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Pension Income in Retirement, Part 2: Can Employees Rely on Future Pension Income?

With consistently low interest rates and increasing longevity over the past decade, most pension funds do not currently have sufficient assets to meet their obligations in the years to come.  Retirees are collecting their monthly benefits longer than projected, and contributions from current employees, combined with investment returns from the pension fund, have not been able to keep pace with the increasing costs.  What does this mean for retirees and current employees expecting to receive pension benefits in the future?  The answer depends on the actions of your specific employer and other unknowns (e.g. investment returns for the pension fund in the future), but we discuss the different outlooks among federal government, state and local, and private pensions below.

Federal Government.  According to the Congressional Research Service, Federal Employees Retirement System (FERS) pensions continue to be fully funded by employee contributions, but the old federal pension system, the Civil Service Retirement System (CSRS), is underfunded, and the federal government has been covering the shortfall to maintain CSRS benefits.  Since the federal government is not averse to running a deficit—and since cutting pension benefits would be a very unpopular political move—we would not expect substantial changes for CSRS or FERS retirees.  However, there is a possibility of slight changes to benefits for those already in retirement and more significant changes for employees who have not yet begun receiving benefits.

In May 2018, Jeff Pon, the head of the Office for Personal Management, sent a letter to House Speaker Paul Ryan, proposing several changes to federal pensions, which would reduce the costs of current and future benefits. The one change that would have impacted current retirees was to eliminate cost of living adjustments (COLAs) for FERS pensions and reduce COLAs for CSRS pensions by 0.5%.  Other proposed changes would have reduced pension benefits for current employees by: eliminating supplemental pension benefits for the years prior to Social Security eligibility, adjusting the pension benefit calculation to use an average high salary over 5 years instead of 3 years, and gradually increasing employee contributions toward their pension benefit.  This proposal, however, did not gain traction in Congress, so it seems unlikely that these or similar changes will be implemented any time soon.

State and Local.  According to Pew Charitable Trusts and the Boston College Center for Retirement Research (CRR), almost all state and local pension systems in the U.S. are underfunded to varying degrees.  While a third of state and local pension plans have more than 80% of their current liabilities funded, others lag far behind—driving estimates of the total unfunded promises for state and local retirees to $1.6 trillion or more.  Most of these state and local pension funds have fallen behind in the years since 2001.  In the wake of the 2001 and 2008 recessions, some pension funds tried to gain ground by chasing higher investment returns, in some cases through increasingly risky investments, such as opportunistic real estate ventures.  This strategy helped alleviate pressure on the politicians—higher investment return assumptions meant that governments did not have to set aside as much money in their budgets to cover pension obligations.  Unfortunately, the reality has not been as rosy as the expectations.  Nationwide, pension plans continue to project median investment returns of 7.25% while the median annual return over the past decade has actually been 6.79%.  Over the past two decades, the median return has been even lower.  According to the Boston College CRR, the top third of state and local pension plans should remain on track to meet their obligations, the middle third (including the Virginia Retirement System, which is 77% funded) will likely need to make some reforms and/or adopt more stringent funding methods, and those in the bottom third (less than 55% funded) will require major intervention in the future.

Private.  As mentioned in Part 1 of this post, many private employers have been eliminating their pension plans in recent decades—shifting from “defined benefit” retirement plans to “defined contribution” plans such as 401(k)’s.  Union pressure drove many companies to begin offering pension benefits in the mid-20th century, but starting in the 1980s, this trend began to reverse course.  According to the National Public Pension Coalition, the number of private sector workers with a pension declined from 88% in 1975 to 33% in 2005.  This trend is likely to continue given that the cost of pensions is relatively high and variable as compared with alternative benefits, such as an employer match to a 401(k).  The stock market dip in the fall of 2018 demonstrated the negative impact that pensions can have on private companies’ earnings, and therefore on their stock prices.  In January, for example, some companies that report pension gains and losses in the year that they occur—such as Ford Motor Co.—faced a hit on earnings due to pension losses that stemmed from the fourth-quarter market decline.  Based on our experience, however, private sector employees expecting a pension in retirement will be compensated with a lump sum payout or annuity option if/when the pension plan is eliminated, which could yield some benefits in terms of estate planning and investment control, as we discussed in Part 1.

If you expect pension income in retirement and are concerned about the health of your pension plan—or if you face changes to your pension benefit during or prior to retirement—give us a call, and we can talk through the ramifications for your financial plan and how best to adapt to any changes that come along.


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