Can Society Afford to Pay Promised Pension Benefits?
By Ric Edelman
We may find that honor gives way to economic reality
Without question, the greatest economic benefit of working for the government — be it federal, state or municipal — is the retirement program. Many governments promise their workers pension and health-care benefits that those in the private sector would define as, well, generous.
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In their defense, government workers would say that if their benefits are high, that is only because their salaries are lower and they are not eligible to receive the bonuses, profit-sharing rewards or stock awards that their private-sector counterparts can receive. Besides, they say, their work is often more difficult or dangerous, and thus worthy of their retirement benefits.
Take the case of Mary Ellen, 51, a caller to my radio show. For the past 30 years, she has been a city employee, and she currently earns $76,000 per year. Thanks to her retirement benefits, she can retire immediately and the city will pay her $46,000 per year for life. That’s 60% of her current pay. On top of that, she’ll receive annual cost-of-living increases. Oh, and she gets full health-care benefits for life as well. With no husband, children or aging parents to care for and expenses of just $2,000 a month, Mary Ellen can easily afford to retire. Not bad after 30 years of work. (When I asked how much she has in savings, Mary Ellen said she has $65,000. She’s had little reason to save thanks to her retirement benefits.)
The response to my conversation with Mary Ellen has been overwhelming — and not because I told her that she could afford to retire. No, listeners called and emailed me because they were angry that someone could retire at age 51, be paid nearly $4,000 per month for life with full health-care and COLA benefits — and that taxpayers have to pay for it. The writers have a point. State and local governments across the country are facing severe financial difficulties — including huge pension liabilities. State pension plans were underfunded by $458 billion in 2008, according to Standard & Poor’s. Left uncorrected, some governments might find themselves unable to honor their obligations to retirees.
Lawmakers are creating solutions for their pension shortfalls. New York is considering a plan that would let it borrow money from the state’s pension plan and use that money to pay its annual obligations to the pension plan. (No, that’s not a typo — they’re essentially planning to rob Peter to pay, well, Peter.)
Meanwhile, the governor of Illinois wants to borrow $3.5 billion to cover this year’s contribution to that state’s pension plan, a move that would cost about $1 billion in interest, according to The New York Times.
Many other jurisdictions are cutting payrolls to find the cash they need to fund their pension plans. The University of Hawaii has cut pay for professors by 6.7%, Albuquerque workers are now paid 1.7% less and New York is planning a 4% pay cut.
According to the National League of Cities, 51% of municipal employers have either frozen pay or reduced salaries, 22% have revised union contracts to cut pay, and 19% have implemented furloughs, which is pretty much the same as a pay cut.
If these steps prove insufficient, the governments might find themselves forced to reduce retirement benefits. But that smacks of reneging on promises. After all, workers accepted their jobs — often dangerous (such as police officers, firefighters, hazardous materials handlers and many other occupations) and usually at lower pay than available elsewhere — and they did their jobs well and have reason to expect that the promises made to them would be honored.
Still, many governments believe they have no choice but to alter their pension plans. The California Public Employees’ Retirement System says 75 cities, counties and public agencies in that state are considering increasing the amount that employees contribute to the plan and changing how benefits are calculated for new hires. The governor is negotiating with the state’s employee bargaining units to make pension benefits less generous for new hires. This fall, voters in San Francisco will decide whether city workers must contribute more to their pensions, the Sacramento Bee reports.
Meanwhile, Utah and Michigan are switching to hybrid 401(k) plans, with those states contributing much less to the plans for new workers. Arizona has cut benefits to current workers and retirees alike: Instead of receiving a 3.5% annual cost of living adjustment, increases are now capped at 2%. Retirees have filed lawsuits in response.
Given the state of our nation’s economy and the financial issues facing the states, Mary Ellen’s situation raises an important question: Is it still appropriate to provide full retirement benefits before workers reach age 66 or 67, which is the “normal” retirement age according to the Social Security Administration? Or should we acknowledge the sacrifices these employees have made and honor our promises to them?
I put the question to a vote on my website, and this admittedly unscientific poll found that Americans are sharply divided on this issue. Two-thirds of respondents say our society cannot afford to pay the pension benefits that government workers have been promised, while one-third think government workers should receive the benefits they were promised. Although I didn’t ask, I suspect most private-sector workers voted for the former, with government employees tending to vote for the latter. (Alas, people are often not objective.)
Many, though, have written me to express sadness: They believe it’s important that we honor our promises but acknowledge that prior legislators simply made promises that cannot be honored. Due to the current economy, TrimTabs Investment Research estimates that up to two million city, state and county employees will lose their jobs by the end of next year because governments can’t afford to keep paying them while also paying retirees their benefits. Should these employees lose their jobs, they will also lose the pension benefits they’ve been promised. So, regardless of political leanings or moral preferences, economic reality will ultimately lead to the conclusion of this debate.
What does this mean for you?
The message is simple: If you are counting on a pension to take care of you in retirement, you need a back-up plan. Start saving for your retirement — and if you are already vested in your pension, consider leaving work now (or soon) because legislators are more likely to reduce the benefits promised to current workers than to cut benefits that retirees are already receiving. And if you’re lucky enough to be able to retire with your pension in your 50s like Mary Ellen, go get another job so you can stash your pension checks into investments for your future.
For help with evaluating the safety of your pension benefits and developing strategies for handling your retirement, talk with a financial planner today.