Of Underfunding and Overpromising
Planning for retirement is no small task, and when news comes that a public pension plan is in financial trouble, both plan employees and local taxpayers should be concerned, because one of the two is going to have to pick up the tab.
Missouri’s State Auditor recently released an audit on the City of Bridgeton’s Employee Retirement Plan, and the picture painted was bleak. In addition to finding that the city’s Finance Commission failed to meet even once from 2012 to 2014, the report says the plan is only 67% funded and that the unfunded liability is approximately $14 million. The plan’s current funds will not be able to pay the benefits that retirees have been promised. The combination of insufficient contributions and lackluster investment returns has brought put the existing plan in its current condition.
Defined-benefit plans like Bridgeton’s typically involve a commitment to make monthly payments to employees for the remainder of their lives. In order to sufficiently fund the promised benefits, plans assume a rate of return on the contributions that they invest. Those assumptions are often too rosy; Bridgeton’s assumed rate has been 7.5%, while over the past ten years the time-weighted return has only been 4.16%.
Over time, the funding gap widens and the result is a large gap between the amount the city has promised retiring employees and the amount the city has set aside for that purpose. In Bridgeton’s case, no payments have been withheld from retirees, but in order for the city to meet its future obligations, contributions have to increase. Either funds must be allocated away from other public services, or taxes must go up.
This is exactly what has happened. In April 2015, Bridgeton increased its hotel service occupation tax from $0.85 to $3.00 per day. A portion of the additional revenue goes toward increasing the plan’s contributions by $200,000 each year.
Bridgeton is not alone. The Pew Charitable Trusts reports the shortfall between state-run promised pension benefits and available funding is nearly 1 trillion dollars nationwide. Defined-benefit plans are often legally binding, so when investment returns fall short of what was predicted for the plan years ago, taxpayers can be forced to foot the bill.
The good news is that Bridgeton’s defined-benefit plan was closed to future employees in 2012 and replaced with a defined-contribution plan. In a defined-contribution plan – think 401(k) – benefits are not paid out indefinitely to employees. Rather, upon retirement the funds that have been accrued are made available to the employee. The key difference between the two is that a defined-benefit plan makes a promise it may not be able to keep without taxpayer assistance, while a defined-contribution plan, by definition, cannot incur a funding gap.
Defined-contribution plans can protect taxpayers, municipalities, and employees from having to worry about underfunded pension plans or budget shortfalls. Bridgeton took the leap to defined-contribution in 2012 to avoid exacerbating its current funding problems; other defined-benefit plans in Missouri should consider doing the same.