Double Whammy

In Friday's post, "Darkness Falling on the Twilight Years," I highlighted posts from the Economist.com's Free exchange blog and Mish's Global Economic Trend Analysis blog that suggested an idyllic retirement may be out of reach for many Americans.

But that's not the end of it. The same financial woes that will force many people to keep working well into their golden years are also poised to hit them where it hurts -- in their wallets and pocketbooks -- right now. In "$1T Hit to Pensions Could Cost Taxpayers, Workers," The Associated Press gives us the details

Massive investment losses sustained by public pension funds are pressuring state lawmakers from New Mexico to New York to spend more taxpayer money to shore up their programs, boost the retirement age for newly hired government workers and seek more from employee paychecks.

Pensions need $270 billion in additional contributions over the next four years, and more than $100 billion annually for two decades hence, according to the Center for Retirement Research at Boston College.

The pension trouble is just one more economic challenge for states. Income and sales tax collections are dropping fast as unemployment rises. Jobless benefits funds are running dry, requiring federal borrowing. And because of substantial budget holes, states are cutting back on a wide range of services, including child care subsidies for low-income families and aid to public schools, and in some cases laying off workers.

But as bad as the budget picture looks, it is dwarfed by the size of the gaps in states' pensions, which have collectively lost at least $1 trillion as financial markets swooned over the past year. Public pensions cover about 14 million state and local employees and paid out almost $163 billion to seven million retirees in 2006-2007, according to the Census Bureau.

Because pensions involve long-term obligations and investments, there's no immediate risk that states will be unable to pay retiree benefits. But replenishing pensions could squeeze states for years to come, forcing lawmakers and governors to juggle their spending priorities - pitting pensions against schools, colleges, health care, prisons and other government services.

"What you hear concern about out there right now is, 'We the taxpayers are going to be stuck with a bill paying for public pensions. And we don't want taxes raised to pay for public pensions.' And that is understandable," says Mike Burnside, executive director of the Kentucky Retirement Systems.

Pensions covering state and local workers, police and teachers in Kentucky have unfunded liabilities of $27 billion. In response, lawmakers agreed last year to increase taxpayer funding and change eligibility for newly hired employees. But budget problems, Burnside said, could undermine the state's ability to boost pension funding.

It's up to legislatures to appropriate money to cover pension funding for state workers. With questions swirling around the future of public employee pensions nationally, legislation is pending in at least 28 states to change funding and benefits:

- In New Mexico, where pensions for educators and state employees are underfunded by a combined $4.6 billion, lawmakers approved longer work requirements for public employees hired starting in 2010. They'll be able to retire with full benefits at any age after working 30 years, up from 25 years. Current workers will pay an extra 1.5 percent into their pension plans and higher amounts for retiree health care.

- In New York, Gov. David Paterson has proposed increasing the minimum retirement age for new hires to 62, up from 55.

- In West Virginia, whose pension fund for teachers has a $4 billion shortfall, the governor has proposed additional taxpayer money to close the gap.

- Illinois, Oklahoma and Florida are among a half dozen states considering defined contribution pension plans, like a 401(k), for public employees rather than automatically enrolling them in a traditional defined benefit pension that pays a guaranteed annuity to retirees.

Two states - Alaska and Michigan - have dropped defined benefit programs for at least some newly hired public employees, according to the National Association of State Retirement Administrators. But slashing benefits for current workers isn't an option for states because statutory or constitutional provisions usually safeguard an employee's earned benefits.

Private sector pensions are also hurting. There was a $400 billion funding deficit at the end of 2008 for pensions at 1,500 U.S. companies of all sizes representing about 85 percent of the stock market, according to Mercer, a global consulting firm.

The gap is likely to accelerate a trend of corporations dropping defined benefit plans in favor of defined contribution plans, according to Adrian Hartshorn, a principal in Mercer's Financial Strategy Group in New York. Companies also will be forced to make higher pension contributions. Workers usually don't pay in to private pensions.

Public employees and their unions are fighting measures that would reduce the value of their compensation packages, such as higher payroll contributions for health care or pensions.

Leslie Boyadjian, a 7th grade social studies teacher in Albuquerque, estimates that higher pension payments approved by New Mexico lawmakers and expected increases for health care could cost her $1,000 a year.

"For me, $1,000 a year is a huge financial hardship," said Boyadjian, 26. "Between car payments, rent, student loans, I'm barely making ends meet as it is."

The market value of state and local pension fund assets has declined by a third, from a peak of about $3.3 trillion in the fall of 2007 to $2.4 trillion at the end December, according to the retirement administrators association. The S&P 500 index dropped 41 percent during the same time.

Investment earnings account for $4 of every $5 in pension financing, according to the Census Bureau. The rest comes from employee and government contributions.

Almost three-fifths of public pension fund assets were invested in domestic and international stocks and slightly more than a quarter in bonds. The rest of pension investments were in real estate and alternatives, including private equities, hedge funds and cash.

Because of the way accountants measure the value of pensions, market losses and gains are averaged over several years. That will give states more time to respond to the recent financial market meltdown.

However, a prolonged recession will make it more difficult for states to rebuild their pension funds through future market gains and will add pressure for more taxpayer funding through payroll contributions, according to one pension expert.

"I don't think they can invest their way out of it," says Alicia Munnell, director of Boston College's Center for Retirement Research.

Comments

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1. Oh no! Retirement age extended to 62! Please. You're meant to live 10 years in retirement, not 30. An extension of the age is way overdue. It should be 70 or 75.
2. Many people (granted, not everyone) want to continue working. Extending the age prevents you from being forced out.
3. Maybe (but probably not) knowing that you're going to have a longer working career will motivate you to take better care of yourself, which is also overdue.
4. It's silly to extrapolate doomsday funding scenarios based on a temporarily depressed market. Granted, the Dow won't hit 14,000 tomorrow, but it also won't be <8000 forever.

[jogleaso]

The sad thing is that young people will never see any pension or social security. They are merely paying for the people that are currently getting benefits.

You need to plan like you will not get these social benefits.

[dearieme]

The "old age pension" in Britain is currently payable at 60 (women) and 65 (men). It is currently en route to 68 (both). I'll bet that before it reaches 68 it starts on its journey to 70.

[mary]

The govt. is engaged with banks to keep the information from the people - because they are afraid of bank runs?? I doubt it - They will drain as much out of the system as possible before letting the scam go. Wm. Black says AIG bailout was used to bailout banks such as goldman sachs - (also advisers to bailout plan) - Black says they will not tell the truth to the people -
Govt works with regulators to ensure there is no regulation - so we have a moral crisis - When govt refuses to govern with integrity and the information is kept from the populace, then citizens are victims - they should not be called sheople- attacking fellow citizens will get us nowhere.

There is lots of blame to go around but attacking the victims of a corrupt govt. system implies that this system responds to the will of the people - It does not - the corruption is pervasive - 9/11 shows that -
There has been a persistent effort for decades to control information that is available to the citizens, and we are all victims - But the good news is that more and more people are waking up to the fact that the emperor has no clothes (I like that cliche). That is the solution. Giving up on social security is not the solution - the crooks would love that - saying no to the bailouts is a start - If we cannot cleanup this system, it will disintegrate and that is a particularly lousy outcome.

[Rocky]

State and local pension plans generally assume an annual investment return of about 7 to 8%. The S&P 500 has returned about -2.80% annually for the 10 year period ended April 9, 2009. Intermediate investment grade bond funds have had an annualized return of about 3.70% for the same period (http://online.wsj.com/fund/page/fund_snapshot.html?symbol=VBIIX). These returns suggest that the unfunded pension liabilities of state and local pension plans may be in the $2-$3 trillion range rather than only $1 trillion, if more realistic future annual returns are used in computing unfunded liabilities.
I wonder how long California pension plans can keep paying out benefits to retired police, prison guards and firefighters that are several times as high as the benefits paid by Social Security to retirees in the private sector? Up to now the Democrats have been in the pocket of the powerful public employee unions and the Republicans have been distracted by their crusade to stop gay marriages. The Golden State is quite tarnished.