Worries over personal finances are kind of like...viruses. While there may be legitimate specific concerns, those concerns seem to spread far and wide for no other reason than they exist. We took a look at a few common pension programs and came up with an evaluation. Are the fears warranted or not?
Most retired people depend on at least one type of retirement income stream. Usually, it’s Social Security. For many others, it’s a state-sponsored public pension. In California, the state pensions are CA-PERS and CA-STRS (for educators). In addition, there are dozens of city and county pension systems.
We are often asked some form of this question, “Is my Social Security (or PERS or STRS) safe? Can I depend on it? Let's check it out.
First, let’s review how pensions are funded.
It's roughly analogous to your IRA or workplace savings plan like a 401k or 403b. You figure out what you need at some future date. You make contributions to fund that need. The contributions are prudently invested. Withdrawals are taken years later. And there’s usually some residual remaining after you’re gone.
Social Security
Social Security immediately pops up as an exception. That's because Social Security is an income redistribution scheme rather than a classic pension plan. Current workers and their employers make contributions that go directly to current beneficiaries. No one has an account somewhere that is accumulating value from which they’ll draw from later. From a certain point of view, my employed children are funding my Social Security benefits. Thank you, children.
The issue with Social Security is that the number of beneficiaries and the amounts due to them will surpass the number of workers and the contributions they make in about 15 years. That’s the meaning of reports you hear that Social Security will go broke by 2035. Or whenever. Unless Congress does something. Which they always do.
This “going broke” narrative has been around for decades. It contributed to my taking Social Security early, thirteen years ago, just to “get my nose in the tent.” Luckily, or smartly, it was part of an overall plan that included maximizing my wife’s benefit. We captured the tails. All’s well. We move on.
The Social Security program will move on and live on. But it’s form, funding, and real value will undoubtedly change. Here are some possibilities:
Future beneficiaries enjoy no such certainty. Future beneficiaries are advised to set up a profile at my Social Security to assure that inputs to Social Security are accurate and to see the schedule of future benefits.
Public Pensions
Moving on to public pensions such as PERS and STRS, we hear about troubling funding ratios and a possible public pension crisis.
Like the personal plan outlined earlier with its contributions, investments, and withdrawals, public pensions have essentially the same process. What’s different is that an individual only has one life (or maybe two) to cover, whereas public plans cover millions, some of whom are still working and some whom are future beneficiaries. So, public plans must be structured to pay benefits into perpetuity, like an endowment. There is no end date.
This is where the funding ratio comes in. The funding ratio is the percentage of assets currently available to pay all future benefits. Skipping the actuarial math, a funding ratio of 60% is generally considered to be minimally adequate. Anything at 80% or more would be flush. Here are some recent funding ratios:
CA-PERS = 74%
CA-STRS = 62%
San Jose Federated = 50% *
San Jose Police & Fire = 74%
Texas Teachers (TRS) = 76%
Texas Employees (ERS) = 70%
Federal Employees (FERS) = 100%
*As of June 30, 2018, among the 39 public pension plans in the state of California surveyed by Cheiron, the contracted actuary, San José Federated had the lowest funded status of all 39 plans.
The next obvious question: How can funding ratios be improved? The solutions involve a challenging and complex mix of economic, demographic, political, and social factors. The various levers include:
· Requiring more employee contributions.
· Requiring more employer contributions.
· Improving investment returns.
· Encouraging early retirements.
· Reducing future scheduled benefits.
· Reducing overall employment.
· Enacting tax increases.
· Leaning on the State for support.
↪ Summary: Regardless of the plan, current beneficiaries are largely insulated from changes that might occur. They are basically grandfathered/grandmothered in. So, if you’re already dialed in, stop fretting.
Future beneficiaries enjoy no such certainty. Future beneficiaries are advised to do two things: (1) set up and aggressively fund your personal defined contribution plan such as a 403b or 457, and (2) track your estimated benefits for CA-PERS here or CA-STRS here.
Most retired people depend on at least one type of retirement income stream. Usually, it’s Social Security. For many others, it’s a state-sponsored public pension. In California, the state pensions are CA-PERS and CA-STRS (for educators). In addition, there are dozens of city and county pension systems.
We are often asked some form of this question, “Is my Social Security (or PERS or STRS) safe? Can I depend on it? Let's check it out.
First, let’s review how pensions are funded.
It's roughly analogous to your IRA or workplace savings plan like a 401k or 403b. You figure out what you need at some future date. You make contributions to fund that need. The contributions are prudently invested. Withdrawals are taken years later. And there’s usually some residual remaining after you’re gone.
Social Security
Social Security immediately pops up as an exception. That's because Social Security is an income redistribution scheme rather than a classic pension plan. Current workers and their employers make contributions that go directly to current beneficiaries. No one has an account somewhere that is accumulating value from which they’ll draw from later. From a certain point of view, my employed children are funding my Social Security benefits. Thank you, children.
The issue with Social Security is that the number of beneficiaries and the amounts due to them will surpass the number of workers and the contributions they make in about 15 years. That’s the meaning of reports you hear that Social Security will go broke by 2035. Or whenever. Unless Congress does something. Which they always do.
This “going broke” narrative has been around for decades. It contributed to my taking Social Security early, thirteen years ago, just to “get my nose in the tent.” Luckily, or smartly, it was part of an overall plan that included maximizing my wife’s benefit. We captured the tails. All’s well. We move on.
The Social Security program will move on and live on. But it’s form, funding, and real value will undoubtedly change. Here are some possibilities:
- Employee and/or employer contributions could increase. That’s called a tax increase.
- The full retirement age (FRA) could be moved farther out as life expectancies (coronavirus notwithstanding) are lengthening. FRA used to be 65. Now it’s 67.
- The COLA could be watered down even more than it already has, or simply go away. Social Security’s purchasing power has declined by 1/3 since 2000. So, forget about maintaining purchasing power.
- Social Security could be merged with unemployment benefits or re-framed as part of a progressive Universal Income Security system.
Future beneficiaries enjoy no such certainty. Future beneficiaries are advised to set up a profile at my Social Security to assure that inputs to Social Security are accurate and to see the schedule of future benefits.
Public Pensions
Moving on to public pensions such as PERS and STRS, we hear about troubling funding ratios and a possible public pension crisis.
Like the personal plan outlined earlier with its contributions, investments, and withdrawals, public pensions have essentially the same process. What’s different is that an individual only has one life (or maybe two) to cover, whereas public plans cover millions, some of whom are still working and some whom are future beneficiaries. So, public plans must be structured to pay benefits into perpetuity, like an endowment. There is no end date.
This is where the funding ratio comes in. The funding ratio is the percentage of assets currently available to pay all future benefits. Skipping the actuarial math, a funding ratio of 60% is generally considered to be minimally adequate. Anything at 80% or more would be flush. Here are some recent funding ratios:
CA-PERS = 74%
CA-STRS = 62%
San Jose Federated = 50% *
San Jose Police & Fire = 74%
Texas Teachers (TRS) = 76%
Texas Employees (ERS) = 70%
Federal Employees (FERS) = 100%
*As of June 30, 2018, among the 39 public pension plans in the state of California surveyed by Cheiron, the contracted actuary, San José Federated had the lowest funded status of all 39 plans.
The next obvious question: How can funding ratios be improved? The solutions involve a challenging and complex mix of economic, demographic, political, and social factors. The various levers include:
· Requiring more employee contributions.
· Requiring more employer contributions.
· Improving investment returns.
· Encouraging early retirements.
· Reducing future scheduled benefits.
· Reducing overall employment.
· Enacting tax increases.
· Leaning on the State for support.
↪ Summary: Regardless of the plan, current beneficiaries are largely insulated from changes that might occur. They are basically grandfathered/grandmothered in. So, if you’re already dialed in, stop fretting.
Future beneficiaries enjoy no such certainty. Future beneficiaries are advised to do two things: (1) set up and aggressively fund your personal defined contribution plan such as a 403b or 457, and (2) track your estimated benefits for CA-PERS here or CA-STRS here.
Additional reference added 9/18/20: How Will Institutions Hit Their Return Targets?
Additional reference added 10/27/20: What's Going to Happen With Underfunded Pensions?
Jim Cosgrove, CFP, Plano, TX jim.cosgrove@verizon.net 972-489-0262
Jim Cosgrove, Dir of Research, San Jose, CA jimcos42@gmail.com 408-674-6315
