pension reform

The pending crisis in pensions is looming larger each day. When a pension fund does not have enough money to meet its promises it is called underfunded. This has happened in the past, most recently in the late 70’s when inflation hit double digits. The funds that are adversely affected are not the 401 K types but those called defined benefit plans and most state employee plans are in this category. Recall how these plans work. The fund has a factor, usually between one and two percent. The factor is multiplied by the number of years you worked and that is the percent of your salary that you will receive at full retirement. If the factor is 1.5% and you have worked there for 30 years you will retire at 45% of salary. Some people have suggested that the factor be lowered to save the fund and this would work but I have a better suggestion. Remember that the benefit is determined by the factor, the years of service and final salary. I suggest that the states announce that all future pay raises will be one half of the inflation rate and this will hold wages down. People who are close to retirement will not be affected but younger workers will and they will have time to make up for the pension loss with other savings. All employees will know that they are not going to receive pay raises comparable to those in other jobs and they can look elsewhere if they are not happy. New hires will know up front what they are getting into and so no surprises for them. How long this restriction on wages lasts depends on the economy and may someday be adjusted. Take one example. Employee A is 30 years old and earns $40,000 per year. If inflation over the next 30 years is 5% his wage at age 60 would be $172,800 per year and if he retired at 45% his pension would be $77,800 per year. If his salary was allowed to increase by only 2.5% his final pay would be $83,900 and his pension would be $37,700. As you can see the reduction in wages would not have to be as drastic as one half of the inflation rate and it could be calculated to make the pension whole again. My experience with pension tells me that holding wages down by a small amount over a long period of time would be the least painful way to solve this problem.

While what I am suggesting here looks and is drastic there are other ideas that are even more troublesome. One is for congress to pass a law that allows states to file bankruptcy after which they can renegotiate the pensions agreements and get them properly funded. In any event you will be hearing a lot more about underfunded pensions in the near future.