Defined Benefit Pensions vs. Defined Contributions

Pensions paid for by the government are practically bankrupting this country.  It is happening at the federal level, the state level, and the local level.

On the federal level, it is Medicare and Social Security.  The unfunded liabilities may be $200 trillion or more.  It is not possible for the government to meet these “obligations”.  Pensions for government workers are significant, but small in comparison to the promises made to everyone.

On the state and local levels, the problem is with pensions for government workers.  Politicians have made promises in many cases that just aren’t possible to be kept.  It is easy to promise a nice pension to someone 20 years down the line when someone else will have to manage the finances.  We are now 20 years down the line, and it is a major strain on government budgets.

We have already seen major cities such as Detroit and Stockton go into bankruptcy.  Pensions played a major role, and they will continue to play a major role in future bankruptcies of other cities.

In the business community, defined benefit pensions are becoming a thing of the past.  It is understandable.  They are an actuarial nightmare.  If someone retires at age 60 and lives until the age of 105, a company will be stuck paying out money to this person for 45 years.  How can you even plan for this, even with good actuaries?

Most companies are moving (or have moved) to a defined contribution system.  The most common is the 401k plan.  The company will typically match employee contributions up to a certain amount.  The company pays now and does not have to make calculations for the future.  The company doesn’t have to worry about how long people will live and what interest rates will be.

Employees, for the most part, miss the defined benefit plans.  This is guaranteed money (or at least it is supposed to be).  It makes planning for the future easier.  Someone with a generous defined benefit pension can typically be more aggressive with other money saved for retirement.

Employers are shifting the risk from them to the employees.  It makes business sense.  Unfortunately, governments have been slow to catch on.  It involves unions and politics.

To be sure, there are still major problems with private sector pensions.  This is why General Motors should have gone through bankruptcy in 2008.  It would have if not for the federal bailouts.  It is hard to sell cars profitably when each car costs thousands of dollars worth of pensions for retired employees.

For local governments, it is often the police and fire departments that add up to the majority of the unfunded liabilities.  Many people are sympathetic to these professions because they see them as public servants.  They see them as heroes in many cases.  They see them as having dangerous jobs.

I do not feel this same way.  I could have sympathy for police officers and firefighters who are struggling to get by with their family.  But I also have sympathy for all of the non-government workers who are struggling to get by while being forced to pay for these extravagant pensions.  And most of the non-government workers struggling to get by won’t have these cushy pensions.

This is just another problem when you don’t allow markets to be free.  I am not even making an anarcho-capitalist case here.  It is obvious that it would be easy to have private or voluntary fire departments.  They could easily be coordinated through your homeowners insurance.

But even if the police and firefighters are government workers, they should not be getting these massive pensions at everyone else’s expense.  It is ridiculous when you see someone work for 25 years and then retire at the age of 50 with at least half his salary for the rest of his life.

There is no reason that these should not be defined contribution plans, similar to 401k plans.  It should be pay as you go, instead of making promises into the distant future.  Voters should insist on this.  There are many people with dangerous jobs (construction workers, lumberjacks) who don’t get pensions.

I think we are going to reach a tipping point where the voters tell their representatives to renege on their promises.  They may not put it in these terms, but they will refuse tax increases.  Most of America is struggling today, and they aren’t going to feel much sympathy for those who are enjoying lush retirements at their expense.

We will see more bankruptcies in the future.  It will be mostly local at first.  We may eventually see pension restructuring at the state level.  Last but not least (because of the Federal Reserve) will be the federal government.  There will be promises broken.  You should prepare for this accordingly.

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