Some experts think it will be the trigger for the next financial collapse. Others call it a “national crisis” of unprecedented proportions.
But what all of them agree on is that there’s no way US pension funds can keep their promises to the next wave of retirees.
Right now, millions of Americans are hard at work believing their pensions will be their saving grace for retirement. But the predicament pension funds across the United States find themselves in does not just spell trouble for the distant future.
Though the challenges are well known by now, many believe that public-sector pension funds will be maintained and the gaps filled by strong investment returns, increasing employee contributions, raising taxes, or some combination of the three. They hope with these measures and ongoing strong asset returns, liabilities can be reduced and pensions salvaged. Unfortunately, this is wishful thinking at best.
Even though the facts are on the table, state and local governments continue to underestimate the crisis at hand. According to Hidden Debt, Hidden Deficits, a 2017 data-rich study of US pension systems by Hoover Institution Senior Fellow Joshua Rauh, almost every state or local government has an unbalanced budget—due to runaway pension fund costs that are continually chipping away at already inadequate budgets.
In 2016, Rauh stated, “while state and local governments across the US largely claimed they ran balanced budgets, in fact they ran deficits through their pension systems of $167 billion.” That amounts to 18.2% of state and local governments’ total tax revenue.
According to the 2017 report, total unfunded pension liabilities have reached $3.85 trillion. That’s $434 billion more than last year. Amazingly, of that $3.85 trillion, only $1.38 trillion was recognized by state and local governments.
The difference between funded levels under Governmental Accounting Standards Board (GASB) metrics and more realistic expectations reveals a massive amount of “hidden debt,” commonly referred to as unfunded liabilities. Under GASB metrics, public pension systems assume they will see annual returns of 7.5%. This assumption ignores the increased risks associated with stocks, hedge funds, real estate, and private equity to realize these returns.
Using that 7.5% annual return, unfunded liabilities for city and state plans are $1.38 trillion. However, when we use a more conservative return of 2.8% based on the Treasury yield curve, unfunded liabilities balloon to $3.85 trillion. Realistically, the truth probably lies somewhere between these two numbers, which still results in a huge increase in unfunded liabilities.
An Alternative Approach
Massive financial market losses in 2000–2001 and 2008–2009 led many pension funds to invest in high-fee and higher-risk alternatives such as hedge funds and private equity. But this strategy only exacerbated the funding gap over the past decade, failing to deliver expected returns.
The California Public Employees’ Retirement System (CalPERS) is one of the largest public pension funds with over $300 billion in assets and nearly 2 million members. After years of poor performance—including a meager 0.6% net return in the most recent fiscal year—the fund is now embracing a lower-cost, diversified investment approach, including exposure to gold.
Failing to meet its 7.5% return objective for several years, CalPERS recently has adopted a “Funding Risk Mitigation” strategy to meet the challenges of a maturing workforce, negative cash flow, longer life expectancies, and underperforming investments.
The facts clearly show that the states’ pension systems are on a losing track and retiree benefits are at risk of being slashed.
South Carolina: Canary in the Coal Mine
The looming pension fund crisis could leave already cash-strapped Americans without a safety net for retirement.
Take South Carolina, whose government pension plan covers around 550,000 individuals. One out of nine residents are invested in the plan… which is $24.1 billion in debt.
According to the Post and Courier of Charleston, government workers and their employers have seen five hikes in their pension plan contributions since 2012, and there’s no end in sight. And this isn’t an anomaly but the norm for many states throughout the country.
The worst-funded US state is currently New Jersey, closely followed by Kentucky and Illinois. By the end of 2016, New Jersey had a $135.7 billion deficit in its pension funds—$22.6 billion more than the year before—while Illinois’ gap grew by $7.6 billion.
This disturbing trend is all too real, with nearly one million US workers and retirees covered by pension plans on the verge of collapse. As GDP growth remains minimal, the situation is less than ideal for those who are depending on these pensions for their golden years. And with the uncertain future of Social Security and Medicare hanging in the balance, it’s a scary thought that for many Americans, even this promised safety net isn’t guaranteed.
Corporate pensions, too, are “in the worst position to meet obligations in more than a decade,” states a recent Bloomberg article. Suffering from deficits due to an overallocation to long-term bonds with diminishing yields, corporate pensions are struggling to meet their ever-increasing obligations.
Demographics Don’t Help
Shifting demographics in the US and around the world only further complicate the pension crisis. We are living longer and experiencing lower birth rates than in past decades. This dilemma increases the number of retirees while decreasing the pool of workers. The population of Americans 65 years of age and older has grown by 35% over the last 50 years.
Americans born in 2010 can anticipate to live nine years longer than those born in 1960. Today, retirees are collecting pensions for up to 20 years. If the well runs dry, Social Security, at this point, is not the answer. This leaves Millennials and Gen-Xers in a financial bind. Even those who aren’t in line to receive a pension will be affected indirectly by the falling value of retirement assets worldwide.
Crisis Insurance for the “Golden Years”
As governments and corporate employers may no longer be able to step up to their promises, it is important to take your retirement savings into your own hands. A strong portfolio should include a mix of stocks, solid funds, and physical precious metals.
For many centuries, hard assets like gold have preserved wealth and will undoubtedly continue to do so. Unlike the dollar, stocks, bonds, or pension funds, gold is an asset without counterparty risk, that means its value doesn’t depend on someone else’s ability or willingness to keep their promises.
Financial professionals often advise investors to hold 5% to 15% of their investable assets in gold bullion—depending on age, risk tolerance, and available cash flow.
With the current state of pension plans in steady decline, now is a good time to consider hard and secure assets like precious metals.
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Article by Shannara Johnson, Hard Assets Alliance
All charts via Hidden Debt, Hidden Deficits by Hoover Institution Senior Fellow Joshua Rauh