones who can afford to pay."


More on SmartMoney and MSN Money:



Nov 8, 2011 9:38PM
Close out the congress pensions, put them under Social Security like real Americans. I am tired of these inbreed liars in office living off the American sweat and tears while screwing hard working Americans. Give all Americans the same benefits the inbreed politicians have.
Nov 9, 2011 5:10AM
Put politicians on Social Security, make them contribute at the same rate as everyone else (or make them contribute, period) with the same restrictions and watch them make social security what it was meant to be.
You people must be out your damn minds. I don't owe these people a thing. Make the politicians and special interest that got these grand retirement schemes together pay it out of their pay.Angry
Nov 9, 2011 5:18AM

It all boils down to....

Too many people on Fed, State, government payrolls...

The United States needs to CUT the size of government..

In many cases, it needs to do away with many departments..

Cut ALL unneeded spending that waste taxpayers money...

America cant keep borrowing money from China,

 and have ANY hopes of reducing ANY debt...FYI

Nov 9, 2011 5:05AM
From 1977 until 2009 I put away nearly $300,000.00.  Every year 4% of the interest earned was reinvested for me through the employee retirement system, over 4% was put into the state general fund.  I also contributed to a deferred compensation plan with the city.  To this day the State continues to use my money to obtain a better credit rating.  The State also reallocated over 8 billion dollars from the retirement system to raise the amount in the state general fund in the past twenty years.

The interest earned in the eighties and nineties, along with the money taken from the system would have made the Employee Retirement System in Hawaii fully funded.  Don't blame the pensions of retiree's in Hawaii for the shortfall.  The state government has been robbing the system for years.

Nov 9, 2011 1:43PM
Are your frickin' kidding me!!??  The TAXPAYERS are going to have to pay???   I don't think so!  We have lost our money in our 401k's...we have lost our home values....we have bailed out the banks...we are paying pensions to state and federal employeess and WE DON'T EVEN HAVE PENSIONS OURSELVES!!  When did the inmates take over the asylum???  This is nuts!  I can tell you one thing....the day the Government tells us we have to pay more so they can get their frickin' pension is the day they will see a taxpayer revolt!  We all have risk in our lives....if their pensions don't have enough money ... to frickin' bad!  They ain't getting it from me!!
Nov 9, 2011 4:06PM

The fact is that governments have been underfunding pensions for years and have known they have been doing it.  They've borrowed (just like the federal government), and purposely balanced state and local budgets by taking funds from pension funds.  They have known the plans were underfunded, hoping the economy would get better.


You can't blame workers for the stupidity of governments.  People need to sue those responsible for deliberately stealing these funds.

Nov 9, 2011 5:52AM
Every paycheck I have contributed to my pension fund I am not a govt worker I work for a major corporation.  I do not think I as taxpayer should bail out a state fund because they can't balance there fund,  Stop paying Welfare and Supplement SS to people that are to lazy to work.  CA problem is never going to be fixed unless it drops in the ocean from a major earthquake
Nov 8, 2011 5:49PM

They will not default on their bonds they will continue to pay Wall Street, what they will do is stiff the retirees.


Prichard Alabama ran out of money in its pension fund and stopped paying their retirees.  After over a year of no checks they starved the retirees into submission as they agreed to a 2/3rd reduction in what they were getting.


Central Falls Rhode Island told the retirees to either take a 50% pension cut or they would declare bankruptcy and try to end all the pensions for good.  The retirees declined and the town filed for bankruptcy.  There’s no telling how the courts will rule, but the state of Rhode Island passed a law that mandates bondholders get paid before anyone else including pensioners.


Jefferson County Alabama and Harrisburg, the capital of Pennsylvania, recently filed for bankruptcy.


The day of fiscal reckoning has arrived and we can no longer avoid it.  The early results show that retirees and union employees are bearing the brunt of the pain.

Nov 9, 2011 3:09PM
Why should the Government get pensions when the people they serve do not?  Think about it.
Nov 9, 2011 6:38AM
I have been a trustee on pension funds for two decades. Our pensions were funded by our contributions from our paycheck. The IRS has rules that dictate how pensions are set up and adminstered. We made enough return on our investments during the 90's to pay for our future liability but the IRS made us change our plan because it was overfunded if we had not made those changes we would be in good shape. Blame the IRS for the condition of Americas pensions.
Nov 9, 2011 6:26AM
I had my pension taken away, and there is no way in h*ll, i'm gonna pay more taxes so all these not needed government workers can retire better than I will be able to. They should have to fund their own 401 just like the rest of us who bust our a**'s to get nowhere!
Nov 8, 2011 9:31PM
The latest GOP proposal out of dysfunctional Congress .. increase the deficit by 4 trillion dollars over the next 10 years, cut the social security benefits, tax the poor more by about 15% .. and call it a job well done.  Fire up the BBQ .. because we have a whole flock of turkeys in Congress.Angry
Nov 9, 2011 9:09AM

I would like to know where these so called private sector jobs what pay so much more than public sector jobs are or were. Because I was never able to find one.. Now THEY want to privatize  Medicare? OMG what next....  retirement @ 99 ?


Nov 9, 2011 6:07PM

Re: the post of givemeabreak69


"Granted it appears we have a lot of time off, I work 10 days a month as a firefighter. But my work day in hours is equal to 3 of the normal persons work day.  I work 240 hours a month.  The average person who works 8 hrs a day 5 days a week in an average month only works 184 hrs a month."


Give me a break!  You "work" 10 days a month  or 24 hours a day.  Using your words, "Really"?  When do you sleep in each of these 24 hour days.  Again, using your comparison of working 240 hours a month to an average worker's 184, that's 23 days for the average worker. No one is paying me to sleep. That's done on my own time.  I also have travel time to and from work 23 times a month as compared to your 10.  As to the other 160 hours of monthly "work", as a firefighter, you go to the gym, watch TV, go to the store to buy your food, probably run other errands "while you're at the store", etc.  use your down time to do all the things I have to do on my own time, time for which I'm not getting paid and using my own vehicle which requires $3.60 per gallon gas, insurance, registration, etc.  You guys engage in "boot drives" for MD - what - while you're on the clock. And you are hailed as giving back to the community.  Hogwash. With 20-21 days a month off, you easily could participate on your days off but, hey, if you're not getting paid, your community spirit evaporates.


Plus, especially where I live, many of the firefighters don't even live in the municipalities where they are employed so they don't  contribute back in the form of property taxes, etc.  I've spent over 20 years at the same job, but can't retire with a guaranteed liveable amount of money.  No, I had to personally save for my retirement- 401-K and IRA- and who knows what that will be worth and how much monthly income that will generate when I finally can work no more.


Working 2 jobs because you have to?  Again, please.  Working 10 days a month gives you  about 3 weeks off.  You work other jobs and start businesses because you can, you want the money, and  you have the free time - plus, many of the businesses you start have to do with services or contracts with the city or county because you have an inside.  What about education?  Did you have to pay for your training like a doctor, lawyer, scientist, hey, even a teacher, etc.?  Do you have debt because of education costs? Do you have to pay for your "work clothes" like I do?  No, it's paid for by your employer - me, the taxpayer.  I could go on and on but what's the point.  You feel entitled.


Personally, I respect what you do when you work. I think you should be fairly compensated, but not to the point of making several times more than I do with cadillac benefits and with a miniscule to non-existent chance of getting fired for anything.  However, when you start whining about how overworked you are, how bad the pay and benefits are and how you are so taken advantage of, I am offended.  My employer says "If you don't like it, there's the door."  You, on the other hand, strike and scare people with images of catastrophe.  Unconscionable and immoral.  If your job is so bad, why is the line to get one so long?  Of, course you could always quit (before your guaranteed lucrative retirement off the backs of the taxpayers starts), let someone who would appreciate the job have it and join the rest of us in the real world.

Nov 9, 2011 9:51AM
I would like to know who will support everyone's underfunded pension fund that went along with the economic failure a few years ago?? It doesn't sound fair that the taxpayers should have to fund this also along with the other failures.
Nov 8, 2011 7:18PM

Turning the clock back say the mid to late 1970's. All and prior to 1970's We still had a middle man and an average wage earner could afford to buy a home and raise a family. I blame the first oil embargo of that era for not long after housing start it's first incline and into the 1980's and there has been no looking back. You mess with fossil fuels you pay the price. Since everything to the last nut and bolt has been on a continuous rise. The middle man as become instinct. We have priced an average wage earner form a home. We have developed a monster in our society and no one what's to take it by the horns. We vote the so called best into our Government. They tell is to tighten our belt that we are living beyond our means. Heck look at the mess they got us into. How do they expect an average Joe to do it when they can't control and run is into an horrendous debt. Housing is to high, many wages instead of a middle of the road are out of this world. What our parents and theirs took a life time to build. In just a few decades we have taken it down. The future generations scary.

Nov 9, 2011 9:31AM

To prevent such a fate, pensions will have to decide soon how to distribute the pain. "Most of it is going to go to the taxpayers," says Mr. Novy-Marx, "because they're the only ones who can afford to pay."


Yeah.  Right.  What kool-aid is this guy drinking.  Why should taxpayers shoulder this debacle?  Oh, yeah.  We're rich.  We can afford it.  One day, these clowns will go to the well and t will be dry.  That day is fast approaching.

Nov 9, 2011 11:16AM
Richard H, you have it right. People in this country are being encouraged to point the finger at each other rather than  look upwards to where the financial crisis began. Social security and pensions were completely funded, the problem is that politicians got their fingers into the savings accounts. Now they want to place the blame on senior citizens, the poor and children. nice bunch...
These accounts were non different than whole life insurance policies/annuities that people pay into for decades with an expected return for their senior years. So do people consider annuities to be "entitlements"? Of course not. Because they are not. Just the same way social security and pensions are not.
The major banks and corporations of the world OWN our politicians. They own the media. They own the base little trolls that post online trying to get the 99% of us to blames each other. Look upwards to see where the problem originated, not the retired fireman down the street that placed his life on the line every day that he worked in order to save yours-

Nov 9, 2011 9:47AM
Not all public safety pensions are underfunded.  I am a firefighter for a large city and our pension is 100% funded.  I also pay into my pension every paycheck.  The majority of pensions are underfunded because the politicians robbed from them to cover the cost of other city expenses.  It is not the public employees fault that the government officials charged with managing the pensions were not fiscally responsible back in the day.  

Not sure if all pensions are like this but ours is based on 32 yrs of service.  If I work 32 years I get 74% of the pension base.  Anything less than 32 years and it drops down to 50% at 20 years of service.  And as mentioned in the article about overtime being saved for those guys who are retiring to drive up their retirement benefit, ours is not that way and many are not.  Your amount is based on the pension base and the years of service and the percentage awarded to that time of service.  Yes, some are like mentioned in the article but more are not.

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