Planning to retire? Maybe not.
As finance director for Redwood, Calif., Brian Ponty knows that his retirement benefit from the state employee retirement system is secure. But that doesn’t keep him from thinking about whether he might delay retirement beyond when he is eligible in a few years. “I have a 12-year-old, and saving for college is our big challenge,” he says. “Our 529 [college saving] program was right on track until last year. Now it’s not so much on track. I’ll have to consider our circumstances when I’m closer to 55.”
Ponty is like many public sector employees who are assessing the damage done to their retirement prospects by the nation’s worst economic downturn since the Depression. Though they retain considerable faith in the security of their defined pension benefits, they are less certain about where the economy is heading, the reliability of their other savings and the wisdom of leaving their positions.
The economic turmoil is only one factor affecting workers’ retirement planning. States and local governments now must calculate the budget implications of market losses in their pension plans, how to save through possible changes to their pension plans and how altered retirement patterns may affect human resources planning. “There’s no getting around the fact that we’ve been affected,” says Keith Brainard, research director for the Baton Rouge, La.-based National Association of State Retirement Administrators (NASRA). “The consequences will play out for the next few years.”
STILL SAFE AT HOME?
Across the country, local and state pension plans are coming to grips with the increased costs of their pension liabilities, even though the full impact of the market losses are “smoothed out,” or averaged, over five, 10 or more years. In Wisconsin, the state pension plan raised employer contributions by about 6 percent to offset market losses. The Illinois legislature is trying to find the money to pay $4 billion that it owes its pension fund to ensure it can pay for promised benefits. New York State is considering a change in pension laws so that future uniformed workers in New York City cannot retire on full benefits before age 50, use overtime in their final years to boost pensions or include special bonuses in their pension calculation.
Perhaps most notably, the California pension system is underfunded by between $300 billion and $1 trillion, according to the State of the State report issued by the Santa Monica, Calif.-based Milken Institute in May. “The item that is most killing the state budget is the huge pensions for public employees,” Joel Kotkin, presidential fellow at Chapman University in Orange County, Calif., and a specialist on public policy, told CNBC. “We have to figure out what we’re paying, how we’re spending and begin to make public employees live by something close to the rules that the rest of society does.”
But others defend the current value of pension benefits for public sector employees. Pension plans covering more than 80 percent of public workers are justified, says Beth Almeida, executive director of the National Institute on Retirement Security, a Washington-based nonprofit focused on research related to public sector pensions. “If you are going to devote yourself to a public calling, there is something in it for you in terms of retirement security in the end,” she told U.S. News and World Report.
REVIEWING THE STATS
There is little doubt that public pension funds, along with private pension funds and 401(k)/Individual Retirement Accounts (IRAs), shared the ferocious beating most investors suffered in the fall 2008 market collapse. According to the Center for Retirement Research (CRR) at Boston College, the value of all retirement accounts fell $4 trillion between Oct. 9, 2007, and Oct. 9, 2008. Of that amount, about $1 trillion was felt by public pension plans. Another $1 trillion was lost in private pension plans, and individuals lost the other $2 trillion in their 401(k)s and IRAs. Even by mid-year 2009, equities, as measured by the broadly based Wilshire 5000 index, remain 40 percent below the peak they reached on Oct. 9, 2007.
Defined benefit plans promise a pension benefit to participants, based on a formula that usually considers length of service and final pay. Because the benefit is fixed, the burden of the investment losses falls to the public employer, which contributes dollars, or “funding,” each year based on calculations of what will be needed to pay the benefit. In some cases, employees also contribute their own pay, which may be mandatory and can change.
According to CRR, the funding level in 2007 for a sampling of 120 state and local plans was at 87 percent of the promised benefit. After the market collapse, CRR estimates that the funding ratio would have declined to 65 percent. But, because of smoothing, the actual impact would probably fall between 59 percent and 75 percent funding, depending on future market performance. The U.S. General Accounting Office considers 80 percent funding acceptable for public plans.
While acknowledging the effects of the market downturn, Brainard says the nature of defined benefit pension plans actually protects workers in the market decline. He points to the advantages of “pooled” investing, which allows for large amounts of money from many communities to be invested together and more easily diversified among a number of investment classes.
In addition, because benefits are paid out over a long period, the funds have time to recoup their losses and maintain a long-term perspective. He contrasts that scenario with defined contribution plans, which rely on the prospective retiree to invest the contributions, both their employer’s and their own, and bear all of the market risk, regardless of how close he or she is to retirement age. Upon leaving work, the employee’s retirement benefit depends on the value of the defined contribution account. “It helps to illustrate the perils of relying on a defined contribution for retirement,” Brainard says. “Do-it-yourself plans are not pooled and often not diversified. They are uncertain vehicles for producing a reliable retirement income.”
A QUESTION OF TIMING
A May survey of employers by the Milwaukee-based International Foundation of Employee Benefit Plans (IFEBP) reflects the uncertainty that employees are experiencing about their retirement. The survey shows that employees are more anxious about delaying their retirement than about losing their jobs or seeing a reduction in their health care, which is similar to a survey of the same group last October. However, in the most dramatic shift in sentiment, the second largest concern for employees is a fear of a reduction in retirement benefits, which was not even named in the earlier survey.
“There is definitely an increase in the concern about a possible reduction in retirement benefits,” says Sally Natchek, IFEBP’s senior director of research. “These trends proceed more slowly in the public sector. Some of these measures came before in the private sector. Now, the public sector is seeing it happening there, as well.”
The significance of the shift in attitudes in the public sector is still uncertain, though some surveys indicate that retirement patterns may be changing, at least in the relatively near future. According to a survey of public sector human resource managers by the Center for State and Local Government Excellence (SLGE), a Washington-based research institute, the slumping economy is delaying retirements among state and local employees, with almost 85 percent of the respondents saying the downturn is prompting employees to postpone retirement.
“Public sector workers may have their pensions, but they could be in two-career families and the other spouse is out of work or their savings are diminished and they want to wait to replenish the other pot of money,” says Beth Kellar, SLGE executive director. “There may be a lot of reasons.”
ROSTERS ARE FULL
While postponing retirement may be disappointing for individuals, there may be a hidden benefit for employers, who have more time to find replacements for skilled positions, Kellar points out. In addition, the longer workers delay taking benefits from the retirement fund, the more time the fund managers have to recoup the loss from the market turmoil.
In a scan of the national retirement scene, it is clear that the recession has touched parts of the public sector retirement infrastructure differently, depending on the financial condition of the entity at the beginning of the recession, promised benefits and policies and practices in place. Ponty points to recently released figures from the California Public Employees’ Retirement System (CalPERS) that demonstrate how the retirement calculation may affect some communities. Based on the actuarial estimate at the end of February, Redwood would be facing a $2.4 million increase in its pension fund obligations in the 2011-2012 fiscal year as a result of the market losses. However, the state is spreading out the effect over several years, so the increase will be $334,000 in 2011-2012, $1.4 million for the next year and $3.1 million for the following year. “The message is clear to the city council,” Ponty says. “We need to contain the budget and reduce expenditures and increase revenues. We have a few years to plan, but we have a very difficult time ahead of us.”
Those constraints follow a time when the city already has cut its workforce by 20 percent in the last 10 years, says Bob Bell, Redwood’s human resources director. “In the 1990s, we went way under the market and couldn’t attract entry-level candidates,” he says. “We had to become competitive.”
He is concerned that the pendulum might swing too far in the direction of austerity. “When the economy rebounds, we have to have the flexibility to attract and retain our knowledge workers,” Bell says.
SURVEYING THE FIELD
For the Texas Retirement System, the recession has been a challenge, but not one that has drastically altered its investment policies, says Amy Bishop, chief customer officer. The unusual structure of the system pools the separate benefit programs of 600 counties and districts into a $12 billion fund. “Our long-term strategy is pretty much in place,” Bishop says. “We make minor tactical changes, and we’ve seen great opportunities in some asset classes, but we take a very long-term perspective. The average career is 18 years, and they spend another 20 years in retirement, so we take a 40-year investment horizon. We’ve weathered these things before.”
For Rodney Pasch, human resources director in Fond du Lac, Wis., the coming year “will be a real challenge for us.” Limitations on revenues and falling state aid have the city in a squeeze. Add the increase in the pension fund contribution, and the prospects are bleak. “These are extremely difficult times,” he says.
Nonetheless, he thinks that most people who had planned to retire will follow their plan. “People who plan to retire are going ahead,” he says. “No one is backing off.” Part of the reason, he says, is that retirement is based on the final three years of earnings, and with possible pay cuts and furloughs, their benefits could decline if they stayed on longer. “It’s part of the daily calculation of retiring,” he says.
In Oakland County, Mich., employees have felt the brunt of the recession in a number of ways. In 1994, the defined benefit plan was closed to new employees, who were placed in a defined contribution plan. With the state’s economy already reeling from the decline in the auto industry, employees have tended to hang onto their jobs, says Jennifer Mason, the county’s human resources director. “People were retiring at a regular clip up through the financial meltdown,” she says. “But hardly anyone has retired, regardless of whether they are on the defined benefit or defined contribution program.”
She says that those on the defined contribution plans lost a lot of money in the market. While the defined benefit was secure, the poor economy has put a damper on other retirement dreams, like selling their home for a big profit. “They’re nervous in general,” she says.
Other parts of the retirement program also have been downsized, she says. The county has eliminated a $300 payment that it used to deposit into each employee’s supplemental retirement program and has raised the out-of-pocket expenses in the retiree health plan. Since 2006, a retirement health savings account replaced the retirement health care program for new employees.
“If the economy turns around in the next year or two, I think things will go back to normal,” Mason says. “But, if it goes on longer, people may change the way they review retirement. They will just have to work longer than they expected.”
Read a survey on readers’ retirement plans being altered by economic conditions conducted by American City & County in May, which found older workers want to hang on to their current jobs.
Robert Barkin is a Bethesda, Md.-based freelance writer.