I’m going to tell you a story. As many of you know, I used to work in finance; the year was 2008 and it was a Monday in September much like any other day. I got into the office 30 minutes before my shift started to get my ritual cup of coffee and open all the necessary programs to make sure the clients for the firm I worked for could be serviced excellently. But it was not quiet, there was a nervous buzz; I started reading the news. Lehman Brothers had collapsed and the market futures were in free fall. That day, all pandemonium erupted. The next few weeks that followed were some of the worst emotionally I’ve ever had. Day after day I would listen to stories about people losing their life savings or their entire livelihood. They were angry, confused, hysterical, but mostly they were just numb. No emotion, like some demonic plumber had shut off all the water from their hearts and minds. A few weeks later, my manager brought our team in to a meeting and had us listen to a phone call of a woman. There wasn’t a question in her voice, there wasn’t any emotion in the call at all. She just asked flatly, “Why? Why had this happened? I have nothing left… there’s nothing left. Goodbye…” and she disconnected the call. We were directed to report any strange conversations like this to our manager, and so I dutifully did. I learned months later that she had killed herself. How many phone calls did I have that were exactly like the one above? I couldn’t tell you, but I know it was a lot. I don’t know what happened to any of those people during those tumultuous few months, but I hope they pushed through those days alive.
Why am I relaying this? That woman who called had just retired and everything that she planned on living on disappeared. Everything. How many of you out there can imagine counting on your state’s pension plan for educators and to wake up one morning and *POOF*, gone? All of those promises, all of those hopes and dreams, your entire future wiped out overnight. Everything. But wait, it gets even worse. Like the woman referenced above, many of those retirees who lost money in the 2008 crash were inappropriately invested in unsuitable positions. Why? Because many of them had pension plans that were either canceled or bought out by their employer and so they never were able to make the promised 8-10% return! As such, in order to compensate, many investors turned to an overbought equities market exposing them to more risk than they should have had. Is your pension appropriately invested? How much risk are you exposed to? A great commentary on this and the pension problem as a whole can be found at an outstanding podcast called Adventures in Finance, it’s Episode 11. These things together compounded a problem that is still causing strife for many retirees even today!There is about $1 trillion in underfunded pensions in the US, and about half of that is from public education; let me put that more bluntly: almost $500,000,000,000.00 in money due to educators ISN’T THERE. I guess some explanations are in order, first what does it mean to have an underfunded pension? Basically, it’s that “the money needed to cover current and future retirements is not readily available. Hence, there is no assurance that future retirees will receive the pensions they were promised or that current retirees will continue to get their previously established distribution amount.” - Investopedia. So, how does this happen?
There are 3 main reasons that contribute to underfunded educator pensions.
1) Promised Returns are untenable. This is probably the easiest to wrap our heads around. Many pensions, especially in education, are written such that they will give anywhere between an 8 and 10% return on investment over time. Sounds Great! But over the last 20 years, the 10-year treasury rate has averaged 3.8% (and is currently around 2.2%). This is obviously a problem where the guaranteed risk-free rate is 3.8% but the guaranteed pension rate is 8-10%. How can a fund manager get these returns and guarantee them? They can’t.
2) Retirement eligibility rules are unfair. There are 2 pieces to this puzzle. The first is that many states have eligibility based on years worked instead of simply age. While on the surface this makes sense, as you want to reward those teachers who are in it for the long haul, it also means that you can have individuals who started their careers at an earlier age, like 25, who are able to retire at age 55 with full pension. They are then living a substantial portion of their life while no longer contributing to the fund and acting as an unintended burden on the fund. The second part of this is that a teacher is highly incentivized to work for longer than they might otherwise work in education in order to qualify for the pension. The difference in some states between full payout and a 20% payout could the difference between working for 20 years versus working for 25 years. If the vesting schedule were more linear, that could encourage teachers to be more mobile while simultaneously encouraging longevity for those who wanted it.
3) Politicians. When politicians sit down to negotiate pensions, they can choose to pay good salaries now and raise taxes to fund them or pay modest salaries now and promise big returns later hoping that some other politician will be in office to be the bad guy and raise taxes. This has been happening for a while and now that piper is asking to get paid; an average of $0.70 on every dollar contributed to teacher pensions is being used pay off pension debt, NOT to future teacher benefits. We are paying for debts, not for attracting the best teachers.
Don’t get me wrong, some states are more solvent than others and some districts are better prepared than others but as a whole the situation is pretty dismal. The situation is much more complex than I’m making it sound, and there are some amazing articles (where I got all my information for this post) at then end. But educators are not alone in this; the pension problem is endemic across all industries. Probably one of the most known is the Dallas Police and Firefighters Pension. This is a story worthy of a Hollywood movie complete with graft, corruption, and all the makings of a blockbuster.
But wait… there’s more! This issue is further compounded by the need to get higher returns than what is available from the risk-free rate. As mentioned before, pension funds, as written, promise a relatively high rate of return, that seems untenable. The solution to that in recent years has been to invest a disproportional amount of assets in equities. I have heard quotes from financial sources like CNBC, Motley Fool, and RealVision that upwards of 90% of assets for retirees or those close to retiring are invested in equities. While every financial situation is different, equities are considered much higher potential return than fixed income but that’s because there is a much higher risk. To me, this seems to be a mathematical problem. But the real issue is why? Why are baby boomers and older Gen-Xers taking on more risk when they should be more risk adverse? Because the returns they have been promised are not coming to fruition so in order to get those returns, they are investing in riskier assets.
Even still, why is this even an issue? If retired or retiring teachers had enough in pensions, it shouldn’t really be a problem, right?
OK, to answer this question we need to think about wealth and net worth. Removing the top 1% of wealth owners in the US, do you know what the median amount of assets a person in the US has at retirement? The numbers vary, but it’s somewhere between $171,000 and $191,000. Keep in mind this is net assets, not liquid money. Assuming a rate of return on income generating securities like 5 year and 10 year bonds, the median retiree can expect an income off of that of between $7,000 and $10,000 a year. That’s it. You can see the temptation to invest in high risk/high reward assets by both individuals and pension fund managers.
But what does this have to do with pensions? Remember that story at the very beginning. In a financial crises, the retirement fund was completely lost. Fund managers are not immune to this either. In order to gain the returns promised, fund managers will have to invest in riskier assets and managers will have to allocate more and more contributions to pension debt rather than current teachers. This means that in a crises, there will be no more money in the pension account.
This post I just wrote is simply laying out the problem and unlike other blog posts I’ve written, this one is more to raise awareness and won’t have a list of 5 easy steps to supplement your retirement income. Though, you can find a pretty decent article here if you are interested in that. Or a list of things you can do to resolve the issue, though you can find that in some of the many links I’ve already added. No, this post is just to help raise awareness of a pending crises. So what CAN we do? Honestly, knowing about what is going on is a big part of it, a few suggestions are on this blog post here, but a very effective way to start is to contact your representatives and voice your concern.
List of different Sources:
Legal article showing why pensions are underfunded
The Pension puzzle, what is the state of educator pensions in US, how do they compare to company pensions (excluding other retirement accounts)
- Also, how did this happen?
it’s not just education
Richard Walter is the OG Training Ninja for SchoolStatus and clearly a wiz when it comes to financial education. Find out more about what Richard does here: