EC Angst In America, Part 4: Disappearing Pensions

“Companies are doing everything they can to get rid of pension plans, and they will succeed.”

– Ben Stein

“Lady Madonna, children at your feet
Wonder how you manage to make ends meet
Who finds the money when you pay the rent?
Did you think that money was heaven sent?”

– “Lady Madonna,” The Beatles

There was once a time when many American workers had a simple formula for retirement: You stayed with a large business for many years, possibly your whole career. Then at a predetermined age you gratefully accepted a gold watch and a monthly check for the rest of your life. Off you went into the sunset.

That happy outcome was probably never as available as we think. Maybe it was relatively common for the first few decades after World War II. Many of my Baby Boomer peers think a secure retirement should be normal because it’s what we saw in our formative years. In the early 1980s, about 60% of companies had defined-benefit plans. Today it’s about 4% (source: money.CNN). But today defined-benefit plans have ceased to be normal in the larger scheme of things. We witnessed an aberration, a historical anomaly that grew out of particularly favorable circumstances.

Circumstances change. Such pensions are all but gone from US private-sector employers. They’re still common in government, particularly state and local governments; and they are increasingly problematic. They are another source of angst for retirees, government workers who want to retire someday, and the taxpayers and bond investors who finance those pensions. Today, in what will be the first of at least two and possibly more letters focusing on pensions, we’ll begin to examine that angst in more detail. The mounting problems of US and European pension systems are massive on a scale that is nearly incomprehensible.

I came across a chart that clearly points to the growing concern of those who are either approaching retirement or already retired. This is from the October 2016 Gloom, Boom & Doom Report from my friend and 2017 SIC speaker Marc Faber. The gap in confidence between younger and older Americans is at an all-time high, after being minimal for many years. A survey by the Insured Retirement Institute last year noted that only 24% of Baby Boomer respondents were confident they would have enough money to last through their lifetimes, down from 37% in 2011. This is the case even after a most remarkable bull market run in the ensuing years.

Even though the equity market has more than recovered, the compounding effect that everyone expected for their pension funds and retirement plans didn’t happen as expected. If the money isn’t there, it can’t compound. If your plan lost 40% in the Great Recession, getting back to even in the ensuing years did not make up for the lost money that was theoretically supposed to come from that 40% compounding at 8% a year. And, as I highlighted in last week’s letter, the prospects for compounding at 8% or even 5% in the next 10 years are not very good. Thus the chart above.

And speaking of Marc Faber’s joining us at the conference; let me again invite you to come to Orlando for my Strategic Investment Conference, May 22–25. I have assembled an all-star lineup of financial and geopolitical analysts who will help us look at what is likely coming our way in the next few years. Then we’ll spend the final part of the conference examining various pathways for the next 10 years and what we have to do to navigate them successfully. There is truly no other conference like this anywhere. I’m continually told by people who attend the Strategic Investment Conference that it’s the best investment conference they’ve ever been to. You can find out how to register here.

Defined What?

Let’s begin by defining some important terms. US law provides for various kinds of tax-advantaged retirement plans. They fall into two broad categories: defined-benefit (DB) and defined-contribution (DC) plans. The differences involve who puts money into them and who is responsible for the results.

Defined-benefit plans are generally the old-style pensions that came with a gold watch and guaranteed you some level of benefit for the rest of your life. Your employer would invest part of your compensation in the plan, based on some formula. In some cases, you, the worker, might have added more money to the pot. But regardless, at retirement your employer was obligated to send you a defined benefit each month or quarter – usually a fixed-dollar amount, sometimes with periodic cost-of-living adjustments.

(Note: There are defined-benefit plans that small, closely held employers such as myself or doctors/dentists can create for themselves and their employees that have significant retirement planning benefits but that function more like defined-contribution plans. For the purposes of this letter we’re going to focus on the more or less conventional types of plans rather than the multitudes of retirement plans that creative accountants and businesses have developed.)

Once your benefit was defined in this way, your employer was on the hook to continue paying under the agreed-upon terms. DB beneficiaries had no control over investment decisions. All they had to do was cash the checks. Employers took all the risk.

This arrangement works fine as long as you assume a few things. First, that your employer will invest the DB plan’s assets prudently. Second, that your employer continues to exist and remains able to make up any shortfalls in the plan’s liabilities.

DB plans work pretty well if those two things happen. It’s simple math for actuaries to estimate future liabilities based on life expectancies. They are uncannily accurate if the group is large enough. So the plan sponsor knows how much cash it needs to have on hand at certain future dates. It can then invest the plan assets in securities, usually bonds, calibrated to reach maturity in the right amounts at the right times.

That all sounds very simple, and it was, but the once-common scheme ran into trouble for reasons we will discuss below. First, though, let’s contrast defined-benefit plans with the other category, defined-contribution (DC).

DC plans are what most workers have now, if they have a retirement plan at all. The 401(k) is a kind of defined-contribution plan (as are various types of IRAs/Keogh/SEP plans, etc.). They are called that because regulations govern who puts money into the plan, and how much. Typically, it’s you and your employer. Your employer also has to give you some reasonable investment options, but it’s up to you to use them wisely. Whether there is anything left to withdraw when you retire is mostly up to you. Good luck.