Pensions Are Creating a Huge Financial Risk for Cities, Counties, and State Goverments

A few weeks ago I noted in my blog, The Real Reason for the U.S. Retirement Crisis, a lack of stable income as the reason most Americans will not be able to count on a decent retirement — it will be the next big financial shoe to drop in this country.  This lack of stable income has come partly because of the elimination of the good old American pension plan… and that seems to now  include government pension plans as well, retirement options for government employees that until recently were thought to be untouchable.
City, county, state, and federal government pension plans are now in trouble due, in part, to a bit of greed by government employees, but mostly due to mismanagement by government entities of the tax dollars they used to fund these pensions. What happened to bring about this crisis? Let’s look at an example of a city entity to help explain how things have gotten so bad for many government retirees.
Pensions were set up by the government employer so that employees, after 20 years of service, would get 60 percent of their highest three years of income while they were working. The employee would pay nothing out of their compensation — it was entirely the responsibility of the city, county, or state (which, by the way, is how the pension worked in private sector companies until these all but disappeared in recent years as well).  The process to establish a pension plan for a city employee worked like this: the city manger would  approach the city council to explain the amount of money needed to pay in order to recruit a certain quality of employee to work for the city.  The city council would negotiate for a lower salary and try to justify it by offering a fully funded pension plan paid entirely by the city.  The city justified this by using tax dollars to pay for the services the employee provided.  So far so good, except the employee came to work and learned that elected officials don’t last very long and that the turn-over is huge with every election.  The employee then started getting the feeling that he/she was not indispensable.  So employees started negotiating  a higher pension plan so that after 25 years of service they would get 70 percent of their highest three years of income.  The elected officials only had to agree to this in the moment, but did not have to fund this for 25 years into the future (since they wouldn’t be around to worry about it anyway).  This made it easy for the employee to get a commitment at the time. This worked for a while until many city employees got greedy and wanted to add a 401(k) plan, which is called a defined contribution plan, to their benefits package. Many U.S. cities have commonly dealt with these defined contribution plans by stating that they will match anything an employee contributes to his 401(k), or 403(b), or 457 retirement plan up to 4 percent. Some city managers, in order to keep employees from jumping ship, pointed out to the city counsel that other cities and counties were offering 401(k) plans and that they better offer one too!
It has now been over 30 years since this process has been in practice and governments have had thousands of employees work to get their pensions and 401(k) retirement funds.  The city of Stockton in California got to the point where over 70 percent of the city’s pay outs were to previous employees, leaving only 30 percent to pay for ambulance services and garbage collection.  The mayor decided to file bankruptcy so all the contracts for pensions and 401(k) were terminated. This meant that immediately 70 percent of the money going to retirees was available to take care of city services, and of course Stockton citizens were happy again, especially because they did not have their taxes go up for the first time in 25 years. Of course Stockton city employees were mad, and some became destitute and had to go back to work at a time in their lives where, for some,  their health prevented this.  This caused great alarm for other government workers in the surrounding counties and the state of California.
Another example of this pension fund mismanagement is Detroit, which had to file bankruptcy because it could not pay out all its pensions to government retirees. You can Google-search and find that 83 percent of all the debt Detroit had was pension and 401(k) plan payments to city retirees.  I am not arguing the rights and the wrongs done here, and please understand I do not have a dog in this fight, not yet anyway.  I am simply trying to show what will happen shortly all across the United States with cities and counties trying to stay abreast of all their retiree payouts.
I have a client who worked 27 years for Los Angeles County and his annual income was $125,000 a year.  He retired early receiving $12,000 a month for life from his county pension and $480,000 from a 401(k)  plan.  He tried to get his pay increased, but when he couldn’t, he was able to get a huge increase in his pension instead.  He just recently told me he has been notified that his pension will be negotiated way lower in the near future and perhaps be discontinued all together.  He is sick about this.
With all this financial mismanagement, government employees are beginning to see that things are changing and that they can no longer work for the government under the assumption that they will never be fired and that their retirement income is safe and secure.  Government employees should consider making changes to protect their income and retirement money. I have been keeping my eye out to see how many other cities and counties look like they may fail. As I mentioned before, Detroit has bombed and so have 12 cities in California, including Stockton and San Bernardino.  I have not tried to find out all government entities that have filed bankruptcy, but for sure there will be more.
The image of an iceberg says it all — remember what happened to the Titanic — it was thought to be unsinkable but the dangerous ice lurking just beneath the water’s surface did the ultimate damage.  Don’t let unseen icebergs destroy your family’s retirement nest egg — if you have a government pension, investigate thoroughly NOW what is really happening financially with your city, country, or state government. Don’t assume that all is well until you know it really is. If you want to learn how to create a predictable, stable retirement please email me: peter@moneymastery.com.