Imagine a morning like any other. Steaming hot cup of coffee in hand, you check your bank balance to confirm your usual pension deposit. But it’s not there. Concerned, you call your administrator, get put on hold, but nobody ever picks up.
You go to their website, send emails to support and receive only auto replies.
Anxiety increasing, you search online and find headlines that can’t possibly be true: your pension is broke, the money ran out, and your administrator is scrambling. Heart pounding, hands shaking, you wonder how you’ll pay your bills.
This actually happened in Prichard, Alabama.
After being warned that their pension fund would be depleted by 2009, the money ran out, right on schedule. Despite laws on the books requiring the town to pay beneficiaries, it didn’t, because it couldn’t.
Distraught retirees demanded payments that had been promised to them their entire working lives. But the money was gone, and the town didn’t have any extra. A cascade of personal tragedy followed:
“Nettie Banks, 68, a retired Prichard police and fire dispatcher, has filed for bankruptcy. Alfred Arnold, a 66-year-old retired fire captain, has gone back to work as a shopping mall security guard to try to keep his house. Eddie Ragland, 59, a retired police captain, accepted help from colleagues, bake sales and collection jars after he was shot by a robber, leaving him badly wounded and unable to get to his new job as a police officer at the regional airport.” —New York Times
Even worse, someone found the retired fire marshal, dead in his house without power or water. He’d been too young to collect social security and too proud to ask for help.
What would you do if the money ran out?
If you’re retired or nearing retirement and counting on a pension to sustain you, how healthy is your plan? Is it fully funded? Do you have other sources of income?
In today’s uncertain world, to preserve independence, it’s crucial to build financial resilience with more than one source of wealth. You simply must keep a watchful eye on your pension administrator and supplement with backup plans.
I live in Puerto Rico, which is essentially bankrupt. One of its biggest creditors is its own pension fund, the one paying retirees who worked all those years in government with the promise that they’d be taken care of in retirement.
As it turns out, the government didn’t properly fund the program, so it went out and borrowed money from the bond markets to make payments to retirees. But now, Puerto Rico is defaulting, so nobody wants to lend them more money.
How will retirees get paid? Good question. Many retirees here on the island, already subsisting on meager payments, live in fear of cuts to inevitably come.
But really, how will anyone get paid? When you spend more than you make, in time the money runs out. Then everybody with a claim piles on to fight over the scraps.
That’s what happened in Prichard, Alabama, it’s what’s happening to Puerto Rico now, and it’s going to happen in a lot of other places if people and politicians don’t rein in their unsustainable spending on promises they can’t afford to keep.
CalPERS flashes a warning signal.
The California Public Employees Retirement System (CalPERS) is often in the news for inadequate funding. Now they appear to be taking a page from the Puerto Rican playbook by borrowing money to fund pension payments. Critics note:
“Back in Puerto Rico, borrowing to fund pensions has been a failure. The government is now demanding that both bondholders and retired workers take a haircut. The Employee Retirement System reported a funded ratio of less than 2% last year. Current retirees will have to be paid from employer contributions, while new hires and current employees will be migrated to a defined-contribution plan. Admittedly California has advantages over Puerto Rico, and some of the worst-case scenarios discussed here are improbable. But proper risk management requires us to consider the improbable. Rather than rushing into this transaction, lawmakers would do well to take the Legislative Analyst’s Office advice to slow down and carefully consider the implications.” —California Policy Center
California, please, listen to your analysts. This did not work out for Puerto Rico, and it’s not going to work out for you long term.
Robbing Peter to pay Paul is not a solution.
Funding challenges occur by not making adequate contributions, but sometimes they become a problem due to outright deception.
Harry Markopolos, known for uncovering the Bernie Madoff ponzi scheme, has uncovered a new fraud involving the Boston Transit Authority’s pension plan. He brought to light a $500 million funding gap due to bad investments, fraudulent accounting and unrealistic actuarial assumptions. Reporters observe:
“The troubles at the MBTA began in 2012, when it was revealed that it had lost $25 million in an investment in Fletcher Asset Management, a hedge fund run by Alphonse ‘Buddy’ Fletcher. The MBTA had been hiding this loss until exposed by an investigative reporter from The Boston Globe. Fletcher had promised guaranteed returns of 12%, similar to Madoff’s sales pitch. The Fletcher irregularities went unnoticed by the MBTA’s board, which Markopolos said consisted of mostly non-college graduates—union members who worked on or operated the city’s buses and subways. The board had one person with an MBA and a couple of lawyers, who Markopolos said were not experts in investing.” —Zero Hedge
In summary, MBTA put people in charge who knew nothing about finance, they got ripped off, and now the whole fund is one bear market away from disaster.
You think this doesn’t affect you?
If you’re in a private pension plan offered by a non-government employer, your plan is regulated by ERISA, the Employment Retirement Income Security Act. It’s a complex law administered by three separate government agencies, designed to ensure that employee retirement plans are properly managed.
To check on the health of your private pension plan, go here.
If you’re in a pension plan sponsored by federal, state or local government, or if you are in a plan through a religious organization, your plan is subject to fewer regulations. This also means you also have fewer legal protections.
State government employees may feel safer in those states where payments to pensions are protected by constitutional law. But as we’ve seen in the case of Prichard and Puerto Rico, when the law meets math, math always wins.
Is your state plan at risk for future benefit cuts? See these charts.
If you’re a federal government employee, you may be feeling the safest of all, knowing that the US government can always print money to pay its bills.
That is true, but there are consequences. Every dollar they print devalues the one in your pocket. As new money is injected into the economy over time, prices may rise to the point where your comfortable pension barely covers your doctor visits. For those who’ve been retired for 25 years, this may already be the case.
Though you may be part of a big plan that seems to have enough money today, will it be there for you when you’re 95? This is something to consider.
Social Security may not be the savior you think it is.
Our social security system isn’t exactly broke, but it does have limits. Its assets are held in two funds: Old Age and Survivors Insurance and Social Security Disability Insurance. According to the 2016 Social Security Trustees report, these two funds have over $2.8 trillion in reserves, which sounds like a lot of money.
Currently, payroll tax income and interest earned on these reserves exceed the cost of benefits paid out. This means we’re spending less than we earn, a good thing. The problem is, this situation won’t last past 2019.
“After this point, Social Security will begin to run a deficit, and trust fund assets will need to be redeemed in order to meet benefit obligations. The annual deficit amount is projected to increase sharply, and the trust funds are expected to be completely depleted by 2034. While this is indeed troubling, it’s important to point out that even if the trust funds were to run out, incoming payroll taxes will still be enough to pay about three-fourths of benefits. So, as a worst-case scenario, your Social Security benefits would be cut by 25% after 2034.” —Fox Business
So for anybody like me planning to retire after that, expect to receive only 75% of your promised benefit. Do you think all those online retirement calculators have accounted for this loss? I would guess not.
After 2019, Social Security becomes a pay-as-you-go program, like living paycheck to paycheck. More precisely, it takes money out of Young Peter’s pocket to pay Old Paul, except that we have a lot of Old Pauls and not so many Young Peters with jobs.
As we drift toward the reality of two workers for every one retiree, where will the money for benefits come from? If the economy slows down and jobs dry up, so may hand-to-mouth payments to retirees. Some call Social Security a Ponzi scheme:
“A Ponzi scheme is a fraudulent investment operation where the operator generates returns for older investors through revenue paid by new investors, rather than from legitimate business activities. Operators of Ponzi schemes can be either individuals or corporations, and grab the attention of new investors by offering short-term returns that are either abnormally high or unusually consistent. Companies that engage in Ponzi schemes focus all of their energy into attracting new clients to make investments. Ponzi schemes rely on a constant flow of new investments to continue to provide returns to older investors. When this flow runs out, the scheme falls apart.” —Wikipedia
Can you see the similarities? Social Security may not attract new participants by offering amazing returns, but it does grab them via the force of law by garnishing their wages. Everyone who gets a paycheck must contribute, and note how the government does expend a lot of energy trying to create new jobs for workers.
This scheme will go on, until one day it can’t, because it’s unsustainable. Early participants win, but later participants will lose.
Math, an inconvenient truth.
There are two recurring themes with the pension problem. The first is the tendency to make persistent, unrealistic assumptions about returns.
Approximately 15 years ago, ERISA required corporations to put their defined-benefit pension plans on the books. Once they did, it immediately brought to light how unsustainable these plans were, given assumptions against actual conditions.
As a result, companies began transitioning to defined contribution plans, the IRAs and 401Ks that you see today. Essentially, they were forced to look at the numbers, change their assumptions, and come up with a plan they could actually deliver on.
Corporations that still offer pension plans are required by ERISA to produce annual reports, which are available to the public. Government pension plans, however, have no such requirement, so they remain in the dark.
The second recurring theme is creative accounting. Since government plans aren’t regulated by ERISA, they are not forced to report against profit. Given the choice between the Government Accounting Standards Board and the Financial Accounting Standards Board, government chose the former because the numbers look better, making it easier to kick the can down the road.
“Because state and local government plans are generally subject to fewer restrictions, they can have features that are not allowed in private plans. Thus, they serve as a laboratory for experimentation in plan designs that would not be allowed under current federal laws for private sector plans. For example, the pension plans for public employees in the state of Indiana provide for a rate-of-return guarantee for the defined contribution plan that is backed by the fund of the defined benefit plan. Such an arrangement would not be allowed in the private sector because it would violate the ERISA requirement that defined benefit plan assets be used only for the purpose of providing benefits from that plan.” — Net Industries
Got that? Your government pension plan may be a long-running lab experiment, possibly designed to run down its own principal if necessary to support some artificial guarantee. Let’s just hope that whoever designed your plan was competent enough to consider an extensive list of actuarial outcomes stretching to perpetuity.
But remember, constitutional provisions won’t help you when the money runs out. Just ask Prichard or Puerto Rico.
Politicians, donors and voters all share some of the blame.
Every one of us who voted for free stuff now with a promise to pay later played a part. Politicians made promises to get the votes, and donors supported the politicians to further their agendas. Unions had their role, fiercely fighting to protect their interests. Regardless, the bills are past due and can no longer be ignored.
Those of you wealthy enough not to care about pensions or Social Security may think this doesn’t affect you, but it does. Taxpayers may be tapped for bailouts, and everyone will lose services as more funds are diverted away from police, fire, parks and schools to pay retirement benefits owed.
Here in Puerto Rico, I have a front row seat for what that’s like—roads with potholes the size of a toddler, unpredictable power and water outages (sometimes for days) government offices randomly shut down, schools closed, abandoned buildings everywhere—the list goes on. Though a beautiful island with lovely people, it’s hard to be productive with a crumbling infrastructure all around you.
When I graduated college, government jobs didn’t pay so well compared to the private sector, however, they did offer generous benefits including a pension. It’s how they competed for candidates.
For police and fire, it makes sense to go heavy on retirement incentives, because how else can you motivate folks to lay their lives on the line, possibly never making it to old age in the first place? You have to incent people for dangerous work.
But now, as government has become bigger relative to the overall economy with its power to tax and borrow, it sometimes pays better to be an employee in the public sector than the other way around.
I have a friend approaching retirement. He took a soul-sucking state government job because he calculated that if he stayed five years, he’d be eligible for a pension. Needing to supplement his savings and Social Security, this job offered him a tremendous return on investment. I thought it was a pretty smart move.
I don’t blame people like my friend. Employees are simply actors in an increasingly complex system. For that matter, so are the politicians, voters, donors, bondholders and unions. Forcing haircuts on anyone isn’t fair, because promises were made.
But the math is absolute. It doesn’t care about feelings or what’s fair—it only calculates what is. And the cold, hard truth is that there isn’t enough to pay everybody everything they were ever promised.
Maybe if you’re lucky, you’ll die before your benefits run out. But if the checks stop coming, what will you do?
Ideas for building a more resilient retirement.
You can lobby and vote for change all you want, but it really comes down to personal accountability. You need to consider the possibility that Plan A might fail, and create a Plan B to improve your personal resilience.
The first step is to save money every month. There’s always room for trimming expenses—eat out less, skip the pink sandals, make the old iPad last a bit longer. Here are a 100 more ideas on ways to save.
Automate the process if you can, so that it happens in the background without any thought. Set your checking account to transfer a predetermined amount to a savings account after each deposit. It may hurt a bit at first, but then you get used to it.
You can also start a side hustle, like renting spare rooms on Airbnb, growing organic veggies or teaching English as a second language. You could even create a YouTube channel telling stories about the history you’ve lived through and make income from the ads. Here are 60 more ideas on how to make money in retirement.
Once you have a few months of living expenses set aside in cash, keep saving, speak to your financial planner, and consider investing the surplus into assets that offer better returns, if that makes sense for your personal situation.
Worst case, you curtail your spending for years, build up a nice surplus and later decide you won’t ever need all this extra money you saved. If that’s the case, then have some fun. Throw yourself one hell of a party, donate it to a land conservancy, or take your daughter a world cruise.
It’s just better to have choices like those than to sit alone in your unheated, waterless house, starving to death.
Pensions and the CalPERS Time Bomb
Pensions 101: Understanding Illinois’ Massive, Government Worker Pension Crisis:
Moodys: Modest Market Downturn Could Spark $3 Trillion Could Spark $3 Trillion Surge in Pension Liabilities:
GE’s Pension Time Bomb, a $31 Billion Shortfall and Rising:
The Disturbing Trend that Could End in a Full-Fledged Pension Crisis:
Differences in Regulations Covering Public and Private Pension Plans:
Differences Between Public and Private Pensions:
The Future of Retirement Plans:
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All expressions of opinion reflect the judgment of Diane Cohn (DC) an investment advisor representative at Maxim Partners, LLC (MP), at this date and are subject to change. Information has been obtained from sources considered reliable, but we do not guarantee that the foregoing report is accurate or complete. MP or its affiliates may execute transactions in the securities mentioned in this report, which may not be consistent with the report’s conclusions. Links contained within any text are being provided as a convenience and for informational purposes only; they do not constitute an endorsement or an approval by DC or MP of any products, services or opinions of any third-party. DC and MP bears no responsibility for the accuracy, legality or content of the external site or for that of subsequent links. Contact the external site for answers to questions regarding its content. This document is intended only for those to whom it may lawfully be submitted. There is no assurance that any of the trends mentioned will continue in the future. Past performance is not indicative of future results.