A Pension Problem

Why are pensions always underfunded?

It’s easy to understand the underfunding of public pensions. Why tax today what you can put off until tomorrow? In New Hampshire the Concord politicians had a unique fix for the State’s underfunding problem: make the Towns pay. Property tax rates are going up to help fund the State pension system.

But why are corporate and union pensions always in trouble? Yes, we had a couple of crashes in the last 13 years, but the markets are at record levels. My 401(k) recovered a while ago. Why can’t traditional pensions?

Partly it’s the Fed, and partly it’s the IRS. Traditional pensions are measured by subtracting liabilities from assets. As long as interest rates are super-low, the present value of any future liabilities is going to be higher. And asset prices haven’t been able to keep up.

But it’s also the IRS. Back in the heyday of defined benefit pensions, the IRS became concerned about small professional offices that would overfund a pension plan as a way to defer compensation and taxes—which was pretty desirable, with the top bracket at 70%. So the IRS got very strict about overfunding—any payments into a fully funded plan were no longer deductible. So when the market collapsed in 2001 and 2008, pensions were already underfunded. And few pension managers had the guts to immunize their plans like Boots Pharmacy did in 1999, by buying 7% government bonds. No mess, no fuss, but no fees.

It’s worse for union plans—their contributions were fixed by contract. Their solution to overfunding was to increase benefits. Now those plans are saddled with generous benefits and underfunding. And union shops like Hostess can’t pay competitive wages because they have to pay $1 an hour toward towards their rat-hole pensions.

It’s been said that a camel is a horse designed by a committee. These pension rules make camels look like Kentucky Derby winners.

Douglas R. Tengdin, CFA

Chief Investment Officer

By |2013-05-10T08:51:48+00:00May 10th, 2013|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. - Leave a comment if you have any questions—I read them all! - And Follow me on Twitter @GlobalMarketUpd

Leave A Comment