How’s My Pension Doing?
We’ve come to take for granted that anytime you hear someone has a pension, that it’s like they’ve won the golden ticket to Willy Wonka’s Chocolate Factory. And with the S&P 500 and Dow Jones Industrial Average reaching record highs, you would expect that any pension benefit is fairly secure in its promise to pay lifetime income.
For decades, there has been periodic concern that state and local pensions have been underfunded in comparison to the benefits being promised to current employees and retirees. Keep in mind that we are talking about state and local government and some private pensions, not employee-funded retirement plans, such as 401(k)s.
A defined benefit pension plan promises to pay a specific (defined) benefit to retired employees. To meet this obligation, employers must fund and invest the pension balance so that it meets these obligations. For state pensions, the risks and realities of underfunded pensions are starting to make headlines, even with market highs.
In a research report by the Pew Charitable Trusts, not all states have benefitted equally from the rising market. In many states, the gap between promised benefits and funding has increased considerably and the funding gap for all 50 states is estimated to be $1.5 trillion as of December 2018. Per their research, the best funded states were South Dakota, Tennessee and Wisconsin (as of 2017). The report notes, “Kentucky, New Jersey and Illinois have the worst-funded retirement systems in the nation in part because policymakers did not consistently set aside the amount their own actuaries said was necessary.” Per Pew research, only 69% of pension liabilities nationwide had been funded and only 8 states were funded at the 90% level.
In addition to funding deficits, a recent Wall Street Journal article titled, "Public Pensions are Stuck in the Cloud" asserted that the balance deficits may grow even larger than estimated. Many plans use an assumed rate of return higher than they are likely to achieve, particularly given the high returns experienced over the last decade. This is clearly a concern given recent market performance, mean reversion theory and a widening funding gap, despite recent high market returns.
How are we doing locally? Maryland had a 68.6% funded ratio and Virginia had a 77.2% funded ratio. Our neighbors in Pennsylvania had a 55.3% funded ratio and West Virginia a 78.9% funded ratio. Per Pew, the sources of information for their calculations were comprehensive annual reports, actuarial reports and valuations, other public documents, or documents as provided by plan officials.
If you anticipate receiving a state or local pension, it pays to be aware of its funding status.
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To view other articles in the August 2019 Financial Planning Focus newsletter, click here.
West Financial Services, Inc. is an SEC registered investment adviser. Registration with the SEC does not imply a certain level of skill or training.
Information contained herein was derived from third party sources including, but not limited to, Bloomberg, Standard & Poor’s, Dow Jones & Company, the Federal Reserve Bank of New York, and Morningstar, Inc. While the information presented herein is believed to be reliable, no representation or warranty is made concerning the accuracy of any information presented. We have not and will not independently verify this information. Please contact us if you would like to obtain a copy of the third party sources.