The 8% pension plan solution

Public pension funds are resorting to riskier investments in a bid to score returns high enough to give retirees their guaranteed payments.

Sarah Gardner: If you want to see some skyrockets today, try taking a look at the target return for a lot of pension plans -- especially the yields that are promised to public employees. Some of them are guaranteeing returns as high as 8 percent. Say what? These days most investors are lucky to get a small yield. Government bonds have been paying record lows of maybe 2 percent, tops.

So what's the magic behind these pension fund returns? As our senior business correspondent Bob Moon reports, could be a lot of smoke and mirrors.

Bob Moon: Pension experts are getting anxious about those supposed 8 percent returns, because the only way to generate that kind of growth is pouring cash into increasingly risky investments -- including debt that you might know as "junk" bonds.

Economic consultant Anirban Basu has been tracking the pension funding shortfall for Baltimore's Sage Policy Group.

Anirban Basu: Either you're going to hit 8 percent by taking on big risks, or you're going to fall short by not taking enough risk, and the worst possibility is that you take big risks and you get a negative 8 percent.

Translation: Pension fund managers are gambling retirement money on an elusive target.

Maybe you're thinking that this doesn't apply to you because you're calling the shots on your own 401(k) plan. Those returns can always vary. But consider that public pension plans are increasingly reliant on that "magic" 8 percent assumption.

Andrew Biggs is a pension analyst at the American Enterprise Institute.

Andrew Biggs: The downside is that the benefits are guaranteed. So the taxpayer has to pay the benefits, regardless of how the investments turn out. If the investment returns turn south, then the taxpayer's on the hook.

At Towson University, economist Daraius Irani warns when the payments come due, we could all feel the sting. Either that, or public workers need to brace for a much smaller retirement nest egg than they've been expecting.

Daraius Irani: There are some studies out there that show it could be somewhere about $1,300 per taxpayer to pay for all these pensions. I know many states and many localities are going to revise downward their pension obligations.

Those cutbacks would hit future employees. The experts we spoke to warn that politicians have kicked this can down the road about as far as they can, hoping to make it someone else's problem, but the bill is now coming due.

I'm Bob Moon for Marketplace.

About the author

Bob Moon is Marketplace’s senior business correspondent, based in Los Angeles.
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One point ignored is the replacement of Social Security with private pension for State and local public sector workers.

Until five years ago, conservatives were calling for replacing Social Security with the kind of private pensions invested in Wall Street funds, just like Calpers and other government pension funds on the promise of 8%-10% annual returns while Social Security offered virtually no return on investment. The Bush administration proposed this as recently as 2005, even as State run pension funds were in serious trouble, betting the stock market would return to the 90s growth in securities price inflation.

If all public sector workers were participating in Social Security, the pensions could be replaced with 401Ks as supplements to SS old age benefits, but without SS participation, they must remain pensions providing survivor, disability, and dependent coverage as SS does for private sector employees.

The public sector pensions were wonderful in the 80s and 90s from the standpoint of conservatives because the high assured stock market returns would reduce the contributions tax payers would need to make to provide social security, cheaper than Social Security FICA. Then, when the tax revenues fell, the public pensions provided the option of skipping contributions, while FICA can not be avoided. Now we hear about how public workers get big pensions funded by tax payers while the workers with Social Security get no pension from their employers, ignoring the Social Security funded by FICA paying taxpayers.

Public sector workers without Social Security need guaranteed pensions by Federal law, last updated in this regard by President Reagan in 1983 making the public pensions entirely responsible for public workers who don't pay FICA, and eliminating the "double dipping" of both public pensions and Social Security.

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