StanCollender'sCapitalGainsandGames Washington, Wall Street and Everything in Between

My New Year's Resolution -- Stop Underfunding My Retirement Plan

02 Jan 2011
Posted by Andrew Samwick

Happy New Year to everyone.  I am happy to be back from my holiday blogging hiatus.  And this week, I go back in the classroom to teach a course on local public policy.  One of the biggest challenges facing states and localities at this moment is the underfunding of defined benefit pension plans for public sector workers.  According to a recent editorial in The Christian Science Monitor (citing work by Robert Novy-Marx and Joshua Rauh):

By this spring, many states will run out of the $217 billion in stimulus money from Washington. (Illinois is already a deadbeat in paying bills.) Their budget woes will only mount as joblessness persists and politics prevents solutions in state houses.

Most of all, they face an estimated shortfall of $3.23 trillion owed to pension plans for current and retired state workers. Municipalities have an estimated $557 billion in pension liabilities. That adds up to about a quarter of the yearly US economic output.

If you have had your RSS reader set to Mary Williams Walsh of The New York Times, then you have seen this crisis coming for quite a while.  Her reporting has been excellent for many years now. 

There is nothing inherently wrong with a defined benefit pension plan, but its implementation has been a challenge in both the public and private sectors.  It is a promise to pay compensation in the future.  To honor that promise responsibly, the plan sponsor needs to fund it adequately in the time interval between when the promise is made and when it is kept.  Simply put, that hasn't been happening in large private sector plans and in most public sector plans.  The problems are worse in the public sector because voters don't pay as much attention to the financial bottom line as shareholders do and because the accounting standards are sharper for private sector plans than public sector plans.  For many years, elected officials have been making promises that future (now, near-future) taxpayers are not going to want to keep. 

It will be interesting to see how this plays out.  The editorial cited above makes a good point -- there should be no federal bailouts of state and local public sector pension plans.  To the extent the federal government wants to get involved, it should offer loans, not bailouts.  Ideally, these loans would have the highest seniority in the borrower's capital structure and be made at penalty interest rates.


I dont want to see any bailouts and I buy muni bonds pretty much every day of the week for clients. And I was for the financial bailouts. Politicians need to stop making promises that cant be kept. Living in NY is horrendous with this nonsense. I'm not against pensions but I certainly dont get one at work so I need to fully fund my own ( via 401k ) each year. Now I realize I'm fortunate which is why I understand the what's good about them since I dont have one but enough is enough.

My brother is a Police Officer and he can retire after 20 years and then go to the private sector and that's nonsense.

If loans are made then reforms better be a condition of the loans. No loans made unless reforms are made first

Compare funding to pay

Compare funding to pay contractual obligations to ordinary workers on the one hand to money volunteered to financial institutions so that they can pay massive bonuses, on the other hand. Compare responsibility of said ordinary workers for current economic conditions to responsibility of the bonus recipients.

Dividing the Middle Class

Another issue used to divide the middle class and have us take our eyes off the true villains. "Everybody knows" that bailouts are not for the middle class. Only the super wealthy are eligible for those trillion-dollar bailouts. We must stand at the ready to again throw money at them the next time they take down the world economy.

Pension crisis is widespread, what to do?

Your resolution to fund your account this year is emblematic of the problem. Voluntary retirement saving does not meet the need.

The 401k/IRA/Roth experiment to move retirement risk to the individual has succeeded in moving the risk off corporate balance sheets. It has succeeded in greatly expanding the fee income of Wall Street. It is an abject failure in terms of replacing defined benefit plan streams of retirement income.

Voluntary retirement saving has failed for private sector and public sector workers. The current drumbeat against pension plans is increasing the fear level of boomers. What does this do to aggregate demand?

We need to expand Social Security to add a new mandatory retirement savings component to bridge the gap. Let's call it Social Security Plus.

Social Security Plus should be funded by a new tax that is more broadly based than SS. For example, it should be levied against carried interest and should not have a cap. It should also allow employees to use their existing 401k/IRA/Roth or cash to voluntarily buy into SS+. Participants should be offered a straightforward plan of benefits in return for optional funding. SS+ should be invested broadly. The assets should be held outside of the federal government accounting system so it is not used to minimize the deficit. The SS+ pension authority should be set up to work independently of the federal political system. For this to work, it cannot be handed over to Wall Street or to the politicians.

Happy New Year to all and best of luck with your catchup retirement funding!

I wonder what the cost of

I wonder what the cost of military pensions is? My brother (friend) is a Police Officer (retired military officer) and he can retire (retired) after 20 years and then go to the private sector and that's nonsense.

Funny how the same people who

Funny how the same people who assured states and municipalities that they could greatly reduce scheduled payments into these pension funds ("the market always yields 10%+!") are now pushing those same pension funds to default on their obligations after a decade of short contributions. It's *almost* like they had a plan to completely disintegrate the public sector...

IMO, since we were "obligated" to allow the Big Banks to cut billions of dollars in bonus checks using taxpayer money to the fools who nearly destroyed the economy because it was a "contractual requirement", then there's no reason why these pensions shouldn't merit at least the same consideration.

There are 3 kinds of risk with pensions

Employers moved from defined benefit to defined contribution to remove the risk from underestimating the expenditures that will be required. Employees earned more than estimated and lived longer. Then employers moved to defined contribution plans and employees assumed the risk of underestimating retirement needs.

But defined contribution plans contained the return risk. When the stock market tanked in 2008, many employers who thought that they had fully funded plans discovered that they were in error. Then employers moved to 401(k) type plans where the employees assumed the investment risk.

The problem is that employees are, as a group, very poor at estimating risk. But now employees have been saddled with that very task.

The next step is to place the initial funding on the employee. But employees are very poor at weighting short term vs. long term economic needs; just look at current savings of the Boomer as we approach retirement.

Combine the above with the attacks on SS and Medicare, and you begin to see the re-emergence of poorhouses and elderly beggars in America.

There is nothing inherently

There is nothing inherently difficult about the pension funding problem. Insurers fund deferred annuities all the time. They sometimes go broke, but usually make okay investment decisions, and keep their promises.

Hmmm. Fund . . . okay investment decisions . . . keep their promises. Maybe the persons making the investment decisions should be obligated to keep their promises? Like the directors and officers of the entity promising the pension?

Simple Question

Whine about Wall St bailouts all you want. How much of Wall st bailouts went to bonuses ?

Also while everyone is at it another simple question. Since I dont see anyone whining about private companies not having pensions ( unless they are affected directly because they dont have one ) what would happen if public pensions had to be funded immediately ?

Answer is a public revolt. Because we couldnt afford it. Politicians promise things we cant afford and pass ot on to the next generation or the next candidate.

Public companies answer to shareholders immediately which is why they are doing away with them.

I wish I had one but lets be real here. There are benefits being offered that cant be afforded.They need to be modified ( and it doesnt need to go to a 401k style plan which people here are crying about )

Yes, let's be real here

What are people going to live on in retirement? If they keep working later in life, where will the jobs be for rising generations? Telling people to be real doesn't cut it. The 401k model has failed. How do we respond as a nation?

The lack of an adequate retirement income is a problem for private sector workers. It needs to be addressed. Benevolent father CEO is not going to take care of us.

Income distribution may be at fault.

For several decades since WW II workers put in their 25-30 years and received a pension in both the private and public sectors. That was the normal expectation. The pension was deferred compensation that workers had always taken into account when evaluating the $$ value of a job. It was also a time when income was more evenly distributed than is now. Possibly there is a relationship between the pension crisis that was building opver the past tne or twenty years, but now seems suddenly upon us. maybe the distorted income distribution as it is is the result of both stagnating wages and inadequate pension plan funding. The distortion of distribution is so great as to be unlikely to be supported by only current income and requiring the withholding of future income as well.


The problem is in some ways similiar to social security. When you have people living longer they are collecting longer which raises costs dramatically. Also when you have dumb rules like being able to retire after 20 years or even 30 year and start collecting pensions and then they turn around and take other jobs in the private sector while they are collecting on their state/local pensions that's a big problem.

When you have employees jucing up their overtime the last few years before they retire because their pension is based on that small sample size that's another problem. Just look at long island railroad workers. All these things add up

I've always been skeptical of

I've always been skeptical of the accounting involved.

Background: I am a public employee in a unit that had a perennially 'overfunded' pension plan (UCRP). In 1988, the overfunding, by actuarial measures, was sufficient that both employee and employer contributions were stopped. Year after year, we kept hearing that the plan was not just fully funded, but so overfunded that adding money would lead to Federal penalties.

After the 2000 market crash, the plan, we were told, was _still_ overfunded. The university faculty were dubious, and began asking that contributions be restarted, even at a slow level, to ensure the plan's long-term viability. But the Regents and the state kept on insisting that this was impossible: overfunded!

By 2005 or 06, voices calling for restarting contributions became louder. Nevertheless, the 'responsible' parties refused, saying, once again, that the plan was fully funded. Only after the 2008 crash did that turn out to be nonsense. Not only was the plan not overfunded, it suddenly showed vast and rapidly rising deficits. An EMERGENCY. We need contributions, rising rapidly (employees 2%, employer 4% now; 3.5/7% next year; 5/10% in two years, going even higher). Even so, the plan is not viable. New employees need a less generous plan! No new enrollments. Turn it into a 401K!

Now, this is a generous but not imprudent plan. The plan did not go through the distortions that affected CalPERS and many plans in the late 90s and early 00s. No last-year stuffing with overtime. Vesting is 5 years, but full service credit takes 40 years. Minimum retirement age 50, but full age credit at 60. Pension based on average of three highest-compensated years. Federal limits on maximum pensions (what some greedy executives, who already have a super-dooper supplementary plan, are now suing over).

So, what happened. How could the experts who told us the plan was fully funded as late as 2007 now tell us that it's catastrophically underfunded in 2010? To be sure, the crash mattered, as it should. But pension accounting is supposed to be long-term, no? Don't models take account of possible major market fluctuations? Why should I believe any of the projections?

Why should I trust accountants when they did such a miserably bad job on this plan?

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