It’s no surprise that interest rates and investment bond yields have been low for years. But what is surprising is that the majority of state and local governments are still projecting unrealistic investment returns of 7-8% per year for their pension fund investments.
Since state and local government pension systems are not getting anywhere close to that rate of return, they owe the difference. This means they owe billions of dollars.
Millions of American workers have been diligently contributing to their pension plans, essentially lending money to the government today for the promise of a retirement pension later. For many, it’s a big part of their retirement plan.
They may never see all of that money. US state and local government pension systems are in trouble… big, big trouble.
Since actual investment returns have been far lower than projected returns, these pension funds have been growing too slowly. Without the projected growth or supplemental payments, the money will not be available for promised pension payments later.
A 2017 Hoover Institution Press study of 649 US state and local government pension systems found that in FY 2015, average investment returns were only 2.87%, but average projected returns were 7.36%.
The difference between the projected return and the actual return is a deficit – and it is something that most state and local governments are not including in their budgets.
In fact, many state and local governments across the United States claimed to have balanced budgets in 2015. In reality, pension system deficits totaled $167 billion. This is the additional amount (beyond matching contributions) state and local governments needed to contribute to their pension plans to prevent an increase in liabilities.
They promised the pensions, so they are on the hook to provide them.
Put another way, state and local government net pension liabilities for 2015 alone were equivalent to 18.2% of total tax revenue. With already inadequate budgets and pressing current needs, unfunded pension liabilities continue to increase.
According to the Hoover Institution report, total unfunded US state and local pension system liabilities increased to $3.85 trillion in 2015, which is a $434 billion increase in just one year. Of that $3.85 trillion, state and local governments only recognized $1.38 trillion, leaving $2.47 trillion as hidden debt.
At some point, something is going to give. Pension systems cannot keep increasing liabilities at the current rate, and that hidden debt will come due eventually.
Will bankruptcies wipe these pension systems out, leaving destitute retirees in their wake? Will alternative investments provide better returns? Time will tell, but for now, it’s a ticking time bomb.