If you are relying on a pension to fund your retirement, you may be headed for a downgrade. There’s a new study that shows the deficit for public pension funds took another giant leap higher. Researchers say the gap is now $1.4 trillion dollars, and it’s growing. They say government intervention is needed to eliminate the shortfall but there’s no “one size fits all” solution, and most options are also painful.
Researchers for Pew Charitable Trusts looked at data from 2016 to analyze funding levels for all 50 states. They say total pension liabilities are $4 trillion dollars, but that state plans only have about $2.6 trillion to cover those obligations. That leaves a gap of $1.4 trillion. But even worse, the deficit in 2016 was about $300 billion more than it was in 2015, because pension deficits are growing. (1)
Pension Fund Hole Is Growing
One reason the total deficit grew so much was a lower-than-expected rate of return on investments. The median assumption was 7.5% but the median return was only about 1% in 2016, according to Pew. That added about $146 billion to the gap. There were also changes in the way that some states calculated their rates of return.
Even if those two things didn’t happen, the Pew analysis says that states are not putting enough money into their funds. State and local governments only contributed $96 billion in 2016. That’s $13 billion dollars less than they should’ve provided to keep the deficit from getting larger.
Pew researchers expect that 2017 investment gains will improve the situation, once that data is known, but governments also need to provide adequate funding as well. They say that policy changes are needed and funding levels increased, to make sure pension funds can keep up with a surge in retirees, and longer lifespans.
Average Funding Level Just 66%
As it stands, the average funding level for all 50 states was only 66% in 2016. Those funding levels vary dramatically from state to state, however. The two states with the very lowest funding levels were New Jersey and Kentucky at just 31%! Illinois isn’t much better at 36%. Connecticut is 41%. A total of 23 states have less than the average two-thirds of what’s needed to fulfill their pension promises to retirees.
That’s scary stuff if you are relying on those checks! And the Pew estimate on the total deficit is very low compared to one by Moody’s Investors Service. That one says that state and local pensions are underfunded by a whopping $4 trillion dollars.
So how did we get to this point? The Wall Street Journal article brings us back to the start of pension funds right after the U.S. Civil War. New York was the first city to create one, to help pay for injured police officers, and then firefighters. The idea spread, and was adopted by other states and local governments in the early 1900s. But one of the primary reasons they came into being was that governments wanted to negotiate lower wages so they offered to make up the difference with pensions and retirement security. (2)
Pension Cutbacks
The current prospect of pension cutbacks has left many people feeling betrayed. Former firefighter Paul Grenon told the Journal, “It’s not only a financial thing. It really gets you sick mentally and physically to go through something like this. It’s a betrayal, as far as I’m concerned.”
Many municipalities also promised bigger pensions when the economy was booming. But as we know, those boom cycles don’t last, and government reserves can plummet. The Pew study found that public pensions lost roughly $35 billion in assets between 2008 and 2009. And while they lost money, liabilities also surged more than $100 billion a year.
Puerto Rico is a good example of what can happen when there isn’t enough money to go around. The island nation filed for bankruptcy in 2017, and the reorganization plan calls for a 10% cut in some retiree pensions. The issue is still under debate, but it’s also a very real scenario.
The Journal points out that California is dealing with several court challenges to a long-standing rule that prohibits any cuts to pensions. According to the Pew study, California can only cover 69% of its pension obligations right now, so it needs to do something. Pension cuts are one way to help resolve that deficit, depending on the outcome of those court cases. (3)
The city of San Jose has already gone through a drawn-out battle to reduce police pensions, and it backfired. Voters had approved the cuts back in 2012, but the city was then plagued with an exodus of police officers, and a corresponding increase in crime. The mayor denied a correlation with the pension cuts, but the cuts were eventually reversed and the city realized savings with changes to police health benefits. Mayor Sam Liccardo told the Journal that, “This is medicine that hundreds of cities and many states are going to have to take.”
Big cutbacks may not affect younger folks. They have lots of time to switch gears, and find other ways to fund their retirement. Older folks won’t have that timeline, but real estate investments could help, especially if you find rental properties that cash flow.
This is why RealWealth promotes the benefits of real estate. It too can have its volatile moments where property values fluctuate, but if you get into the rental business, and you have a property that provides a monthly income, chances are that income will continue even during an economic downturn. It’s a good hedge against inflation and an uncertain future for pension funds and other entitlements like Social Security and Medicare.
Links:
(2) The Wall Street Journal Article
(3) Pew Trusts Study
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