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Making Your Money Last

Public Pensions: The Trillion-Dollar Hole

Some states are scaling back their retirement plans to help close the funding gap in their pension systems.

If you thought earning a fat pension in a public-sector job was a sure thing, think again. According to an analysis by the Pew Center on the States, state and local pension plans are operating under a massive deficit of at least $1 trillion. A separate report on 125 state plans by Wilshire Consulting found that the ratio of assets to liabilities -- the so-called funding ratio -- of state pension systems slipped from 85% in 2008 to 65% in 2009.

How did this happen? Simply put, the states weren't sufficiently diligent. They didn't make big enough payments to their pension plans, they failed to squirrel away enough money to pay retiree health benefits and, perhaps most egregious, they increased their benefits without figuring out how they would pay for them. Pew's $1-trillion figure -- tallied through the end of the 2008 fiscal year -- is conservative given that it doesn't capture the stock-market losses incurred in the second half of that year.

To help close the gap, some states are scaling back their retirement plans. According to Pew, ten states have curbed benefits to new workers or raised the retirement age. Nevada, for instance, changed the formula used to calculate pension benefits for those hired after January 1 to provide a lower payout. It also raised the retirement age for public workers from 60 to 62, starting this year. Another ten states -- including Iowa, Nebraska and New Mexico -- boosted employee contributions.

Workers are also starting to contribute or are contributing more to the health-care plans they'll get once they exit the workforce. New state workers in Kentucky, for instance, must now put 1% more of their paychecks toward their retiree health plans. Likewise, employees in Connecticut who have worked for the government for fewer than five years must contribute 3% of their salaries to such plans.

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The outlook is grim. "If pension systems continue on the course they've been on, the bite out of state budgets will get bigger," says Katherine Barrett, consultant to Pew. Unlike the federal government, which controls the printing presses and can run huge deficits, states must balance their budgets. For individuals living in states with severe deficits, that could mean an increase in taxes or a reduction in public services, or both.