On July 18, Detroit once the United States fourth most populated city became the largest American city to ever file for a chapter 9 bankruptcy. Now with this latest move in its multi-decade decline there are more than 20,000 retired public employees who have a big question in mind. What happens to my pensions? Those pensions could be cut – perhaps deeply – leaving current and future pensioners nationwide to wonder about the stability and amount of their own promised incomes. It should be underscored that Detroit’s unprecedented drop in population which mirrored the city’s economic decline made bankruptcy virtually inevitable. This is the only American City ever (and ever is a long time) to see its population grow beyond 1 million and then decline below 1 million , as it is a city that once had 1.85 million citizens by 1950 and today it has slightly more than 701,000 citizens.
Courts will decide the fate of those 20,000 retirees’ pensions. While a federal judgeoversees Detroit’s bankruptcy proceedings, Michigan’s constitution states that pension benefits can’t be altered. On July 24, the judge froze state-court lawsuits against the city that argued the bankruptcy filing violated the state’s constitution. Much as Detroit wants to scale back pensions for fiscal relief, the law may forbid it. Of course future retiree’s in Detroit and other cities, states and private companies should pay very close attention.
Municipal bankruptcies lead to smaller pensions. Central Falls, R.I. filed for bankruptcy in 2011 and whittled more than 50% of the pension checks to a third of its retirees. The average retired firefighter’s annual pension income, for instance, plummeted to $30,786 from $68,414.
Such slashing may not happen in Detroit or in Stockton, Calif., the second-largest American city to go bankrupt. Stockton cut bond payments but so far has left pensions alone. California’s constitution also bars reducing pension benefits, so Stockton’s retired public employees may wait on the courts as well. Ironically, this city’s biggest creditor is the California Public Employees’ Retirement System (CalPERS).
Municipal pensions aren’t the only ones at risk. Polaroid went bankrupt and its retirees receive pension checks courtesy of the federal Pension Benefit Guaranty Corp. (PBGC), the independent government agency that takes over private pension plans that go insolvent. MarketWatch columnist Robert Powell notes, however, that those checks represent “a fraction of what they were supposed to receive.” By the end of last year, the nation’s biggest multi-employer pension fund, the Teamsters’ Central States, Southeast & Southwest Pension Plan, had $17.8 billion in assets – and $34.9 billion in liabilities.
Even with no bankruptcy filing, most pensions are woefully underfunded. According to the investment advisory firm Wilshire Consulting, the median funding ratio of pensions fell from 78.1% in 2008 to 76.9% by 2012, meaning the typical fund has just 76.9% of the assets needed to cover payouts to future retirees. Of the 308 companies in the Standard and Poor's 500 (S&P 500) with pension plans, Wilshire says 94% are underfunded.
The federal government projects that as many as 150 private pension plans are underfunded to near insolvency. The PBGC already has a deficit of $34 billion and estimates pension insolvencies could double over the next decade. This would force the PBGC to assume as much as $295 billion in liabilities. The agency itself, by its own estimates, also has a 91% chance of going insolvent by 2032.
Employers, unions and Congress propose to reduce existing pension payouts of underfunded plans, meaning some existing pensioners could see cuts as high as 60%.
Plan for the worst – just in case. If you receive or are in line for a pension, these developments should make you explore your options if your pension shrinks. Suppose your pension was cut 20% to 30%. Would you live on less, maybe move somewhere with lower living expenses? Become a consultant or business owner, look for part-time work or keep working full time? How will you generate enough income to plug such a hole?
With many pensions – including Social Security – shaky these days, a talk about your financial & retirement planning is a very good idea.