Public Pensions: Can Your Benefits Be Cut?

You know the fight over public pensions is heating up when you see articles in The Wall Street Journal, New York Times and Mother Jones all talking about the same thing: do states and local governments have the legal authority to cut public pensions?

It's a complicated question given current laws, but laws can be changed. And that's what this is all about. If there's enough financial pressure on state and local governments and if taxpayers turn against public employees, there's a reasonable chance that someone will change the law and open public pensions up to revisions.

Why is this happening? For decades, some politicians have been playing fast and loose with the public pension system. Public pensions in general are not subject to ERISA, which is the law that governs private pensions and is basically focused on making sure employers live up to the promises they made to employees.

But governments have never wanted to be subject to the strict pension accounting and funding rules of ERISA. That creates an environment where public pension benefits can be used as a political tool to gain support and votes, and unfortunately, some have done that.

Also, many public employees have pushed for greater retirement benefits without fulling understanding the costs of doing so. I certainly understand the desire to push for more pay and benefits, everyone does that. And if your employer agrees to increase your retirement benefit, who wouldn't take that deal. But without firm rules on funding costs, you create lifestyle expectations that can't be fulfilled because you aren't putting away enough money to cover the future obligations. When that sort of funding deficit goes on for 20 or more years, you've dug yourself a pretty big hole.

So now we're faced with the reality that many public pensions are running the risk of not being able to deliver the promised pension benefits. Could they get out of this mess without having to cut benefits? Possibly. If the financial markets go on a big run for a decade or if the economy and tax receipts grow significantly, then public pensions will probably be fine. But if markets don't cooperate and tax receipts don't rise significantly, expect state and local governments to seek ways to change pension benefits.

The debate will come down to an issue of fairness. If taxpayers feel the pension benefits are unfair, meaning public employees are getting a windfall compared to the situation taxpayers find themselves in, then expect benefits to be cut. If public employees can convince taxpayers that their pay is fair and that they aren't getting a better deal that the taxpayers who are footing the bill, then benefits will probably stay in tact.

So if you're a public employee, what do you do? As with real estate, these issues are all local. First, if your pension plan is fully funded, then you're probably not at a big risk of pension cuts. And many government plans are in good shape, but others are in terrible shape. So you have to find out what's going on with your particular plan.

Second, if your plan isn't in great shape, then you should assess the financial health of your community and then compare that to the pension and lifestyle expectations for public employees. If the private and public sectors are about evenly matched, you may not have much to worry about. And many communities across the country have done a responsible job over the years managing their budgets, and their citizens are happy with their public services and employees.

But if you sense there's a big mismatch, your pension plan is underfunded, and citizens are grumbling about public pay and benefits, you may have to start planning for some reduced benefits. To counter that, you should consider increasing your own savings rate. Most public employees have deferred compensation plans that they can fund using their own dollars, such as 403(b) and 457 plans. If you put your own money into it, then it's yours to keep for retirement. That's one advantage of defined contribution plans; it's your account and your money.

Bottom line. The debate over public pensions will come down to an issue of fairness. If the taxpayers feel they're getting a bad deal, expect them to figure out ways to reduce benefits.

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