Fintech executive, writer, math geek, and investment systems developer. Founder and CEO of Altruist and Founder of FormulaFolios.

When Pensions Go Belly Up...

I just read an interesting blog post by Mish Shedlock regarding the dire situation of quite a few State of Illinois pension systems.  In a nutshell, Illinois is close to broke.  There are hundreds of thousands of people depending on pensions promised by the state, and frankly, there's almost no possible way all of these obligations will be able to be met. In their most simple form, pensions are pools of money where employees have money deferred from their wages.  These wage deferrals are then invested and retirement incomes are then "guaranteed" for life (or a form of joint life for those that are married and choose that option).  In order for the concept of the pension to work, those managing the large pools of money must earn a decent return in order to meet these obligations.  If they do not, the pension becomes "under-funded."

Those pensions in Illinois are really, really underfunded.  Here's the quick and dirty rundown (percentage of each pensions funding level):

  • Teachers Retirement System (TRS) - 46.1%
  • State University Employees Retirement System (SURS) - 45.3%
  • State Employees Retirement System (SERS) - 34.9%
  • General Assembly Retirement System (GARS) - 20.2%
  • Judicial Retirement System (JRS) - 31.0%

As you can see, this is problematic.  All of these pension systems are less than 1/2 funded and a couple less than 1/3 funded.  For comparison the average private pension of S&P 1500 companies was 78% as of January 2012. (source: Reuters)

Even scarier - these funding percentages assume the pension investments will earn 8% annually from this point forward.  Ouch, that's highly unlikely to happen (in my opinion anyway).

If you'd like to read the full report you can access that here.

What does this mean to folks with pensions?

First, if you have a pension it might be a good idea to find out its current funding level.  If you have a pension your provider is required to send you a Pension Funding Notice at least annually.  If it is low, ask the pension administrator what their plans are to keep the plan from running out of assets.  If they beat around the bush with no real answer, you may need to lead the charge in rallying fellow pensioners to get some answers.

If you're still working but not yet collecting a promised pension, you'll want to make sure your own retirement assets are being managed in the most responsible possible manner.

Generally speaking pensions are safe bets.  But they can go bad, and they can default.

When that happens usually the government sponsored Pension Benefit Guarantee Corporation (PBGC) steps in.  This allows current benefits to continue to be paid in full, but since plans are usually frozen at this point, workers just a few years shy of retirement are likely to receive less (sometimes a lot less) than they originally thought.  This is because pension estimates assume you work up to retirement and in the latter years of employment generally are at your peak earning years.

The big risk, in my estimation, is that too many pensions will eventually freeze and/or default.  If this happens the Pension Benefit Guarantee Corporation will have a very tough time paying out all of the defunct pensions.  Since the PBGC is government sponsored, this ultimately means our already financially stressed budget could be further weighed down with dozens (or more) bad pensions.

Will all these nasty pensions turn the USA into Greece?

This is different, but no so different than what has happened in Greece.  The government was paying way too much in guaranteed retirement benefits and didn't have the funds to do it.  Eventually Greece couldn't keep up with all the pension obligations, general operating costs, and interest on their debt.  When that happened retirement benefits had to be reduced substantially (along with many other entitlements) - leading to riots in the streets.

I have family, friends, clients, and an entire business in Illinois.  I know they're not the only state with pension funding issues, but for the sake of everyone there, and ultimately the whole country, I sincerely hope they figure out their pension shortcomings.  Only time will tell though, and I'm not sure how much of that they have.


Jason Wenk

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