If you are one of the thousands of employees that work for the state of Ohio or a teacher at a public school in Ohio, chances are you have a traditional state sponsored defined benefit pension plan. These retirement plans require the employee put a certain % of their gross income into the plan each paycheck. At retirement, the employee is promised a defined benefit that pays out each month. The plan assumes the investment risk so the employee does not have to worry about where to invest the money.
These types of retirement plans are becoming a rare benefit to anyone in the private sector because most businesses do not want to be on the hook for paying retiree benefits many years after an employee is gone. The problem is that it’s very hard to predict rate of return, mortality expectations, inflation etc., in an ever changing world.
This leads us as advisors to ask:
Should we be worried about the benefits being promised to our clients who are state employees/teachers?
There are several reasons to be concerned that these benefits will erode over time. Let’s take the STRS pension system as an example:
- 10 years ago, a new teacher began with the assumption that they could work 30 years, retire (regardless of age) and have an unreduced benefit for life. Today, that same teacher is now required to work 35 years (and be at least age 60) to receive an unreduced benefit.
- 10 years ago, a new teacher was required to put 10% of their gross pay into the system. Today, that same teacher must contribute 14% for the same benefit.
- 10 years ago, a retired teacher was provided a 3% cost of living adjustment each year in retirement to keep up with inflation. As of April 20th, 2017 the cost of living adjustment for retirees has been suspended indefinitely. This means that someone retiring today will lose more than half of their purchasing power as they progress through retirement! (assuming a 2.5% inflation rate over 30 years)
- The rate of return that they project going forward on the pension itself is 7.45% even though the state board’s investment consultants project a 6.84% rate of return over the next 10 years based on the asset mix!
As you can see, in a short period of time, there have been significant reductions in assumed benefits. In addition to that, the STRS board is using what we would consider an aggressive assumption for what the future rate of return will be, thus resulting in more cuts if it doesn’t achieve that return. Therefore, our answer is YES, we should be aware that the current benefits that are being projected will be changed and reduced in the future.
To be fair, it is a good thing that the board has made some changes to keep the system solvent long term. By taking a proactive approach and reducing ongoing benefits, they are avoiding a crisis that would result if they didn’t do anything and suddenly there were no benefits at all. However, we feel that it is prudent to take a conservative approach for our clients who will be counting on these benefits long term in retirement.