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Published on: January 21, 2012
The Great Minnesota Pension Scam

If you are a current or former state employee in the state of Minnesota, watch out.  Your pension depends on hot air, sketchy arithmetic, and the willingness of future taxpayers to make huge sacrifices to cover the deceit, wishful thinking and sketchy math at the heart of your pension system. According to a recent analysis […]

If you are a current or former state employee in the state of Minnesota, watch out.  Your pension depends on hot air, sketchy arithmetic, and the willingness of future taxpayers to make huge sacrifices to cover the deceit, wishful thinking and sketchy math at the heart of your pension system.

According to a recent analysis in the Minneapolis Star-Tribune by Mark Haveman (Executive Director of the Minnesota Taxpayers’ Association), Minnesota’s pension plans, even after recent mandatory increases in employee contributions, are essentially hollow.  Even using the state’s extremely aggressive ‘assumed’ rate of 8.5 percent annual return on its investments, the pension fund is about $10.5 billion short of being able to pay off its future obligations. For every $1 the state has promised to pay retired civil service workers and teachers, it expects to have about 79¢.  The good fairies and the wood elves are responsible for coming up with the rest of the money.

Most of us think of Minnesotans as a little dour and down, but when it comes to estimating future performance of their investment funds, they turn out to be a bunch of cockeyed optimists: much more Ted Baxter than Lou Grant. Minnesota projects that its investments will average 8.5 percent growth year after year; this is the highest projected rate of return of any state in the country.  Using the more common (and perhaps still a bit optimistic) rate of 8 percent, the fairies and the wood elves will have to come up with another $2.9 billion. (In fact, Minnesota’s investments have done pretty well over the years, averaging 9.7 percent over the last thirty years. But those years were an unusually benign period in financial markets; the two longest economic expansions in the US occurred back to back with only a very mild recession in between. Few expect such calm waters ahead.)

The fairies and the wood elves may have to work even harder. There has long been concern among accountants and finance experts that states use skewed assumptions and tweaked numbers to understate the true cost of their pension liabilities.  For politicians, this is a convenient Ponzi scheme: they can promise the moon to future retirees and then cook the books to avoid raising taxes to cover the benefits they have promised. Mounting concern about the horrors lurking in the murky waters of state accounting has led to pressure to adopt a national set of accounting standards; if proposed new standards are accepted, most state pension funds will have to face the unpleasant fact that they are even more in the hole than previously thought.

According to this Boston College Retirement Research report (full text available as PDF) the average state pension fund will see its shortfall rise from 23 percent to 47 percent of the funds needed. That money will have to made up from higher taxes, higher employee contributions, lower benefits, or tribute from the fairies and wood elves.

The lesson for public sector employees should be obvious: your personal retirement planning should assume that you will only receive about 75 percent of your state-promised pension benefits. In some states (Illinois and California spring to mind) you are likely to receive even less.  The farther you are from retirement, the higher the discount rate you should apply; this is a classic Ponzi scheme, and those who get out early tend to get out ahead. It’s the late investors who lose the most: younger workers and new hires, this means you.

You should also be fighting for defined contribution rather than defined benefit plans. In a defined contribution plan, you pay into your pension fund and the employer matches all or part of your contribution.  Your income at retirement will be based on the amount you and your employer put into the fund, and the performance of the assets in which the money was invested.  The biggest risk is that poor investments or bad luck could mean that there won’t be as much money as you had hoped.

The other kind of pension plan is known as a defined benefit plan.  In these plans, you and your employer pay in, but (in theory) your final pension is based on some formula based on your number of years on the job and your annual earnings. Under some circumstances, these programs can be safer than defined contribution programs because you are protected against investment risk.  If the funds in the pension kitty aren’t enough to pay your pension, the company is supposed to make up the difference.

These days, those defined benefit plans aren’t as safe as they used to be.  In the old days, companies like Kodak and Chrysler were believed to be safe; in effect your defined benefit pension was a claim on the earnings of a blue chip company.  But these days, fewer companies are such safe bets for the long term, and many workers have been hit hard when their past employers folded or, desperate to stay alive, used bankruptcy or other methods to cut pension payouts.

With state governments the risk is that when the funds run short, voters will balk at higher taxes to make up the gap. This is almost certain to happen going forward; states are cutting school, university and health care funding as it is.  Voters were never told how much these obligations would cost; they won’t feel responsible for honoring what many will see as fraudulent contracts.

Mother Goose Reads Fairy Tales to Children

Under modern conditions, for younger workers especially plans where you make contributions matched by your employer are safer bets than defined benefit plans.  In defined contribution plans, they can’t touch your money to pay pensions for older workers; in other plans they can suck you dry to keep the better connected and better organized geezers happy.  Your union reps and state legislators won’t tell you about this, but it’s true: badly funded defined benefit programs will be looted to pay the oldsters in full as long as possible, and younger workers will be stiffed when the bill finally comes due.

Save more on your own, and fight for defined contribution plans that will let you keep what you save.  Otherwise, expect to be eating acorns and drinking bark tea with the wood elves.

show comments
  • MaleschMorrocco

    No truer words were ever written!

  • WigWag

    Were Minnesota’s returns of 9.7 percent an historical anomaly unlikely to be repeated? Were they the result of an unusually outstanding economic climate as Professor Mead contends?

    Probably not.

    Measured over the past 100 years the average annual return of the S&P 500 is approximately 9.6 percent which is virtually identical to the return achieved by Minnesota over the past 30 years.

    It is true that during this 100 year period the stock market experienced periods of extraordinary strength. It is also true that during this same period the market experienced periods of extraordinary stagnation (the Great Depression years, the 1970s and the past decade come to mind).

    Perhaps the 20th Century was America’s greatest century and we are in for a long, slow economic decline. But in post after post, Professor Mead keeps telling us that pundits whining about decline have it all wrong. Mead seems to believe that the United States continues to possess the social capital that will allow it to continue to thrive.

    In light of this, Minnesota’s projections may be significantly less unreasonable then the critics suggest.

    All of this is far less apocalyptic than those predisposed by the strange character flaw of hating government believe. The United States is working it’s way out of an unusually severe economic downturn and it is facing a difficult but temporary demographic reality; the aging of the baby boom cohort. As the baby boomers age all of the costs inevitably associated with aging go up. By mid century the problem will die a natural death.

    The truth of the matter is that it makes little difference if future retirees derive their retirement income from defined benefit or defined contribution plans. If the American economy grows either type of plan will pay handsome benefits; if the economy fails to thrive, neither will.

    To grow the economy we will need strong doses of innovation and a willingness to let the forces of creative destruction kill off companies like Kodak. We will also need a strong government providing a safety net for the victims.

    What we don’t need is a backwards looking nostalgia for an antiquated version of federalism or a quaint yearning for a mythologized past when the government was small and most of us were far better off than we are now. That time never existed.

    The surest way to kill the goose that lays the golden egg is to encourage the Government to practice austerity in the middle of an economic downturn. Worrying about inflation when interest rates are approaching zero and investors throughout the world are dying to get their hands on U.S. debt is equally stupid.

    The world is full of dopes predicting that the world will end tomorrow. My guess is that the world won’t end tomorrow and neither will Minnesota.

  • Dave

    Your comparison of the state’s pension plan performance with the S&P500 historical performance is not an apt one. The Minnesota pension plan is assuredly not 100% invested in equities. The greater EXPECTED returns from equities come with greater investment risk. Fixed income instruments will decline in value when interest rates begin to climb. To think that past is prologue is a very dangerous game. But if it makes you feel better, have at it.

  • http://www.hedgehogparty.com ezag

    Social Security is nominally a defined benefit plan. It is a pretense of course, because the funding winds up in general revenue. Add to that escalating benefits and coverage, and you have a disaster in the making. Over time, no set of politicians can resist such easy vote buying.

  • http://www.alfin2400.blogspot.com Alice Finkel

    Those with the strange propensity of both working for government and screwing the taxpayer at every turn, will urge public sector unions onward in their ongoing murder-suicide of state and local governments across the US.

  • Lina Inverse

    WigWag is spot on: The success of defined contribution (and just plain saving money) retirement plans depends on two things: finding a Greater Fool to buy your assets when you need to convert them into cash (iffy with our demographics), and current production necessarily covering current consumption (you can’t eat dollar bills or gold for that matter).

    Although I wouldn’t consider defined contribution plans very safe; sure, Argentina is an extreme but how many of us are CERTAIN our desperate, dying because they will “run out of other people’s money” ruling class won’t just confiscate them? If you say “that can’t happen here”, that’s just what FDR did with the nation’s gold, buying it at the traditional price of $20/oz and then repricing it at $35/oz.

  • peter

    I can only scorn the naive arguments about the “return” of 8 or 9 percent, and comparisons to the stock market. Firstly the
    Fed is the sole buyer propping up stock prices. Secondly, real inflation – including food and energy – is FAR higher than than any figure used by any pension calculation anywhere.
    Even if the pensions miraculously balance their books, the retirees will still be hungry and cold.

  • Jim Jenson

    Arguments about past and predicted growth rates miss the point. The value of defined contribution plans is that present elected officials cannot overpromise benefits to be made good after they are out of office. This is happening now in my city, Omaha, NE., and is much worse in many other cites around the country. If the pension contribution to governmental employees is justified, the officials can do so. But, defined benefit plans enable our mayors, representatives, etc. to get support for the next election from unions of governmental employees by giving them a benefit package that will not come due until ten or more years in the future.

    All this will be eliminated by a switch to defined contribution plans, which can be invested in all stocks, all bonds, or any mix chosen. It is not anti-pension for governmental employees, just a transparency argument.

    Note that many university employees (I am one) are covered by defined contribution plans going into TIAA-CREF. An added benefit is that the money is in my name from the beginning. No worries about my employee going bankrupt and not fulfilling its pension promises. Also, there are no vesting issues since the contributions are in my name, not the employer’s.

    My recommendation is that ALL retirement plans, public or private, should be required to be defined contribution plans.

  • WigWag

    While there is a definite and overwhelming trend in the direction of defined contribution plans as opposed to defined benefit plans, this trend may very well end up proving deleterious to the retirement plans of ordinary Americans and the future prosperity of the United States.

    Invested intelligently there is no reason why one type of plan should outperform the other. The problem is that ordinary Americans make the decision about how their defined contribution plans are invested and what vehicles are utilized. These Americans are far less likely to invest these assets in a manner that maximizes long term growth than the institutional asset managers who control the investment strategy of large defined benefit plans.

    This is one case where the experts dramatically outperform the average guy although the average guy can usually beat the experts by investing in index funds. Unfortunately most don’t and dramatically underinvest in stocks and overinvest in other vehicles.

    The question to ask (I don’t know the answer) is whether the average Minnesotan with a 401K or similar plan has achieved the same 9.7 rate of return over the past 30 years that Minnesota’s asset managers have.

    It is also important to remember that individuals with defined contribution plans have a much easier time accessing their money pre-retirement than participants in defined benefit plans do. This makes it much more likely that defined contribution plan holders will have squandered a portion of their money that they should have relied on for retirement.

    Put it all together and even if you discount the fact that holders of defined benefit plans may end up with less than originally promised, they will likely still end up better off than defined contribution plan owners.

    As millions of Americans with defined contribution plans begin to retire only to discover that they don’t have enough money to live on it will not only be a tragedy for them, but also for our country.

    A nation of millions of citizens impoverished by inadequate defined contribution plans won’t make the United States any stronger.

  • Larry

    “The surest way to kill the goose that lays the golden egg is to encourage the Government to practice austerity in the middle of an economic downturn.”

    Wow. So when SHOULD the government reign in spending? When the economy is rolling along? Ever?

    “.. investors throughout the world are dying to get their hands on U.S. debt”

    Um, not so much any more:
    http://seekingalpha.com/article/251302-why-foreign-investors-are-shunning-u-s-treasuries

    “The world is full of dopes..”

    Well, you got that part right anyway.

  • WigWag

    You’ve stumbled into the answer, Larry, the government should run deficits in times of economic stagnation and surpluses when things are, to use your term, “rolling along.”

    In case you have a short memory or are too young to remember, that’s precisely what happened during the Clinton Administration. Times were good and the federal government began running substantial budget surpluses. These surpluses were so robust that Alan Greenspan and others began questioning just what the implications of completely paying off the federal debt might be. The bottom line is that we were well on our way to completely eliminating the federal debt, at least temporarily.

    Then came the disputed election in Florida, the disastrous Bush tax cuts, 9-11 and the wars in Iraq and Afghanistan. All followed by the worst economic downturn in decade.

    Had Gore been elected it is quite likely that
    there would be far less federal debt than there is now. In any case, the time for deficit spending is when the economy is stagnating. The time to run fiscal surpluses is when the economy is robust.

    Haven’t the gurus at “Seeking Alpha” explained that to you?

  • herrman

    I also agree with Wig Wag to a point. The economy will do what it does, and both of these retirement plans will suffer or thrive accordingly. The threat lies in a wildly dysfunctional government killing the very innovation and risk reward Wig Wag cites as needed for a robust economy. Government can’t fix the economy, but it sure can screw it up more.

  • Kenny

    “The surest way to kill the goose that lays the golden egg is to encourage the Government to practice austerity in the middle of an economic downturn. ”

    The words of a fool especially considering how bloated all levels of government are in the U.S.

  • Les Nessman

    “…and younger workers will be stiffed when the bill finally comes due.”

    Oh, they’ll be alright. The pols and/or courts will just force the taxpayer to pick up the tab, as usual, because ‘promises were made to the poor ol’ govt workers’ or ‘ it’s just not faaaaiiir ‘ or somesuch whine.

  • Ron DeWitt

    Wigwag’s argument is basically that the common man is incapable of managing his own affairs, and that the investment decisions required for his pension plan should be left to angelic experts in the employ of the government. Wigwag does not seem to consider the possibility, mentioned by other commenters, that the angelic administrators of the pension may have an agenda that differs from that of the purported beneficiaries. Wigwag should place greater emphasis on the fact that a government pension is backed by the coercive power of the state, unlike those of Kodak and Chrysler, so the government would be able to enslave the populace to the extent necessary to carry out whatever promises it decides to honor. Of course, this would require subverting democracy at some point, or the whole scheme would crumble.

  • John Stephens

    WigWag’s analysis contains one small but crucial flaw: it assumes honest and competent government.

  • crypticguise

    There is. no more money folks! Public employees can no longer expect to have golden goose paychecks, benefits and pensions.

    There are simply not enough tax paying citizens who work in the private sector to subsidize government employees

  • Gary

    To paraphrase Wig Wag. Individual are too sighted (dumb?) to live their lives in their own best interest. Only the benevolent politicians and their disinterested “experts,” in government and union offices can protect us from ourselves.

    So don’t worry, 9% returns yesterday mean 9% today and 9% tomorrow. The benevolent politicians and their experts wouldn’t say it if it wasn’t true. It’s all about the hope ‘n change.

  • Robert Arvanitis

    “Younger workers…safer in defined contribution.”

    Not so. The left will just nationalize defined contribution as well as defined benefit plans if they get the chance.

    Just like Argentina. See for example http://www.amazon.com/gp/product/B001QXCAXK/ref=as_li_qf_sp_asin_tl?ie=UTF8&tag=wwwviolentkicom&linkCode=as2&camp=1789&creative=9325&creativeASIN=B001QXCAXK

  • Robert Arvanitis
  • james wilson

    Speaking for all taxpayers as I am, unfunded pensions are going to mean unpaid pensions. State employees have already been paid for not working once. Game over.

  • Stu

    “… that’s precisely what happened during the Clinton Administration. Times were good and the federal government began running substantial budget surpluses.”

    Really Wig? Then why did the Total Public Debt Outstanding go up every year during the two Clinton terms? Increasing Total Public Debt would belie budget surpluses, unless you kept something off budget– for instance, Intragovernmental borrowing. See for yourself at the U.S. Treasury website:
    http://www.treasurydirect.gov/NP/BPDLogin?application=np

  • cubanbob

    Wag I also remember the Clinton Administration but without the fantasy. A republican congress keeping spending in check, a drastic reduction in military spending and a stock market boom. Winning a lottery doesn’t make one a financial wizard. Just lucky. Clinton was never the competent and admired figure you fantasize about. But for Perot he never would have been elected to begin with and but for Gingrich he would have an Obama. had killed Bin laden when he had a opportunity we may have been spared 911.

    As for Al Gore, you must be kidding.

    Lina what make you so sure that future voters and taxpayers will honor public sector pension schemes? Why would they and why should they?

  • Dave in SoCal

    All of this is far less apocalyptic than those predisposed by the strange character flaw of hating government believe.

    Trillion dollar budget deficits. A national debt of 15 trillion dollars (and rising). Record numbers of job-killing regulations being published every year. Unfunded pension liabilities for state and government workers in the trillions of dollars.

    Gosh, why on Earth would anyone in their right mind not love and embrace big government?

    In case you have a short memory or are too young to remember, that’s precisely what happened during the Clinton Administration. Times were good and the federal government began running substantial budget surpluses.

    Attempting to rewrite history, are we? As noted here, the reality is that there never was a budget surplus under Clinton, nor did he pay down the debt.

    Try again.

  • Willis

    To those arguing that defined contribution plans are as risky as defined benefit plans or that the rates of return for Minnesota’s pension plan are reasonable, you miss the point. With a defined benefit plan, politicians can buy votes today with taxes from tomorrow. This is not so with a defined contribution plan. With an underperforming defined benefit plan, the risk of ever returning to funded status is shifted to the younger participants. Such a risk does not exist with a defined contribution plan. While it is true that the investments for a participant in a defined contribution plan may crater, the risk of such loss lies only with the participant’s account holding those investments, it is not shifted to those with the longest time remaining to retire.

  • gringojay

    Vouchers will be issued redeemable at participating in-state points of food, clothing, housing & medical care. Nobody will need to obtain heat for where they live because all the CO2 breathed out shuffling into lines outside will warm up the globe.

  • Wesley mouch

    i have little sympathy for public wokers. They gleefully accepted the propaganda their Union bosses about how they could make so much in retirement. They have fleeced us once, its time that the taxpayers fleece them

  • darylsacks

    The argument that wigwag makes that the if Gore had been elected we would not have had 9/11 or the impact that it produced would be comical if not so pathetic.

    The financial impact of 9/11 on America was incredibly profound and is still felt today.

    But to argue some how that the economic downtown began when Bush took office after Florida is to ignore reality. The “bubble” had already burst before the first ballot was cast in November 2000. Neither Bush nor Gore could have done anything to have countered it.

    Bluechips in late 2000 were feeling the effects LONG before Clinton left office.

    And please explain how Gore would have stopped 9/11… We’d all like to know.

    Raising taxes in the middle of a recession has never proven to reduce spending or deficits whenever it has been tried. And you cannot spend your way out of a recession… never works and has only lead to more economic failure.

    FDR didn’t succeed with his crippling plan, he only prolonged the pain.

    I strongly recommend reading a history book cover to cover before setting it on fire.

  • Gene

    In his utterly predictable desire to attack Republicans, Wig Wag misses the point once again: My defined contribution plan is my property; I am 100% vested in all of it, including the employer matches, and therefore 100% responsible for its performance or failure. Which is AS IT SHOULD BE. I don’t rely on the promises of politicians, union bosses or plan administrators with political debts to those politicians to get the benefit of my retirement savings. And if I screw up and mis-invest it? I’m responsible, and that is, again, as it should be.

    OTOH, the commenter mentioning a government seizure of my retirement savings brings up a very real possibility, one that becomes even greater if the Supremes uphold the individual mandate in Obamacare. Once we can be forced to buy a product from a private company, imagine how easy it will be to be forced to buy US Treasuries as part of our retirement plans?

  • http://thepencilofnature.net Lorenz Gude

    I receive some of my retirement income from TIAA-CREF and I am completely satisfied with their management of the funds . And I have no trouble accepting that my pension rises and falls with the market. With social security I know that I get way more than was justified by my contributions because I only worked in the US the minimum 10 years before emigrating, yet I get a high percentage of a full benefit. I’m glad to have the money because I need it, but I am concerned that I am living off other peoples money rather than my own.

    On the Keynesian discussion about tax cuts, as the government did in response the .com collapse, tax cutting is a legitimate a Keynesian tactic as deficit spending in hard times. It worked and there is certainly a case to made that taxes should have risen to control the deficit and pay for the war. I don’t think Gore would have cut taxes, and it hard to imagine him getting involved in Iraq the way Bush did, but he would have had a war to finance however he chose to fight it. However, the rhino in the room is that the US economy had cancer all along in the way it was financing housing. Corruption of both parties, key segments of our bureaucracy, and most of all on Wall St destroyed a significant portion of America’s wealth. Yes, it would be disastrous to quickly cut spending but there are limits to how much you can do deficit spending without the disaster of default. The best we can hope for are soft landings. Like reduced pensions. And having to work longer and harder.

  • Tom Gates

    The debates between DB and DC plans will soon be moot. I can assure you that a second term of the Obama presidency will bring an integration of the these plans into the Social Security system. The final product, like Obamacare, will be a dressed up pig that will look great to the average, brainwashed citizen. THe only way to save State DBs and Social security is for Government to get it hands on 401-K and IRA money.

  • Chris

    “In case you have a short memory or are too young to remember, that’s precisely what happened during the Clinton Administration.”

    AKA the Happy Newt Years.

  • David Sandbeck

    The truth is Overall, Minnesota’s middle-income earners pay 10.3 percent of their income in state and local taxes, compared to the state’s highest earners who pay 7.7 percent of their income in taxes.It’s very shortsighted to say Minnesota can not afford to keep it’s promise to our long time career state employees. One should look at the overall budget. State employees cost less then 10% of the budget. The real challenge is health and social services. The state of Minnesota can’t afford the rising cost of Health care and Education,which are rising faster then inflation. Health and Human services are where the majority of our budget is spent. I work for the private sector, where short term oriented management approaches are hurting the stability of the American family. I agree cuts must be made, but we should make the right cuts. That means balancing our budget on the backs of the elderly, the poor, and the young. It would be outrageous to ask the wealthiest to pay 3% more if you make over 150,000 dollars a year. Keep in mind the average income is only $27,000. Minnesota is quickly becoming more regressive in it’s tax policy.

  • T

    Lets not equate state workers, politicians, and teachers with volunteers or peace corps volunteers

    Why should other people be supporting your retirement? You get social security, thats more then I’ll have

    and my 160k in student loans arent paying for the actual cost of my education (the actual expense hasnt gone above inflation) it props up budgets, pensions and fringe benefits for people who cant earn a living themselves or are a politician

    Which is more like 300k by the time i can pay it off with “forgiveness”

    The average income u say is only 27k

    Whats your pension and social security? They leave that out of that average income equation as its nice and tax free

    Do you know how hard its going to be for this work force thats supposed to support the most spoiled generation when we have that much debt?

    Starting a business, buying a house, if a person has a job

    Dont start counting your chickens yet

  • T

    How is right in any way shape or form to increase the cost of education, property taxes, and cut the trickle of services and funding while everyone is going broke and cant find work and losing their home

    2007 on they really turned up the heat, its like they arent even gonna pretend they are doing anything besides line their pockets

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