• Victor C. Bolles

The Pension Pit



You have probably been wondering why most private sector workers have defined contribution retirement plans (basically 401ks) while most public sector workers have defined benefit retirement plans (pensions). Or maybe you haven’t. It‘s a rather wonky thing to think about. I sometimes get obsessed about wonky stuff, but that’s just me.


But maybe you should think about why public sector workers have defined benefit pensions, because it affects you no matter what type of retirement plan you have (I hope your retirement plan does not consist of just relying on Social Security). Warren Buffet advises people against moving to states with large unfunded pension liabilities. “If I were relocating into some state that had a huge unfunded pension plan I’m walking into liabilities,” he said on CNBC.


When you have a defined contributions pension plan, you and your employer make contributions to a retirement fund like a 401k that is invested in various kinds of assets (usually a selection of mutual funds) that will grow tax free over time and become a substantial amount by the time you retire. When you have a defined benefits retirement plan, your employer guarantees that you will receive a certain sum of money calculated based on your years of employment (usually paid monthly) after your retirement. The sum of money paid can also include an adjustment for inflation (COLA) so that your payment isn’t debased over the long years until your retirement. Good employers set aside and invest the funds needed to pay such pensions.


You might be thinking, “why should I care what kind of pension some other guy has.” You may also think, “hey that defined benefits plan sound a lot better than my 401k. I wouldn’t mind having one of those instead.” But if you worked in the private sector, you might be out of luck. Most private sector companies have switched to defined contribution plans. Defined benefits might be great in good times, but when times get tough many companies have difficulty setting aside the funds needed to honor its current and future pension obligations. Bankrupt retailer Sears claimed the $4.5 billion it had to pay to fund its pension shortfall impaired its ability to compete. Sears ultimately collapsed into bankruptcy.


“Well,” you might say, “That’s too bad, but the pensioners were protected by the government’s Pension Benefit Guaranty Corp. So why should I care?” As taxpayers you might be concerned that the PBGC has an accumulated deficit of over $50 billion, which is getting close to the amount of the bailout of Fannie Mae and Freddie Mac that outraged so many people. But the government can print money so you won’t be on the hook for that bailout (although your grandkids probably will).


But that is the private sector pension fund problem, and we are talking about the public sector unfunded pension plan problem. It is true that the federal government can print money to pay the pension of federal employees. But only about 4 million of the 20 million public workers are federal employees, the rest are state and local employees. And state and local governments can’t print money. All they can do is tax their residents.


And that’s why you need to pay attention to Warren Buffett’s warning. You are on the hook for those unfunded liabilities. And they are enormous in some cases. Residents of Chicago are on the hook for its unfunded pension liability of almost $47 billion. That’s about $43,100 per taxpayer according to truthinaccounting.org! But that’s not all. The state of Illinois has an additional unfunded pension liability of $111 billion despite spending a quarter of its annual budget on pensions. No wonder people and companies (along with their jobs) are moving out of Illinois.


There is something else you need to know before you start running around the country following Mr. Buffet’s advice. The Federal Reserve reports that the states with the largest unfunded positions in relations to state revenues are Illinois (-247.7%), Connecticut (-159.5%), New Jersey (-155.7%), California (-140.2%) and Kentucky (-137.3%). I just told you about the pension problems in Chicago. The other cities in the US facing the worst pension crises are New York City, San Francisco, Boston, Detroit, Los Angeles, Philadelphia, Cincinnati, Baltimore and Milwaukee.


But that’s not the worst of it. Although I have tried to use the most recent statistics available, most of them are at least a couple of years old. Most of the assets of these state and local government pension funds are invested in stocks, just like your 401k (most likely). And if your 401k has taken a major beating in 2022, just think what the unfunded positions of all these states and municipalities will look like when they report their 2022 results.


Ponder that


Welcome back!


Citizens across America are on the hook for trillions of dollars of unfunded pension plans of various states and municipalities. And it’s not just a future financial liability that afflicts the residents of these states and municipalities. The taxes they pay for city and state services goes to retired workers instead (many of whom retire before they are 60 years old). Over the last ten years in Chicago, funding for pensions increased 239%while funding for city services only increased 18% over the same period. And 19% of the Illinois state budgetgoes to pensions instead of services. This scenario is repeated ad nauseum all across this country.


It may come as no surprise to you that all of the five worst states and ten worst cities are led by Democrats. It may also come as no surprise that the unions representing the government workers (such as the Service employee International Union (SEIU), the American Federation of Teachers (AFT), the National Education Association (NEA) and the American Federation of State, Country and Municipal Employees (AFSCME)) make huge political donations to political leaders, almost exclusively Democrats.


It strikes me as a conflict of interest that government workers’ unions make political donations to the politicians that will be negotiating their collective bargaining agreements. A conflict of interest that borders on bribery.


The politicians have no skin in the game, and they will do almost anything to promote labor peace. If they negotiate too much of a sweetheart deal with the unions (like the 24% pay increase recently granted to railway workers) it may have a negative impact on their political careers. But the financial impact of pensions is far in the future and, hopefully, they will have moved on long before the payments come due.


Except now they are coming due. As taxes rise and services decline many residents (at least those that can afford to do so) take Mr. Buffet’s advice and move away to less financially dangerous climes. Those who remain behind are the least wealthy and most vulnerable communities in the city. The census bureau reports that cities like Chicago, Detroit, Baltimore and even Los Angeles have lost population and now have majority minority populations. The evacuation of the middle class population isn’t racism, it is economic necessity. Citadel Securities recently announced that, after 30 years in the windy city, it is moving its headquarters from Chicago to Miami because of rising crime and taxes.


The government workers unions continue to lobby to protect their benefits including their defined benefit pensions, even as they strangle the golden goose. It is the remaining residents of these cities that will suffer. Those residents, who routinely reelect Democrats whose policies undermine their wellbeing, need to take charge of their future. The union will fight like hell against the changes. So will the politicians. They have a pretty sweet deal, at the expense of the residents. Residents of these cities and states need to set things straight and elect representatives that will convert the defined benefit plans to defined contribution plans. Contracts with public sector unions should contain no future payments that can’t be quantified. Maybe those reformers might also be interested in doing something about rising crime, failing schools and deteriorating living conditions as well.

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