Yesterday, the Wall Street Journal posted a story on its website, “Pension Bills to Surge Nationwide.” (Click here to read, if you are a subscriber.) The point of the article is no surprise: Stock market declines have wacked the value of state and municipal pension plans—the median rate of return for a public plan was a negative 25 percent last year, Wilshire Associates estimates, according to The Wall Street Journal.
In the coming years, public pension plans (as well as private defined benefit plans) will have to play a game of catch up; contribution rates would have to surge by seven-fold, “from about 4 percent of payroll to 28 percent, starting in 2012,” the story says, in order to close the funding deficit.
Higher taxes might be required to top off state and municipal pension plans. To avoid that scenario, some governments are asking lawmakers to allow them to put off payments to their plans for a year.
“’It’s going to be a huge showdown’ between tax payers and public employees,” Susan Mangiero, president of Pension Governance Inc., told the Journal’s Craig Karmin.
Actually, we think the situation is even worse than that. Back in November, we ran a cover story titled, “Promises Will Be Broken: A retirement crisis looms—but not because of the market’s meltdown. It’s worse than a temporary swoon.”
The point of the article was simple: If you have clients who are expecting pension benefits in retirement, they may want to save a little (or a lot) on their own. Forget about the short-term gyrations of the capital markets or real estate values. The Social Security Trust will start running a deficit in 2017. Already the government has promises worth $53 trillion in future benefits (including entitlements, from Social Security to Medicare). That works out to about $175,000 per person.
As our story noted, this is why some advisors discount the amount a pension plan is promising their clients. Who knows what a plan, private or public, will look like in a decade or more. Some advisors tell high-salaried clients to discount future annual benefits by 30 percent to 50 percent, sometimes more. (The Pension Benefit Guaranty Corp., the government entity that protects American private pensions, pays about 84 percent of retirees’ benefits. But if you make “too much,” (i.e. as airline pilots do) you receive just a fraction of your promised annual benefits.) Remember that you’ll need to analyze the health of your clients’ employers when creating a financial plan for them. Lots of companies have underfunded pensions—it fluctuates, often based on market performance. Fran Hawthorne, a contributing editor to Registered Rep., notes in her book, Pension Dumping, that the absolute size of the underfunded pension doesn’t always matter. You’ll need to regard the company as you would a bond investment, keeping an eye on its capital structure. Hawthorne writes, “Key ratios include: pension assets to corporate assets or to market capitalization, pension contributions to cash flow or to revenue, pension liability to market capitalization or to corporate assets, pension underfunding to the size of the plan and the size of the workforce to net profit.”
What is the solution? More taxes? Probably not, says the Peter G. Peterson foundation, since income taxes would have to rise by 2.5 times, across the board, from today’s levels to close the financial gap. And government spending is on a tear, as is government employment. Government spending is expected to reach about 36.2 percent of total U.S. GDP in 2009—a post WWII high, according to carriedaway.blogs.com. It’s been high recently—flirting with the 30 percent range under Bush.
One appalling feature of government: It is a growth industry, seemingly immune to the same market forces that drive private business decisions. The New York Post notes this weekend that the number of Federal government employees is expected to rise to 2.25 million. (Click here to read, Capitol Gains: One American city is riding high in this recession—the taxpayer-funded oasis of Washington, D.C.) Investor’s Business Daily recently published a chart showing the divergence in hiring between government and private business. In the private sector, jobs are being cut. “Payrolls in one sector, however, hit another new high. Compared with the 111.2 million jobs in the private sector, down 4.5 million since the recession started in late 2007, nearly 22.6 million people now work for the government at one level or another, up 247,000.”
Who will pay for all those nice pensions?