American workers expect to work longer than they used to — 27% say they’ll retire at age 70 or higher and 7% say they’ll never retire. They also voice jitters over retirement income and expect to rely on several sources during retirement: 56% expect to have a traditional (defined benefit) pension; 72% expect to use an employer-sponsored savings plan; and 64% expect to have an IRA. Far more expect to work in retirement than actually do so.
Recently, long term interest rates are so low and that they undermine the yields available for growing pension funds. This factor thwarts fund managers of both private and public-sector pensions. But ordinary employees who allocate contributions within sponsored savings plans, 401(k)s and IRAs face the same challenge. Employees check the level in their retirement accounts, and can gauge how far away they are from their target. But gauging the funding level behind their expected “pension” is tougher.
Public sector state employees’ pension funds total about $3 trillion. Estimates of their funding shortfall run between one-half trillion and $2 trillion. Underfunding varies by state with a few states that are 95% or better funded and 12% are funded at less than 60%. Those with large funding gaps generally behave badly on a regular basis, e.g.; failing to make required contributions or picking a too-low discount rate. Making good on their pension obligations will be painful for state taxpayers. Illinois is a basket-case example. Assuming it can earn 6% on assets, Illinois will need to raise pension contributions from 8% of total state budget to 14% of budget for 30 years. Delaware would need hike to its contribution by only 2% of state budget.
Horrors of this magnitude will awaken political factions who want everyone to be equally miserable, even though the pain was self-inflicted. We can expect to hear calls for socializing this problem over the next few years as state and local governments struggle to balance their budget. We may hear calls even sooner to compensate for lower block grants stemming from a fiscal cliff dive.
In the private sector, employee pension account funding totals $2.2 trillion and the funding gap is $388 billion. Low interest rates will continue to confound private sector pension fund managers looking for growth.
Those responsible for underfunding of defined benefit pensions can be forced into compliance unless they are bankrupt. If they are bankrupt, the Pension Benefit Guaranty Corporation (PBGC) tries to protect beneficiaries from the worst of outcomes. PBGC assures they receive at least some pension, albeit lower than they may have planned. As pension plans migrate to the defined contribution format, a cost squeeze on those that remain a defined benefit plan is likely. PBGC is funded through premiums on defined benefit plans that cover 34 million workers. Despite being private, if it fails, we can expect it to join the “too big to fail” club. Hopefully, that is a problem for another decade.
Alan Daley is a retired businessman living in Florida and following public policy from a consumer’s perspective.