Is Your Texas Pension Enough For Retirement?
Houston, we have a problem
Texas governments often get credited for being good at managing their finances.1 Yet, despite its fiscally conservative reputation, the state faces long-term economic health problems with underfunded public pensions. For example, Texas's largest cities Dallas, Houston, San Antonio, and Austin, are now struggling with mounting public-pension debt.2 The growing expense of paying down that debt is beginning to cut into important services, such as public safety and road repairs.
Texas governments have slightly more than 300 public retirement systems. Of this number, 93 are pre-funded defined-benefit plans (discussed below).3 The rest are small, pay-as-you-go defined-benefit systems, in which governments pay pensions out of their annual budgets rather than pre-funding them. Or there are defined-contribution plans, similar to private-sector 401(k) plans.
Most of the state's defined-benefit plans provide an annual retirement benefit based on the number of years an employee works and that employee's salary over his or her final few years of service. Public workers and their employers make contributions before they retire and are supposed to cover the cost of promised benefits. Pre-funding ensures that promised benefits can be paid when due, that they are fiscally sustainable, and that the costs of providing them are borne by the taxpayers and politicians who made the promises. But many Texas pensions are not fully funded.
The issue for public pensions is typically that the plan must assume many things. It has to assume a future rate of return on the invested portfolio, an inflation rate, and in some cases, future health care costs (medical benefits are part of many plans). These are a lot of unknowns that can only be guessed.4 As a result, when we say a plan is "fully funded," it may not be if the assumptions do not hold in the future. Almost all public pension funds assume investment returns somewhere around 7% or higher. This high investment return is doubtful.
Texas-Sized Retirement Plans
Texas state and local governments have three types of retirement plans.5
Defined benefit (DB) plans are "traditional" pension plans. The employer establishes a retirement fund for all employees, manages its investments, and uses a formula to determine each employee's specific benefit amount upon retirement. Participation in a DB plan typically is mandatory, and benefit payments are guaranteed by the employer, which is responsible for investing the fund and bearing any related risk.
Employers also sponsor defined contribution (DC) plans. DC plans offer employees optional enrollment in individual retirement accounts such as the government equivalent of the private sector 401(k) plan. Employees and employers may contribute to these accounts, although government employers generally do not. With a DC plan, much of the investment responsibility and risk remains with individual employees. Employees must select among various plan options, typically in mutual funds or annuities. Benefit amounts are not specified but are based on the amount contributed and investment returns. Future retirement payments thus depend upon investment performance.
Hybrid plans typically involve mandatory contributions to a DB and a DC plan, distributing the risk between employee and employer. The DB component gives employees a guaranteed monthly annuity, while the DC component gives them some control over their investment portfolios. As with traditional DB plans, employee participation in public hybrid plans usually is mandatory. Another "hybrid" variation is the "cash balance plan," which resembles a DB plan but with employer and employee contributions maintained in individual accounts rather than a pooled trust fund. Many local governments use the cash balance plan in Texas. The defined benefit, in turn, is stated in terms of an investment account balance at retirement, similar to a 401(k), rather than a defined monthly payment.
Pensions have been used to attract and retain skilled workers for dangerous or relatively low-paying public-sector jobs. For example, if you are a police officer or firefighter, your city grants you a typically very generous retirement compensation for the years you devoted to or risked your life. However, the private sector moved away from pension plans long ago because of rising costs and liability.
Texas Pension Plans
While DB plans are almost nonexistent in the private sector, most state and local governments still offer them. As of March 2018, according to the US Bureau of Labor Statistics, 86 percent of all US state and local government employees had access to a DB plan, while 37 percent could participate in a DC plan. In addition, about 89 percent of all state and local employees with access to a DB plan participated in it, versus just 45 percent of those with access to a DC plan.
Texas's two largest statewide plans are the Teacher Retirement System (TRS) and the Employee Retirement System (ERS). Together, these plans make up two-thirds of the state's entire retirement pension plans and 72 percent of its total pension debt. The TRS and ERS are Texas' largest public retirement systems, serving about 1.5 million and 360,000 members, respectively. Together, TRS and ERS serve more than three-quarters of all Texas state and local employees, dependents, and retirees. However, during the last 10 years, the funded ratios of both systems have declined considerably.
According to the Employee Retirement System of Texas, the average monthly pension of the state's 111,000 retired state employees and beneficiaries is $1,690.6 For the Teachers Retirement System of Texas, a teacher with 16 to 20 years of service retires, on average, at a salary of $42,813 and receives a monthly retirement benefit of $1,292. Even more problematic with TRS is that most school districts in Texas don't pay into Social Security, and teachers will not receive this as a benefit in addition to their public pension.
Possible Solution?
As mentioned, DC plans resemble 401(k)s in the private sector and the optional retirement programs (ORP) available for higher education employees in Texas. These DC plans to put the power of an individual's future in their own hands instead of depending on government-directed DB plans. DC plans are portable and sustainable over the long term as they are based on the contributions of retirees and a defined government match. But the risk of investment performance is borne on the employee.
With DC plans, retirees can determine how much risk they are willing to take. They also reduce the risk that the government will default on their retirement or fund those losses with dollars from taxpayers who never intended to use these pensions. By giving retirees more freedom on how to best provide for their families, DC plans can be a smart choice to meet your retirement goals.
Public service workers should take full advantage of your Texas public pension.7 A pension is a good steady income source to fund your retirement. But you should also be encouraged to save for retirement in a defined contribution plan such as a 403(b) for teachers or a 457 plan for state and local government employees.
Because of underfunded Texas public pensions, which will most likely get worse in the future, current employees cannot be fully guaranteed that the retirement benefit will be as good as current retirees. Also, the amount of money you will most likely receive will only cover up to 2/3rds of your preretirement salary. Therefore, other sources of retirement income are strongly encouraged, such as 403(b), 457, or Individual Retirement Account (IRA) - Roth and Traditional.
You should talk to a financial advisor to learn more about your best options to achieve your retirement goals.
2. https://www.citylab.com/solutions/2017/01/the-great-texas-pension-fix/512060/
3. https://www.city-journal.org/html/time-fix-texass-public-pensions-now-14732.html
5. https://comptroller.texas.gov/economy/fiscal-notes/2019/feb/liabilities.php
6. https://www.statesman.com/news/20190905/retired-state-workers-urge-state-leaders-to-hike-pensions
7. https://www.forbes.com/sites/realspin/2016/05/02/public-pension-crisis-solution/#691098325d9e
*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on to avoid any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets.
