The Grumpy Labourski

I just realized the serendipitous nature of the topic I chose for this Labor Day weekend’s post, which is pension safety.  Of course, for my one international reader, I refer to U.S. Labor Day.  Don’t confuse it with the rest of the world’s International Worker’s (Labour) Day, otherwise known as May Day.  The U.S. celebrates its laboring workers in September due to May Day’s association with the Haymarket Affair and the Communist Party.  There’s no way this Cold War kid would celebrate some Commie Red version of Labor Day.  Of course, now I feel torn between shouting either “WOLVERINES!” or “YeehaaAAAWWW!” in homage to one of the two greatest Cold War movies of all time.  I’ll let you decide which one is laced with more irony. (Grumpus Maximus is an Amazon Associate, see Disclosures for more details.)

Jokes aside, this article marks the start of a new series of posts centered on pensions.  My choice of Labor Day weekend to begin this series, while fitting, was coincidental.  In all honesty, I don’t plan that far in advance.  I decided to write about pensions because I noticed that the blog’s kind of light on pension discussions.  That’s not good for a blog “Where Financial Independence (FI) and Pensions Meet to Create a Better Retired Life”.  Thus, I felt it was time to rectify that oversight.

One disclaimer before we start.  In no way do I consider myself a pension expert.  Other than laboring for one myself, I don’t possess any credentials that makes me the expert on pensions in the FI space.  However, if you read my About Me and What is a Golden Albatross? posts,  you’ll realize that I’ve grasped the potentially powerful role a pension could play in someone’s FI plan.  I’ve also grasped the potentially destructive role a dangling pension, so tantalizingly close, might play in one’s calculation of happiness.  As a result of these dual and conflicting realizations, I want to learn all I can about pensions.  And since I started this blog in part to help people, I also want to pass that knowledge along.

For this series, I liken myself to a private investigator, or investigative journalist, doing the initial hard work and research on your behalf.  I hope to deliver interesting posts on topics relevant to someone plotting their course to FI using a pension.  However, don’t consider my posts the definitive word on any given pension related topic.  Rather consider them jumping off points from which you can explore the topics further.

I admit up front, that I assume some level of knowledge already in my readers.  You won’t find any articles that describe what a pension is here.  Yet, as I do in my other posts, I will link to articles that describe and explain certain concepts better than I.  This saves your and my time.

Finally, just as a point of clarification, throughout this series when I refer to pension, I mean a Defined Benefit (DB) plan.  In other words, you work an agreed amount of time for an organization and based on a set formula you receive an amount of money paid as an annuity for your previous work.  There are other types of pensions out there, but DB plans continue to serve as the standard.  Without further ado, let’s get on to the first pension topic in the series:  pension safety.

Are Pensions at Risk?

At the risk of sounding like Captain Obvious, I think it’s important to point out that if you can’t rely on your pension to be there in retirement, then you shouldn’t rely on it when planning for FI. Yes, I know that’s common sense, but you know what I say about common sense? If it was common, we’d just call it sense.

It shouldn’t be news to anyone who works in the U.S. that pensions are no longer a common practice in corporate America. The public sector, often referred to as the last bastion of pensions in America, has started to phase them out too. There are multiple reasons for these phase outs, some which I touch upon below. Despite that, some of us will earn pensions at some point in our career. If you can count on that pension to materialize on time and in the correct amount, it could prove decisive in achieving FI. Unfortunately, that is an increasingly big if in today’s fiscal environment.

With that said, not everyone’s pension is in peril. So what makes one pension safer than another? One separating factor is management. Well-run pensions that have more assets than liabilities are much safer and reliable than those that don’t. From what I can tell, member contribution requirements that reflect realistic rates of return from the pension’s investment portfolio, serve as a good proxy for determining good management. Unfortunately, as we’ll see below, there are certain types of pensions where this type of good management is more common than others.

Another factor separating pensions is the bank roll of the plan’s sponsor. In other words, how much money does a sponsor have to fund pension shortfalls that the investment portfolio and contributions can’t cover? Until recently, government sponsored public pensions were typically considered the pensions with deeper pockets. This was due to their ability to levy taxes. In a post-Great Recession world, that no longer rings true. Like their corporate counterparts, fewer governments can afford the cost of defined benefit public pensions.

Public Pensions: Federal, State, and Local Level

If you are a U.S. Federal employee, the only issue necessary to compute the safety of your Federal Employees Retirement System (FERS) pension or Military pension, is the solvency of the U.S. government. The U.S. Government, for better or worse, always pays its debts — if not technically on time, then at least with back interest. Your future pension is one of many U.S. government debts. Thus, about the only time you might remotely worry about your pension is when issues like U.S. debt limit ceilings, balanced budgets, and tax cuts with offsets are being debated in Congress. That said, it’s probably worth keeping an eye on inflation. Even though Federal pensions come with Cost of Living (COL) increases, rampant inflation can be a killer.

The U.S. is not the only country who always meets its financial obligations. As of 2011, Canada, Denmark, Belgium, Finland, Malaysia, Mauritius, New Zealand, Norway, Singapore, Switzerland, and England (I assume they mean the UK) had never defaulted on their sovereign debt. That is not to say those countries never faced financial crisis. Nor am I saying they’ve never stilted their Federal pensioners. What I am saying is that their ability to keep their finances in order speaks well to the future likelihood they’ll pay their Federal pensioners.

Conversely, if you are an employee of the Greek, Spanish, or Italian Federal governments, and are owed a Federal pension; future pension obligations probably take on more importance every time a member of the European Central Bank comes to town. Argentina and Brazil are other countries that spring to mind where discussions about the security of Federal pensions turn sour. Argentina has a particularly long history of defaulting on its domestic debt, which includes pensions.

Move down to the state level in the U.S. and again, depending on the state, your pension may be more or less at risk. When I originally wrote this as a blog post in September 2017, state workers in Kentucky were tripping over themselves to retire, due to pending changes in their state’s retirement plan. If you are a state worker but never looked into the viability of your state’s pension plan, check out this Bloomberg article as a quick reference. I hope all of you work in New York, South Dakota, Washington D.C., Tennessee, or one of the other handful of well-run states. Unfortunately, I doubt that is the case.

The story is much the same at the county, city, and local level. Some pensions are well run, but many others are not. Does Detroit or Stockton, CA ring any bells? Both U.S. cities declared bankruptcy after the Great Recession. Their inability to meet pension obligations played a big part in both of those bankruptcies. Over obligating benefits while under funding those obligations is a sure sign your local government pension plan is in trouble. Taxes don’t always save those plans either. At some point local taxpayers push back, especially if they perceive mismanagement.

So, if you stand to earn a public DB pension in the U.S. are you doomed? Absolutely not. However, you should start researching your plan’s fiscal health now, especially if you are relying on that pension to fund major portions of your retirement and/or reach FI. Boston College runs an organization called the Center For Retirement Research, and it is a fabulous resource for this type of research. The site includes links to the Public Plans Database (PPD).

The PPD accounts for over 90% of public sector pension plans. You can search state-by-state, plan-by-plan, and read up on national trends. The database provides you a quick overview of your pension’s financial status. In some cases, it also links to the financial documents that pensions publish annually. Again, I hope you find good news when you delve into the facts. If not, I will address some options in future chapters.

Private Pensions

From the 1980s through the present, the total number of American corporate workers covered by DBPs shrank from 60% to approximately 10% of the workforce. DBPs proved too expensive for corporate America. When the Regan administration loosened some of the rules regarding pension administration in the 1980s, Corporate America saw its opportunity and headed for the exit. It did this through several different mechanisms including freezing pension funds from new employees, and transferring the remaining obligations through mechanisms like Pension Risk Transfer to insurance companies.

That trend continues. 2017 was a banner year for the number of corporations unloading their pension obligations to insurance companies. If you want to know more about Pension Risk Transfer because you think your pension may be subject to that action, take a look at my blog post on the topic linked at the end of this article. I concentrated on it separately because Pension Risk Transfer is a somewhat niche issue, and doesn’t fit the overall flow of this post.

Today’s remaining corporate pension plans face the same two hurdles that public pensions face: increased obligations and under-funding. In August 2017, The Wall Street Journal reported that the funding gap for all remaining S&P 500 pension plans “could exceed the previous record set in 2012 when the funding shortfall hit $451 billion“. That headline was based on an S&P 500 Indices report that I’ve linked at the bottom of this post along with some other resources.

The S&P 500’s report is mandatory reading if you work for an S&P 500 company, and a pension is coming your way. Among other things, it contains an annex of the S&P 500 companies with pension obligations and their status. One interesting note from the report is that despite today’s historically low-interest rate environment, the shortfalls apparently remain manageable for the near term. Shortfalls will only shrink as interest climb as well.

The report also points out that pension obligations will eventually crest as the remaining Baby Boomers retire and die (my subtle words, not theirs). In other words, since most Gen-Xers and Millenials don’t have a pension coming their way, corporate pension obligations will slowly shrink as a total percentage of a company’s bottom line as its Baby Boomers pensioners die off. This will increase corporate fiscal health. So, if you are a Gen-Xer or Millenial, and corporate America owes you a pension, then congratulations! If the pension fund can survive the wave of Baby Boomers, it’s likely you’ll get yours.

The Pension Benefit Guaranty Corporation (PBGC)

One final note about corporate pensions, the Pension Benefit Guaranty Corporation (PBGC) covers most of them in the U.S. If you think that sounds like an insurance organization, you’d be correct. The U.S. government runs PBGC as an insurance plan for private Single Employer Plans (SEPs) and Multi-Employer Plans (MEPs) in case they fail. Congress commissioned the PBGC in the 1970s to prevent companies (and their pension plans) from leaving workers high and dry when they declared bankruptcy.

What’s the difference between a SEP and a MEP? SEPs are funded by only one company like Xerox or FedEx. MEPs are funded by multiple companies like the auto manufacturers who employ union members. Thus, an overly simplistic way of thinking about the difference between SEP and MEP is a union job vs. a corporate job.

It’s extremely important to note that the PBGC has a separate insurance fund for each type of plan (SEP vs. MEP). More importantly, there’s a qualitative difference between the funds that every contributor to a private pension needs to understand. While both schemes were underfunded as recently as 2018, the SEP fund was projected to be in the black by no later than 2022. Conversely, the MEP fund is projected to be insolvent by 2025. Thus, if the MEP plan steps in to take over a pension fund, pensioners receive drastically reduced monthly payouts.

The bottom line on the PBGC is this, while it’s great that the PBGC exists, depending on the type of plan you contribute to you might be OK or you might be screwed, if it’s forced to take-over your pension fund. That’s all I’m going to say about the PBGC for this post. I wrote an extremely in-depth blog post about the PBGC for the Pension Series, which I’ve linked at the end of this post. If you’re in a SEP or a MEP, and want to know more about the PBGC, check it out.

Bottom Line: How Safe is Your Pension?

Spoiler alert, there is no way I can answer the above question for you.  At best, I can point you in the direction where that answer might lie.  I believe that is what I’ve done here.  At worst, I’ve painted such a dismal picture that you’re ready to withdraw all your money, head to your closest casino, and “always bet on black“.  (Grumpus Maximus is an Amazon Associate, see Disclosures for more details.)  Don’t do that.  Wesley Snipes is an awful fiscal role model who served prison time for income tax evasion.

More to the point, the pension story is not all doom and gloom. Depending on your pension plan, you may be fine. If you look at the data, and you believe that to be the case, head over to the Planning section on my blog. Plug your pension numbers into your retirement plan, test that plan with a high powered calculator, and let me know how things work out.

On the other hand, if you read this post and got a sinking feeling in your stomach, don’t despair. First of all, make sure you utilize the resources below and put together the most accurate picture possible of your pension fund’s health. This includes obtaining the latest financial report from your pension plan administrator. They must make those available by law.

Lastly, stay tuned to this series because depending on your pension plan, there may be an opportunity to cash out or take a lump sum payment. Many pensions offer lump sums as an alternative to the lifetime annuity. It’s good for the company because they rid themselves of future obligations to pay out over the remainder of someone’s lifetime. If you think your pension is doomed to failure, a lump sum may be the right move for you too. There are drawbacks to consider though, which is why I examine how to make the determination in a future post. For now, make sure you utilize the applicable resources listed below. Feel free to contact me with any questions, comments, or ideas for future Pension Series posts.

Happy Labor Day … Comrades!

Pension Plan Resources

• The Balance.com Pension Page. Start here for a series of short articles on the basics surrounding pensions if you are in need of a tutorial, or a refresher.
• Investopedia article: Is Your Defined-Benefit Pension Plan Safe? Turns out someone at Investopedia wrote a similar post to mine a few years ago. It’s dense but worth the read.
• Investopedia article: 7 Signs Your Pension Fund Is In Trouble. If you walked away from my post feeling queasy, double check with this article. If multiple signs listed in the article are swirling around the office, start your in-depth research now on your pension plan.
• Investopedia article:  The Investing Risk Of Underfunded Pension Plans. This is a graduate level article on how to analyze the risk associated with your pension plan’s investment portfolio.
• Boston College’s Center For Retirement Research. As mentioned previously, this site is a great resource.
• Public Plans Data. A one-stop-shop for public pension safety information from the state down to local level.
• S&P 500 Indices’ 2016 paper on the health of private pensions for the top 500 corporations in America. A must read if you work for one of these companies and are due a pension.
• The Pension Series (Part 14): Pension Risk Transfer.Who wins and loses when a pension fund transfers its obligations to an insurance company?
• The Pension Series (Part 15): The Pension Benefit Guarantee Corporation (PBGC). What is the PBGC? What happens when it intervenes in a pension fund?