Since the Great Recession in 2008, warnings of an impending pension crisis have been splashed across the business pages of newspapers across the country. Despite these boisterous decrees, America’s public pension funds are stable. We explore the roots behind the false pension crisis narrative and examine the facts.
Last week we wrote about how the so-called “pension crisis” is a myth promoted by people who are hostile to traditional pensions. We focused specifically on Stanford professor Joshua Rauh and his misleading argument for using a “risk-free” discount rate. Today we want to address the question of unfunded liabilities in public pension plans and why pension critics typically misrepresent the truth about unfunded liabilities to promote their false pension crisis narrative. Pension critics also ignore the shocking unpreparedness of most Americans for retirement, which could be improved if more people were covered by pensions.
Critics of traditional pensions constantly warn about unfunded liabilities in pension plans, but they seem to be deliberately misleading about how pension plans actually work. A large public pension plan covers hundreds of thousands of active public employees and current retirees. These plans always have large liabilities because they are obligated to manage and pay out the retirement benefits of these thousands of employees and retirees over the course of decades.
When there is a difference between the total amount of benefits owed to ALL current employees & retirees and the value of the financial assets the pension plan manages, then there is an “unfunded liability.” This means that at a specific point in time, the pension plan does not have the full amount of money it will need to pay out ALL of the retirement benefits it will owe in the future to ALL of its current and former employees. But the system never needs all that money at one time. Here’s how it really works.
An employee working today who will retire and begin collecting her pension benefit in twenty years won’t collect her entire benefit all at once. She will receive her pension benefit paid out in monthly installments over the course of her retirement, which could be another twenty years. So, for our public employee working today, the pension plan in which she participates has twenty years to earn investment returns on the contributions to her pension and may then have another twenty years over which to pay out those benefits. If the pension fund today only has 85 percent of what it will owe her, that does not mean there is a pension crisis because the fund has a long time to earn investment returns and then pay out its obligations. Those pension critics wailing about unfunded liabilities either don’t understand or are being intentionally misleading about this very basic fact.
The reality of financial markets means that as the value of financial assets goes up and down, a pension plan can be more or less well-funded at a certain point in time. Some states, like Wisconsin, that do have fully funded pension plans have specifically designed their pension plans with certain features to guarantee that the plan remains fully funded. Other plans, like those in New York and North Carolina, are funded somewhere between 90 and 100 percent, meaning they may not currently have every dollar they will ever owe, but they are pretty close. Some states, like Illinois and New Jersey, do have real, legitimate problems with their public pension plans, but those problems are not caused by the nature of defined benefit pensions themselves. They are directly caused by political malfeasance, when governors and state legislatures- of both political parties- have neglected their pension obligations, often for decades.
The true unfunded liability in retirement is the lack of any real retirement savings of many Americans. At any time, slightly more than half of all working Americans do not have access to a retirement plan through their employer. This means they can’t participate in a defined benefit pension or contribute to a 401(k) or a 403(b)- nothing. The reality is that most of these Americans are saving nothing for retirement, since most IRA contributions are just rollovers from 401(k) accounts. Even for workers who are contributing to a 401(k) plan, they are most likely not contributing enough and will find themselves falling short of what they need financially in retirement. Except for those at the highest income levels, who have the disposable income to make the maximum contributions, most Americans simply can not or do not save enough money in their 401(k) plans. There are a number of other design flaws in 401(k) plans that mean most working families will come up short in retirement.
As we said last week, the “pension crisis” is a myth promoted by people who are either hostile to public employees, have a financial interest in moving from pensions to 401(k)s, or both. The real pension crisis in the United States is the lack of pensions by most working people. Many Americans are at risk of falling behind their standard of living in retirement and the move away from pensions to 401(k)s has made this worse, not better. Here at NPPC we are fighting for real retirement security for working families. Will you join us?