Legislative ambiguity about public pension funds, as well as their underfunded status, has financial advisers who work with public employees scrambling to plug holes in their retirement plans.
Cash-strapped states and municipalities are confronting the realities of their public pension liabilities and have been pushing this year for legislative changes that would raise contributions from employees, cut cost-of-living increases and require workers to stay on the job longer.
Some states, including Arizona, Illinois and Kansas, have floated legislation this year to put forward some of these changes, while governors in Alabama, California and other states have said recently that they will tackle pension reform, according to data from the National Conference of State Legislatures.
How exactly these reforms will shake out is still unknown, but public employees are asking advisers how their retirement plans might be affected.
“I was meeting with a client, and the question was, should he take his public pension now that he has a private-sector position he can move to, so that he has a bird in the hand?'” said Kenneth F. Robinson, a financial adviser at Practical Financial Planning. “Or should he wait to see what shape the legislation takes?”
A recent study of some 126 state-sponsored pension plans by the Center for Retirement Research revealed that assuming investment returns of 6%, the plans will run out of money by 2023 or 2025, depending on their framework.
Assuming an even more generous 8% investment return, the plans will run out of money in 2033 or 2041.
CALIFORNIA INITIATIVES
In California, clients and advisers feel the pension frustration acutely as the state addresses its fiscal crisis. Gov. Jerry Brown, who got huge support from public employees in his 2010 election run, last week proposed bills to end pension abuses, including one that would deter workers from buying service credits to retire earlier and with a full pension.
The governor's attempt to put a stop to pension spiking — the act of receiving a promotion or large raise just prior to retirement in order to get a higher pension — could take a large chunk out of some clients' expected retirement income.
Publicized battles between lawmakers and unions aside, advisers on the ground say the most drastic changes are ahead.
“These are proposals that look and sound really aggressive, but these are low-hanging fruit,” said Jim Heitman, owner and founder of Alta Loma, Calif.-based Compass Financial Planning, which manages more than $20 million. “I think long-term, there will be more adjustments to pension plans.”
The Ohio House of Representatives is weighing a slate of changes to the state's five public pension plans, including tying the cost-of-living-adjustment to the Consumer Price Index and capping it at 3%, instead of an automatic 3% increase.
Another part of the law would raise contributions by police officers and firefighters to 12%, from 10%, and raise the age at which employees could take their full pension to 52, from 48.
Hesitant to make drastic changes while legislation is still being hashed out, advisers are finding places where their clients can cut costs. The discussions in some cases include confronting the reality of working longer or scouring personal budgets for further savings.
“You have to check your cash flow and whether you're operating at a surplus or deficit,” said Robert Dowling, an adviser with Modera Wealth Management.
He has worked with private pension clients but has found that threats to pension dollars require a back-to-basics check of cash flow and a plan for the worst-case scenario in the event of a pension reduction.
“If your deficit is small, you need to reduce your expenses,” he said. “If it's large, then some adjustments need to be made.”
For Mr. Robinson, whose public pension clients have faced mandatory furloughs, it's been a matter of asking clients whether it's still realistic to contribute to their voluntary retirement savings or scale back in order to manage their regular expenses. Clients edging toward retirement have had to dial back their equities exposure, he added.
States also may backtrack on non-pension retirement benefits such as medical coverage. The Center for Retirement Research is studying the topic, according to Jean-Pierre Aubry, a research associate.
Advisers have worked on models to make up for that expected shortfall.
For instance, Mr. Heitman assumes that health care costs will grow at inflation plus 2%. He noted that states could slash medical coverage to save costs without actually trimming pensions.
“We're building into the models a monthly cost of $500, depending on their situation and assuming they have to buy their own insurance,” he said. “You're talking $6,000 a year, which can put a really big crimp in what they hope their retirement will look like.”
Mr. Dowling typically budgets for medical expenses with the assumption that medical expenses will rise by about 5% annually.
Even in the private pension space, “there are a lot of asterisks, and they can cut medical coverage for retirees,” he warned.
E-mail Darla Mercado at [email protected].
