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The $1 Trillion Empty Promise

Employees of state and local governments across America labor for (usually) fairly modest salaries, but they have the security of knowing that their employers guarantee them generous pension, health care and other retirement benefits.

They ought to feel quite a bit less secure. A recent report by The Pew Center on the States found a $1 trillion gap between what states have promised and what they have actually set aside to pay for those commitments. At the end of fiscal 2008, the promised benefits nationwide added up to $3.35 trillion, but the amount in states’ coffers totaled only $2.35 trillion.

By making promises now without actually setting aside the money, politicians curry favor with employees without having to tax today’s voters. Better benefits allow states to attract high-quality talent without having to pay more for it upfront. In an earlier report on the condition of pension funds, released in 2007, The Pew Center on the States noted, “In some states, retiree benefits have been vulnerable to a buy-now, pay-later mentality. In bad budget times, retirement benefits become easy substitutes for salary increases.”

The present report reveals that most states are indeed putting off their bills. In 2008 only Florida, New York, Washington and Wisconsin had enough money reserved to fully fund their pension systems. Illinois, in the worst shape, had only 54 percent of the necessary assets on hand.

In total, the states’ pension promises are 84 percent funded. While this is better than the 80 percent funding level that experts consider a prudent minimum, states are not doing what they need to do now to close that gap before the obligations come due. During the past five years, 21 states made contributions that averaged less than 90 percent of what their actuaries estimated they needed to set aside.

The situation is worse when it comes to non-pension benefits, like retiree health care. The report noted that, rather than putting aside money for current workers to whom they have promised benefits, “states continue to fund retiree health care and other non-pension benefits on a pay-as-you-go basis — paying medical costs or premiums as they are incurred by current retirees.”

Because of this attitude, the states have on hand only about 5 percent of the money they need to provide the non-pension benefits they have promised. All but two have less than half of the money they will need. Only Alaska, Arizona, Maine and North Dakota made the annual contributions recommended by their actuaries in 2008.

By postponing payments, states increase the overall cost of their programs. In the 2007 report, The Pew Center on the States estimated that Massachusetts could save $5.7 billion in retiree health and other non-pension benefits by making actuarially required contributions each year, since “the interest the state is likely to earn when it invests more money over the long term can be applied to paying down the bill.”

Another problem with failing to adequately fund pension and other benefit funds now is that it creates the possibility that the promised benefits may ultimately be reduced. I am a firm believer in the principle that the impossible never happens. If governments do not have enough money set aside to fulfill their promises, the day will eventually come when they will have to turn to lenders or taxpayers to make up the shortfall. Neither may be able or willing to meet those demands. If the states and localities can’t get the money, they can’t make the payouts. So they won’t.

This is just one more in a growing list of promises made to today’s workers that may not be kept. Medicare, Social Security and many private company pensions are all woefully underfinanced. Health care costs continue to rise. And, as baby boomers age and life expectancies lengthen, the ratio of retirees to workers will increase in the future. The Social Security Administration has projected that by 2030 20 percent of Americans will be over 65. The current system in which retirees are supported by the workers of today is unsustainable.

The alternative is to set aside now the money that will go toward future benefits for today’s workers. But that would mean taxing today’s voters. So politicians will probably continue to buy now and pay later.

Larry M. Elkin is the founder and president of Palisades Hudson, and is based out of Palisades Hudson’s Fort Lauderdale, Florida headquarters. He wrote several of the chapters in the firm’s recently updated book, The High Achiever’s Guide To Wealth. His contributions include Chapter 1, “Anyone Can Achieve Wealth,” and Chapter 19, “Assisting Aging Parents.” Larry was also among the authors of the firm’s previous book Looking Ahead: Life, Family, Wealth and Business After 55.

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