If I believed it was so, I’d be writing that there’s no retirement problem looming over us.
But there is a problem, and you and I alone cannot fix it. I’m not sure it’s fixable. All we can do is be aware of it and at a personal level, figure out ways to survive it.
As I tell people who enroll in my online school about retirement, no one is going to show up at your front door with a bucket of money so you can pay your bills and enjoy financial freedom.
You either have to find more money, find ways to reduce your cost of retirement, or accept the inevitable disappointment. Many of you have worked for a large employer where in years past, they put in place what is known as a defined benefit retirement plan.
Based on how long you participated, your income levels as an employee, and a few other metrics, you qualify for a stream of income when you qualify for retirement. On one hand you’ve been a loyal employee, doing what you were hired to do and on the other hand your employer held out a carrot that said they would contribute to a plan with your name on it.
The bargain agreed to was if you meet certain criteria, they in turn would pay you a retirement ‘reward’. In too many cases, employers haven’t lived up to their side of the bargain and there’s not enough money in the plan with your name on it. That has huge implications for you when you get old enough to retire.
Is there a solution? What does it look like? Will it actually work? Meanwhile, every day you get a little older and less able to enjoy life with no money.
by John Mauldin \ May 20,, 2019
A decade ago I pointed out that public pension funds were $2 trillion underfunded and getting worse. More than one person told me that couldn’t be right.
They were correct: It was actually much worse. It has gotten to $2 trillion and much worse in just a few years.
Note that we are talking here about a specific kind of pension: defined benefit plans. They are usually sponsored by state and local governments, labor unions, and a number of private businesses.
Many sponsors haven’t set aside the assets needed to pay the benefits they’ve promised to current and future retirees. They can delay the inevitable for a long time but not forever. And “forever” is just around the corner.
The numbers are large enough to make this a problem for everyone, even those without affected pensions. The underfunded pensions could also be one of the triggers to the unprecedented credit crisis I see coming in the next five years.
The problem is “solvable”… but the solutions will be problems in themselves.
The Funding Gap Is Actually Much Bigger than Reported
A defined benefit pension plan knows it owes a certain number of retirees certain monthly benefits for life. Their lifespans are quite predictable when the pool is large enough.
From that, it’s simple math to calculate how much money the plan should have right now in order to pay those benefits when they are due. But then the assumptions start.
The plan must presume a future rate of return on the invested portfolio, an inflation rate, and in some cases future health care costs (medical benefits are part of many plans).
So, when we say a plan is “fully funded,” it may not be so if the assumptions are wrong.
Almost all public pension funds assume investment returns somewhere around 7% (and some as high as 8%+). That’s highly unlikely due to the debt we’ve accumulated, and debt is a drag on future growth.
If you make more realistic assumptions on future returns the unfunded liability becomes $6 trillion according to the American Legislative Exchange Council.
A more conservative and realistic approach would force the state and local governments to fund those pension plans at a much higher level. They have only two ways to do that: either raise taxes or reduce services.
That may be the reason policymakers have turned a blind eye to this.
Pension Fund Underfunding Is Also a Local Problem
Another problem is that the taxpayers who might have to cover these amounts are mobile. They can move to other states with lower tax burdens.
And to make it even more interesting, the beneficiaries often no longer live in the states that pay them. Retired public employees from the Northeast might live in Florida now, for instance. They can’t even vote for the people who govern their incomes.
The broader point: As with the federal debt, some portion of this unfunded pension debt is going to get liquidated in some way. Any way we do it will hurt either the pensioners or taxpayers.
The Future Looks Grim
The most common solution to this problem so far has been cutting services in the hope no one notices.
It is happening nationwide but California takes the lead, thanks to its massive pension debt. This is from a recent Brookings Institution note.
Pension and health-benefit costs are bending education finances in California to their will. The sheer magnitude of the rising costs is staggering. Large numbers of school board officials who participated in our survey indicate that the rising costs are meaningfully affecting educational services. For example, many report making cost-saving changes to district budgets that include deferred maintenance, larger class sizes, and fewer enrichment opportunities for students in response to rising pension and health benefit costs.
So in effect, today’s students are paying to keep benefits flowing to retired teachers and administrators.
Meanwhile, the Berkeley city council is taking criticism for prioritizing pension payments ahead of public works projects.
Voters approved bond issues supposedly dedicated to infrastructure but the city is apparently not doing the work.
Nor is it just California.
Bank of America analysts found an inverse relationship between infrastructure investment and pension fund contributions. Each additional $1 billion in plan contributions takes away about $2.5 billion from state and local government investment.
We have multiple parties fighting over pieces of the same pie, all hoping that Uncle Sam will step in and save them. Uncle Sam may well do it, too, but it won’t remove the pain.
It will just redistribute the burden, perhaps more widely, but the aggregate amount won’t change.
I see this leading to some kind of Japan-like deflationary recession or debt monetization. If we’re lucky, it will be mild and long. It won’t be fun but the alternatives would be worse.
I predict an unprecedented crisis that will lead to the biggest wipeout of wealth in history. And most investors are completely unaware of the pressure building right now.
The source article is here: https://tinyurl.com/y2m3bu5w