The traditional defined-benefit pension that is the dominant retirement plan for public-sector employees officially has a huge target on its back. And 2011 is shaping up as the year politicians begin to take serious aim at cutting promised benefits. What was a mere trickle of states and municipalities starting to address massive unfunded pension liabilities in 2010, which are now estimated to total more than $1 trillion, looks to grow to a torrent in 2011.
New Jersey Governor Chris Christie may be the most voluble agitator for pension cutbacks, but he's got plenty of company across the country. Here's what some other states and cities are considering:
- Virginia. Governor Bob McDonnell recently proposed that Virginia's public employees be required to chip in 5 percent of their pay to the state's pension fund. Virginia stopped requiring public employee pension contributions in 1983.
- Houston. Mayor Annise Parker has started the "conversation" by deeming the city's three major pension plans covering Houston's police, firefighters, and municipal employees unsustainable. "There's a difference between a fair pension and a gold-plated pension, and the citizens of Houston have to know that we can find a fair balance in there," Mayor Parker told the Houston Chronicle.
- Maryland. A proposal released yesterday by a state pension commission would increase the years of service for workers to qualify for Maryland public retirement benefits. Employees would need 15 years on the job (up from the current 5) to qualify for retiree health benefits, and the vesting period for the state's pension plan would increase from its current five years to 10 years. The commission also wants to shift half of teacher pension costs from the state to local counties.
That's just a short list of recent proposals to scale back old-fashioned pensions for public sector employees. I think the rarity in 2011 will be Americans who somehow manage to live in a state/city/county/school district that does not have to at least start addressing the unfunded liabilities for public retirement plans. And while the specific remedies being floated vary, the bottom line is clearly universal: Public sector workers face a reduction in the benefits provided by their employer.
Current public sector employees, especially those decades away from retirement, would be wise to take a hard look at how they are preparing for retirement outside of their existing pension. No one is suggesting those pensions will disappear, but any change has a direct impact on your retirement security. I'd consider starting -- or beefing up -- your own retirement savings accounts. A Roth IRA would be an ideal way to start providing some cushion if -- just hypothetically say -- your future pension scales back or does away with its cost of living adjustment.
And for anyone currently considering a career in public service, don't put too much weight in the current retirement benefits package. Yes, you will have retirement benefits, but they are likely to be less generous.
Residents Will Pay, Too
But no matter what concessions legislators are able to wrest from current public sector employees -- and that is indeed going to be the hot debate across the country -- or impose on future hires, closing the funding shortfalls will not be solved solely on the backs of public sector workers.
Joshua Rauh, a business professor at Northwestern University, and Robert Novy-Marx of Rochester University recently published a paper that took a look at how states might be able to address their unfunded pension liabilities. To set the scene, they re-examined the current conservative estimate that states have unfunded pension liabilities of $1 trillion. They deemed that to be too low, given that it's based on pension funds earning strong stock returns. When the professors assumed a lower-risk, bond-like return and factored in future wage increases, they put the actual shortfall at between $2.5 trillion to more than $4 trillion, depending on a variety of assumptions. Then they ran their models to see how various cutbacks in employee benefits, including scaling back or eliminating cost of living adjustments (COLAs) and increasing retirement ages, would affect the shortfall. Even with these "relatively dramatic policy changes," the pair still projected a shortfall of $1.5 trillion. The professors' conclusion?
"This suggests that taxpayers will bear the lion's share of the costs associated with the legacy liabilities of state [defined benefit] pension plans."No matter your level of pension envy, we're all in this mess together. The way this is likely to play out is that in 2011, the main focus will be on the "if" and "how" of reducing current pension benefit levels. Then assuming legislators do, in fact, make inroads on scaling back existing plans, they will ultimately need to come hat in hand to the general populace and start the conversation on how to fund any remaining gap. That's not a conversation elected officials are ever eager to have, but in the midst of a painfully slow recovery that still feels like a recession in many areas, it's a doubly painful step to contemplate for 2011.
But as Rauh and Novy-Marx assert, it is a question of when, not if. Sometime soon we all are going to have to step up to the plate and decide what spending cuts we can stomach, and what level of tax increases we will be ready to shoulder. It's just a localized version of the same conversation our leaders in Washington must have about our $1.3 trillion and growing federal deficit.
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