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The True Crisis Over Public Pensions

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Public pensions have gotten a huge amount of attention ever since the city of Detroit declared bankruptcy last month. Concerns have focused on whether pension funds can generate adequate returns to support their long-term payouts while maintaining their promised benefits, especially in light of the many recipients who aren't eligible for other forms of financial assistance, most notably Social Security.

Some analysts, including Fool contributor Morgan Housel just last week, don't think the pension crisis is a crisis at all. They argue the pension crisis has gotten blown out of proportion, with investors and workers all overreacting to the financial stresses that the 2008 recession and market meltdown put on the pension system. As those stresses have lessened, the argument goes, pension funds will see their conditions improve.

One study from the Center for Retirement Research strongly supports the non-alarmist point of view, with hard evidence that the measures that state and local pension funds have taken to shore up their finances will ensure their survival. But the way in which those conditions will improve will itself have big ramifications for employees, potentially causing a retirement crisis among workers who were led to expect much more from their pensions.

When the cure is worse than the disease
The CRR study took a look at 32 pension plans across 15 different states to see exactly what responses the plans made during the financial crisis. Far from concluding that all pension plans themselves shared the views of CalPERS CIO Joseph Dear that "there is a reasonable basis to be confident" about the poor performance of its pensions, all but three of the 32 plans have made at least some reforms.

The most popular reform, made by three-quarters of the plans, was to adjust age and tenure requirements. Most of the plans did so on a new-hire basis only, but four plans made adjustments for all employees. Similar changes to the average salary period used to measure pension benefits and reductions in the benefit accrual factor were largely targeted at new hires, although some existing workers were also affected.

Yet several of the measures had a major impact on longtime workers. Of the plans, 14 increased the amount of money they require employees to have taken out of their paychecks in order to cover their pension costs, with most of those doing so for all employees. For instance, the Texas Employees Retirement System boosted employee contributions by a full percentage point, raising withdrawals to 7%. Also, reductions in the way that benefit payments reflect cost-of-living adjustments hit 15 of the plans, again with the majority of those imposing COLA changes on all employees and even on current retirees.

Solving one problem, creating another
From the perspective of the plans, these reforms have been wildly successful. The CRR now estimates that pension costs as a percentage of state and local government budgets will actually fall over the long run, as reform efforts have an increasingly large impact over the next 15 to 35 years. One big question remains whether future returns will live up to expectations, especially as public pensions have followed the moves in past years by private companies UPS (NYSE: UPS  ) , Ford (NYSE: F  ) , and Lockheed Martin (NYSE: LMT  ) by increasingly raising allocations to bonds in their respective pension portfolios. But despite some sensitivity to return assumptions, the CRR study found that governments would likely be able to absorb some deviation from expected returns.

But the more important issue is how, for workers, falling benefits and increased contributions add up to increased economic pressure now. Even the CRR study acknowledges that plans won't necessarily stick with reforms in the long run, instead bowing to increasing public pressure to expand benefits once again after the economy begins to improve more strongly.

As a result, the true crisis over public pensions might well come not from the financial condition of the plans themselves but rather from the shock that future retirees face when they realize that the benefits they had hoped would sustain them prove inadequate to the task. For workers with enough time before they retire, personal financial planning of their own can help them overcome their new challenge. But no one should dismiss the cost that employees are increasingly bearing in efforts to shore up pension-fund finances -- even if public pensions eventually do get a clean bill of health as recent stock market gains take hold.

You need to take your own responsibility for your finances in light of pension-plan troubles. In doing so, your best investing approach is to choose great companies and stick with them for the long term. The Motley Fool's free report "3 Stocks That Will Help You Retire Rich" names stocks that could help you build long-term wealth and retire well, along with some winning wealth-building strategies that every investor should be aware of. Click here now to keep reading.

Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter @DanCaplinger.


Read/Post Comments (5) | Recommend This Article (4)

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  • Report this Comment On August 12, 2013, at 5:06 PM, mdk0611 wrote:

    There will be costs to the employees, but the change in retirement age and the calculation of benefits is not necessarily unjust. Even Robert Reich has pointed out that reforms were needed to prevent "pension spiking" and the problems it created for public pensions. And some of the ordinary retirement ages were unrealistic given the current longevity of the work force.

  • Report this Comment On August 12, 2013, at 6:47 PM, devoish wrote:

    "Approximately 80 percent of full-time employees of firms with more than 100 workers were covered by a pension throughout the 1990s compared to only about 45 percent of employees in smaller firms and 95 percent of state and local government workers". - US dept of Labor

    "In 1975, 88 percent of workers with workplace retirement plans had defined-benefit pensions". - Wa, Post

    Those people are retired and living off SSI and defined benefits today. - Steven

    "Today, more than half of U.S. workers have no workplace retirement plan. Of those who do, just 35 percent still have defined-benefit pensions.

    So only 17% of all US employees have defined benefits, down from almost 70% - Steven

    A 2010 survey by the Federal Reserve found that the median amount saved through 401(k)s by households approaching retirement was $100,000 — not nearly enough to support those households through retirement years, as seniors’ life expectancy increases". - WaPost

    I would say that on his or her own, over the last thirty years the American employee has been no match for their employers and his financial advisers, aligned with a "business friendly" and "right to work" government.

    Best wishes,

    Steven

  • Report this Comment On August 12, 2013, at 7:16 PM, SkepikI wrote:

    ^ Steven - I don't know if you live anywhere near Detroit, but you would do well to pay it a visit and reflect on what happens when public employees control and over match their "employers". At least in the US when pension and crony hires and crooked dealings eat up what should have been spent on services, you can still move out...

    Its too late for many boomers since FICA, and other mandatory fees have siphoned off enough to have made their retirements comfortable (presuming they would have saved or invested it, a big presumption)

    But I can say for myself that my sacrifice and investments over 40 years have paid off so I have enough with my tiny private pension to make it by even if the gov screws me out of the over 100 K I put into FICA, which by my calc would be worth about 5 or 6 times as much. Hmm I wonder if thats why they stopped sending the paper statements last year...sort of like waving a red cloth at a bull....

  • Report this Comment On August 12, 2013, at 9:44 PM, devoish wrote:

    Sorry Skep,

    The only reason most Americans have their SSI is because the financial industry cannot touch it.

    Without mandatory deductions that money would go out into the economy today and the financial industry would bid the cost of living up 15% higher and employment still wouldn't pay.

    Best wishes,

    Steven

  • Report this Comment On August 13, 2013, at 11:09 AM, CTobe wrote:

    The Pension Crisis is overblown in about 3/4 of the cases including Detroit. However in Illinois and Kentucky which at 27% funded is the worst state plan we have issues that I write about in my new book Kentucky Fried Pensions

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Dan Caplinger
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Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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