Public Workers, Don't Count on Your Pensions

Be prepared for the possibility that you may not get what you were promised. Start saving on your own.

Few have a bigger stake in Detroit's financial struggles than the employees who made a deal to teach, fight fires or push papers in the municipal building in return for a pension. As the city navigates a bankruptcy filing, workers and retirees worry about "significant cuts" in benefits called for by the city's emergency manager, who cites a $3.5 billion funding shortfall, and about the likely restructuring of retirement plans.

The courts will decide how Detroit's pensioners fare. But the debacle should serve as a warning to public workers everywhere: Don't pin your hopes for retirement security on an old-style pension without saving on your own. "It's a wake-up call," says financial planner Alan Hewitt, a retired Los Angeles firefighter who himself receives a pension.

City bankruptcies are rare. Only 14 cities, towns or counties have filed for bankruptcy protection since 2008, reports Resulting pension cuts are even rarer, but they do occur. Ask the residents of Prichard, Ala., where retirees have experienced dramatic benefit reductions (unlike private pensions, public pensions are not backed by the Pension Benefit Guaranty Corp.). An analysis in 2012 of 126 state and local pension plans by the Center for Retirement Research at Boston College found that the plans on average had just 73% of the funds needed to cover promised benefits—a $1 trillion shortfall.

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States and municipalities are taking steps to put pension funding back on track. Since 2009, 48 states have revised their plans. Changes include raising age and tenure requirements for new hires, requiring all workers to contribute more to their retirement savings, and cutting cost-of-living increases, even for those already retired. Some plans are adding 401(k)-style savings options to less-generous traditional pensions. Others have become cash-balance plans, in which each worker gets an account (managed by the employer, with a guaranteed minimum return) and, upon retirement, receives an annuity based on the balance.

Funding levels are improving, thanks to reforms and stock market gains. But state and local workers aren't home-free, especially because 30% of them are not covered by Social Security. "Relying solely on your employer is never a good move," says financial planner Jacob Kuebler, in Champaign, Ill., who works with state university employees.

If you can contribute to a supplemental savings plan, such as a 403(b) or 457(b), do so. Given a choice between a savings plan and a pension (or how much to contribute to each), consider that with most pensions, workers employed the longest receive the greatest benefit. So-called defined-contribution savings plans, however, are yours to take with you if you change jobs, and many offer enticements, such as generous matches and shorter vesting periods.

If you're not offered a savings plan outside a traditional pension, set up your own individual retirement account—even if you don't qualify for tax-deductible contributions. Kuebler tells clients to aim for savings equal to 15% of income, which means that if the state requires you to contribute, say, 8% toward a pension, you should sock away another 7% elsewhere.

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Anne Kates Smith
Executive Editor, Kiplinger's Personal Finance

Anne Kates Smith brings Wall Street to Main Street, with decades of experience covering investments and personal finance for real people trying to navigate fast-changing markets, preserve financial security or plan for the future. She oversees the magazine's investing coverage,  authors Kiplinger’s biannual stock-market outlooks and writes the "Your Mind and Your Money" column, a take on behavioral finance and how investors can get out of their own way. Smith began her journalism career as a writer and columnist for USA Today. Prior to joining Kiplinger, she was a senior editor at U.S. News & World Report and a contributing columnist for TheStreet. Smith is a graduate of St. John's College in Annapolis, Md., the third-oldest college in America.