The U.S. federal government and several states are in horrific financial condition. But I like to keep an eye on Illinois because they are running the fastest toward a financial cliff. Illinois spends more of its annual budget on state-employee pensions than any other (more than 25% of its state budget), and it also has the most underfunded pension (only 37.6% funded). The result is a $130 billion pension shortfall and the state is checkmated into doing nothing about it:
- Illinois cannot raise taxes higher without more residents and businesses fleeing the state
- The Illinois state constitution forbids reducing pension benefits for any reason
I am curious how this will play out because this situation cannot last for long. The state has long been operating without a budget and not paying vendors; so what would happen if the state goes into a recession? However the Illinois financial calamity unfolds, it could become a model for other insolvent government institutions such as Chicago and the state of California.
When the city of Detroit went through bankruptcy two years ago, its $18B debt was reduced to $7B and the pension benefits to city employees were reduced. The pension trustees had to decide if they wanted to accept a slight reduction or risk the possibility of dramatically larger reductions. Public pensions are simply unaffordable, as the state of New Jersey is finding out. Their state credit rating has been reduced 10 times since 2010 because the already sky-high taxes in New Jersey are not enough to cover their pension shortfall. New Jersey recently raised its gasoline tax “for roads,” but some of the money was diverted to its pensions instead. Philadelphia passed a soda tax to fund “children’s programs,” but instead, some of the money was diverted to fund the city’s underfunded pensions. Government pensions seem to slowly consume all tax revenue.
The implication for state employees is sobering – you accepted a job based on a commitment of a pension, but what if that pension payment is cut by a substantial amount or even goes to zero? If your money is in someone else’s hands, particularly the government’s hands, it is at risk. Federal Social Security payments need to be reduced within a decade as well. There are reports on their website pointing this out to anyone who reads it. But instead of taking action, most people ignore it and hope the politicians will be able to solve the insolvable, or at least kick the can down the road.
The most financially prudent people that I know live off of their investment income from either stock dividends or real estate rents. Any pension and social security payments that they receive are just a small financial bonus. This way, they have no stress about potential reductions to pension or social security payments because they don’t rely upon them. This is the opposite for most people: What is the percentage of retirees whose social security payment provides over 50% of their total income?
- 48% of married couples
- 71% of single retirees
My best advice is to save a minimum of 15% of your income for your retirement. This way you’ll have the money to buy an annuity to create your own monthly pension payment, or build an investment portfolio from which you can withdraw from to support yourself when you stop working.