Minnesota 2020 Journal: Pension Lessons and the Coming Retirement Crisis
Minnesota has a pension problem. Most Minnesotans haven’t saved enough money to adequately and securely fund their retirement. More than half of Minnesotans can’t count on a pension as a retirement funding mechanism because they don’t have one.
That’s a problem.
Minnesotans need to aggressively save more money for their retirement life needs than they’re currently saving. Making this observation is much simpler than changing saving behavior. Retirement security savings shortfalls call every social safety net assumption into question. Without change, can people actually count on a secure retirement?
Pensions are a form of retirement savings designed, through working life contributions, to provide a retirement revenue stream. It’s the money that you live on after you’ve stopped working. Pension principal grows through paycheck contributions and pension fund investment returns. Pension funds are invested in some combination of stocks and bonds carrying a diverse range of financial risk, using strategies designed to preserve and, ideally, improve the contributed funds’ purchasing power.
Pension popularity rose with the middle class’ growth in the 20th century. Pensions are a work benefit that, along with health insurance, created a stable, low-turnover workforce by financially incentivizing workers to remain in an employer’s long-term employ. The pension, along with other non-wage benefits, created greater compensation value than wages alone.
Rapid growth of non-wage work benefits occurred in fast growing, post-World War II manufacturing industries. Rapidly expanding consumer demand in, for example, the automotive industry, induced company owners and managers to preserve worker experience and extend tenure by creating a host of non-wage benefits. Pension and healthcare costs, companies discovered, could be managed efficiently by leveraging group purchasing. This lowered employers’ non-wage costs while creating greater benefit value for workers.
This idea works best when the economy is expanding and sales are exploding. Growth tends to disguise the true nature of genuine problems, making it harder to implement long term solutions. Unchecked expectation of never-ending growth and growth’s reward are chief among those.
There are two principal pension forms, defined benefit plans (DBP) and defined contribution plans (DCP). They may sound similar but more separates them than a single word of three.
The defined benefit plan is the worker’s best option yet it carries a small but significant long-term risk. As a retirement benefit, DBPs creation, management and fund responsibility fall to employers. The employer is responsible for fund shortfalls if the portfolio underperforms. Employees receive a fixed monthly disbursement, adjusted per terms of the labor contract but generally increasing to meet rising inflation costs. The employees’ risk is catastrophic risk of business failure and, with it, company-linked retirement savings plans. A dying business tends to take the pension fund down with it, leaving workers with no or few retirement savings.
Defined contribution plans are typified by 401(k) savings accounts. They’re tax-deferred retirement savings plans, principally funded directly by workers although employers may contribute to the employee’s account. Apart from facilitating direct deposit and possibly contributing to an employee’s retirement account, employers have little else to do with DCPs. Outside of government, DCPs have replaced DBPs as retirement savings plans. By moving to DCPs, companies have, in effect, discounted the long-term benefit of an experienced, stable workforce. They’ve shifted worker retirement costs to government while benefiting from worker productivity gains.
Both DCPs and DBPs rely on accurate risk calculation to determine retirement fund health and obligation.
Calculating life span and associated outcome probabilities is a branch of mathematics called actuarial science. While perceived as duller than playing poker for a living, actuarial sciences make the same risk assessment judgments, assigning a monetary value to probable outcomes. Popularly associated with the insurance industry, actuaries are found wherever financial risk is managed.
Workers with a properly funded and managed DBP pension are in better retirement financial shape than DCP holders. Underscoring retirement life’s growing insecurity risk, however, Minnesota’s largest and most secure public pension plans are coming up short when it comes to contributing to retirees total expense needs.
According to Minnesota’s Public Employees Retirement Association, their 2012 annual report calculated the General Plan fund's market value at 73 percent, which meets Morningstar's "fiscally sound" threshhold. That means, given reasonable retirement life span projections, and if current employees made no further contributions, the fund will be able to pay 73 percent of its commitment. Market returns and younger workers will continue to replenish recessionary period market depleted fund value. MPERA also notes, however, that 75% of pensioners are receiving less than $2,000 per month, which for many families will not meet retirement needs. Despite holding up their end of the contract, retired public workers will have to come up with rest of their money from somewhere else.
I raise this example because even under the very best circumstances –a worker organized, negotiated and publicly administered defined benefits pension plan- workers aren’t saving enough money to fully secure their retirement. This means that we need to think differently about how we save for retirement, putting middle and low income earning Minnesotans’ working and retirement life needs first.
The solution is remarkably simple. Minnesota needs a publicly-guided retirement savings plan that uses its financial weight to only serve its member savers. It should fall somewhere between current DCPs and DBPs; allow for direct payroll contribution regardless of employer’s retirement benefits plan; charge the absolute fewest, lowest fees possible; and be created no later than next year.
The best crisis outcome is the one that, with quiet, determined work, largely fails to materialize. We can do this in Minnesota.