Monday, October 5, 2015

Lessons for Individuals from the Current $1 Trillion and Constantly Increasing Public Sector Pension Funding Fiasco

Individuals are wisely and properly encouraged to save and invest from an early age until retirement. Of course, the overwhelming and stark evidence is that far too many Americans don't bother to heed that sage advice.

The problem represents a 3-fer in that (1) we don't begin to save early enough, (3) we don't save enough when we do begin to save, and we don't invest wisely for the long haul that which we do manage to save and invest. That negative trifecta creates huge problems for us upon reaching oldster status along with unnecessary bouts of anxiety during our working years.

Although there are countless teachable examples from which we can and should learn, how many of us will learn those valuable lessons in time to do something about it? That's the question.

Connecticut, America's Richest State, Has a Huge Pension Problem describes the state's pension funding debacle and serves as a useful reminder of what's happening in other states and individual families as well:

"Connecticut has roughly half of what it needs to pay future retirement benefits for its workers . . . with financial distress rivaling that of Kentucky or Illinois. . . .

Connecticut’s surprising pension predicament shows how even the wealthiest parts of the U.S. are struggling to keep pace with ballooning retirement obligations that now amount to $1 trillion nationally.

Connecticut’s unfunded pension liabilities more than doubled over the past decade to $26 billion as the state’s retirement system reeled from inadequate state contributions, a subpar investment record and longer lifespans for its retirees. . . .

Some Connecticut officials and union leaders said they are unfazed by the pension problems and pledge to reverse the deficit in the coming decades. Their strategy hinges partly on predictions the various state retirement systems will be able to earn 8% or more annually, a goal that is more optimistic than most public pensions across the U.S. The average target for all state plans is 7.68%, according to the National Association of State Retirement Administrators....

Connecticut’s pension gap developed as a result of decisions made over decades to scrimp on payments when the economy sputtered and to cut taxes, according to state leaders and public-finance experts. And there is a quirk: Connecticut officials contributed almost no money to the state’s various public pensions from the late 1930s until the early 1980s, meaning little had been saved up because the state had chosen not to prefund the retirement system for future payouts....

Connecticut only has 51.9% of the assets it needs to pay future obligations to workers, lower than all states except for Illinois and Kentucky, according to the National Association of State Retirement Administrators.

Connecticut has scaled back pension benefits in recent years, reducing cost-of-living adjustments for retirees and pledging to make the appropriate annual payments to fully fund the system by 2032. State officials have raised taxes twice since 2011 as a way of covering some liabilities, reduced its workforce by more than 3% and held back on deeper spending on education and local aid.

Connecticut now allocates 10% of its budget to paying down unfunded pension obligations, up from about 7% four years ago . . . ."

Summing Up

(1) For several decades, Connecticut didn't set aside and invest funds to cover its growing pension liabilities. That has proved to be an unaffordable oversight.

Of course, too many individuals make exactly the same mistake by not saving and investing early in their careers.

(2) Connecticut assumes it will earn 8% annually on its pension investments going forward. That's highly unlikely to happen unless 100% of the funds are invested continuously in stocks, which they won't be.

In other words, that 8% assumed rate of return on a blended portfolio of stocks and bonds is a pipe dream.

Bonds will have difficulty earning much in excess of the rate of inflation over the next several years, and the annual rate of inflation will probably be 2% or lower. Thus, any investment in bonds will seriously restrict overall portfolio investment returns.

A blended total return of 5% to 6% is a much higher probability than the assumed 7.68% to 8% rates assumed by most states. That will mean annual large funding shortfalls for the pension funds over the next several years.

(3) The states won't make big enough contributions to offset the shortfall in earnings, and the shortfalls may result in adding several hundred billion dollars to the current $1 trillion funding hole.

All this means one of two things: lower pensions or higher taxes are ahead for many states, including Connecticut, Illinois and Kentucky.

Here's the real point: individual families should be forewarned and forearmed.

That's my take.

Thanks. Bob.

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