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The Looming Pension Crisis And Your Retirement Plan

Doug Carey, CFA

Key Points

  • Many states and cities are not even close to funding their public pension systems.
  • The deficit for all states and cities combined is more than Japan’s entire GDP.
  • One town in Rhode Island already cut its promised pension payments by more than half.

Many who worked for the local or state government over the past few decades were certain they could retire in their 50s with a large pension and gold-plated health benefits. This is what they were promised. But it turns out, most of these promises were nothing but Ponzi schemes where the payments coming in would eventually not be enough to cover the payments going out.

Cost Of Pensions


Moody’s Investor Service now estimates that the combined pension shortfall for all cities and states is $5 trillion. This is larger than Japan’s entire economic output in a year. Because of this massive shortfall, the coming years will see many more cities declare bankruptcy, as Detroit did in 2013.

Cities And States In Trouble

Local and state pensions lost nearly $35 billion in pension assets in the last recession. As that was happening, pension liabilities skyrocketed by over $100 billion per year. Although the stock market recovered over the past nine years, it was still not enough to close the pension gap. 

Pension Problems By State

According to a Pew Charitable Trusts report, New Jersey could run out of money in 12 years. There are multiple cities in Illinois where pensions are not even 50% funded. But a worst-case scenario has already played out in Central Falls, Rhode Island.

The town of Central Falls was completely insolvent in 2011 and declared bankruptcy. They were insolvent partially due to overgenerous pension benefits that could never possibly be fully paid. The day of reckoning came for them and they cut their pension payouts by more than 50%.

Another case that is still playing out is in Puerto Rico. In 2017, Puerto Rico filed for the largest U.S. municipal bankruptcy in history. As part of the bankruptcy plan, they are supposed to cut promised pension payments by 10%. However, this is being fought in court and the outcome is uncertain. 

What Happens To Retirement Plans If Pensions Are Cut

Those who are fearful about their promised pension payments can join the millions who are fearful that their promised social security benefits will be cut. We should all at least know how we will fare if our pension or social security payments are less than expected.

I set up a sample case in the WealthTrace Retirement & Financial Planner to test what will happen to a typical couple if their pension is cut. Using WealthTrace, you can run these types of what-if scenarios yourself, without the need for a costly financial planner.

Let’s take a look at a 58 year old couple that plans on retiring at age 67. They will receive a combined $40,000 in Social Security benefits each year and $50,000 per year in pension payments. Their annual expenses before taxes in retirement are projected to be $75,000. They also have $25,000 saved in an IRA.

With their large annual pension payment, they easily cover their annual expenses as you can see below:

Income vs. Expenses With Pension Payments

Monte Carlo analysis, which runs 1,000 scenarios on their plan using historical performance and volatility data, shows that they have a 100% chance of never running out of money.

Monte Carlo Results With Full Pension

This couple looks all set for retirement. But what if the city that owes them their pension goes bankrupt? Let’s look at a few scenarios where their pension is cut.

Pension What-If Scenarios

Pension What-If Scenarios Results

This couple can withstand a 10% cut to their pension, but as we approach 20%, things get dire pretty quickly. If their pension is cut by 20%, they only have a 10% chance of not running out of money. Put another way, they have a 90% chance of running out of money in retirement.

What To Do?

If you are planning on living off of a public pension, it is very important that you know the fiscal situation of your city or state. If your city or state has very little chance of meeting all pension obligations, it is smart to assume the full amount won’t be there.

It is also wise to have more money saved to an IRA or 401(k) plan than the couple in our story had. They were very much dependent on their pension, which is putting too many eggs in one basket. If they had $200,000 in their IRA instead of just $25,000 their pension scenario results would look much better:

Pension What-If Scenarios Results With More Money Saved

Everybody should know their retirement situation. WealthTrace will show you how much you need to save, when you can retire, and allow you to run what-if scenarios on your plan. Learn more

Do you want free tips on how to retire early? How about retiring stress-free? Learn how to make sure you do not outlive your money by signing up for our free articles.

Doug Carey, CFA