Public Pensions: Are They Doomed?

| February 3, 2011 | 0 Comments

A very popular – and heated – topic these days is the fate of public pensions.  Most developed countries have some form of public retirement plans for their elderly citizens.  And a huge number of government employees in the US and elsewhere rely on state and local pensions for their retirement.

Very few topics get people’s blood boiling like this one.  Of course, possibly not being able to afford your retirement is a big deal.  And it’s always going to elicit a strong emotional response.

Here’s the deal…

Public retirement plans are extremely popular.  There’s simply no denying the facts.  These plans have dramatically reduced poverty levels among the elderly wherever they’ve been in place. And they’ve been doing so for over 50 years.

So what’s the problem?

Basically, the global debt crisis has forced public pension issues into the spotlight.

There are several potential reasons why public pensions are in trouble.

For one, the baby boomer population is reaching retirement age.  Basically, a lot more people will be receiving money from the government than contributing to it.  It’s just a matter of simple math.  If cash outflows are greater than inflows for any significant period… there’s a big problem brewing.

But there’s more…

In theory, the government should be able to cover the gap between pension inflows and outflows through pension investment returns or budget surpluses.  Unfortunately, neither of those are reliable sources of cash flow right now.

You see, pension investments tend to be safer, cash flow generating instruments such as government bonds.  Those types of investments are heavily dependent on interest rates.  And with interest rates so low, returns are also miniscule.

The fact is interest rates are at historically low levels… and they could stay low for a while longer.

What’s more, budget surpluses seem to be a thing of the past.  With all the debt being taken on by governments across the country – and overseas – there just isn’t enough cash to go around.

Look at what’s happening in Europe…

According to the European Commission, Spain and Belgium are projected to spend 15% of GDP on public pensions.  Ireland is expected to spend 11% of GDP on their public pension.  And Greece… they’re tabbed for a robust 25% of GDP.

Clearly, public pensions are a large and growing burden for many countries.  But solving this problem isn’t an easy task.

Remember when the Greek government raised the retirement age and cut benefits?  There were riots in the streets!  Think this is an emotional topic for folks?

In the US, the situation with state and local pensions is looking more dire every day.

Some estimates have the gap between current pension assets and future obligations as high as $3 trillion.  That’s just crazy.  Even conservative estimates have the gap at $1 trillion.  One thing is clear… there’s a serious problem.

But what can be done?  Are public pensions a hopeless case?

Fortunately, there’s hope.  But it isn’t going to be easy.

First of all, an improving economy will help in many ways.  If good economic conditions push up interest rates, pension investments will earn higher returns.

What’s more, a hot economy will do wonders for government budget shortfalls.  (Unless we’re talking about the US government’s budget… that one may take a few hundred years to reach a surplus.)

Another way pensions can improve their returns is by investing in riskier assets.

More risk means potentially greater returns.  Of course, more risk is more risk, but Treasury bonds aren’t going to solve the pension crisis.

Then there’s the more painful road…

Just like in Greece, it’s very possible the US must raise the retirement age, decrease pension benefits, or both.  Of course, nobody wants to consider those options.  But then, I doubt anyone wants their government to go bankrupt.

Look, it isn’t going to be easy.  Drastic measures may need to occur in order to make sure public pensions are funded in the coming years.

There’s a silver lining though… robust economic growth will make everything easier.

If you’re worried about your pension, you can start pinching pennies now.  But the better bet might be spending those pennies to support the economy.  Very few things will alleviate the pension crisis like a red hot economy.

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The Dynamic Wealth Report works with a number of staff writers and guest experts who specialize in everything from penny stocks to ETFs to options trading. These guest analysts post under the 'staff writer' moniker for ease of use.

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