In October, the Congressional Budget Office estimated that the private retirement plans of Americans — including 401(k) and IRA accounts — dropped by some $2 trillion, or 20 percent in the 15 months ending September 30. Yes, those are big, scary numbers, but the retirement savings crisis, as many call it, is actually worse than that. And — as you probably know — it wasn't caused just by the recent market meltdown that saw a record-breaking 18 percent drop in the Dow Jones Industrial Average and the S&P 500 in just one week's trading.

The United States has a severe savings problem, one so hardwired into our culture that it is institutionalized. You've heard that before, perhaps you've even warned your clients about it. The bottom line is that if you are using promised future cash flows from a client's defined-benefit plan in your retirement calculations — employer- or government-sponsored — you had better be careful. Retirement promises will likely be broken — and sooner than you think. In the private sector, more and more DB plans are shutting down or reducing their payouts as future obligations are overwhelming companies' ability to pay. The government itself is also facing some tough times ahead: It is running historic deficits and, recently, the national debt has been growing at a pace never before seen in this nation's history. (And that's saying something.) The promises on the books for future payments from entitlement programs — from Social Security to Medicare — already represent $53 trillion. That works out to about $175,000 per person.

The trouble is, we haven't got $53 trillion. “Social Security trust funds are a misnomer, and, in fact, they're an oxymoron,” says Peter G. Peterson, a former secretary of commerce and chairman of the Blackstone Group. “They shouldn't be trusted and they're not funded.”

Peterson and many other Wall Streeters, legislators and policy wonks have been singing this refrain for some years. But nothing much has changed; governments continue to spend more than they take in, as do private citizens. Peterson, Warren Buffett, Alan Greenspan and many others appeared in my film, I.O.U.S.A., a documentary released this summer that outlines the fiscal challenges the U.S. faces as the nearly 80 million baby boomers begin to retire, to articulate the coming problem.

When we started researching the film (and book), we realized most Americans don't know how bad this country's fiscal situation actually is. The only way to fix this mess is to demand fiscal responsibility from our leaders and from each other. But let's face it: Most Americans would do better if they simply controlled their own personal spending, saved more and invested wisely for their own futures. On this issue, the financial advisory community owes the investing public real leadership.

The message is ugly, but necessary. David Walker, a former Comptroller General and head of the Government Accountability Office, told me, “By the time today's college graduates are ready to retire 40 years from now, the only things our government will be able to pay for are interest on the federal debt and some of the Social Security, Medicare and Medicaid benefits. All other parts of the federal government will be closed and out of business.” (Peterson's nonpartisan Concord Coalition backed the film and Walker is CEO of The Peterson G. Foundation.)

IMPAIRED PENSION PLANS — NOT JUST FOR AIRLINE EMPLOYEES

You might warn clients that the crisis has already started in the private sector. “Yes, it is true that promises made have been broken,” says John McKeehan, an advisor with National Retirement Partners, in San Juan Capistrano, Calif., a broker/dealer and an RIA with about $50 billion under management. “Corporate America has frozen future benefit accruals for even the largest employers or have converted pension plans to cash balance plans — which have the potential to significantly reduce benefits for older, long-service employees. In addition, retiree health care plans have been virtually eliminated, putting the onus on Medicare.”

In all, over 3,600 American corporations have terminated their pension plans since 1974, including some big steel makers and a slew of auto parts companies. (See table on page 27.) Plenty more are expected to follow in this financial mess. (All eyes are on the auto industry.) Sometimes companies are blindsided by unexpected problems — for instance, no airline could have foreseen a terrorist act on the scale of 9/11 and that it would scare droves of people away from flying for years. But often, these shortfalls occur because of management promises that were based on unsustainable projections for future growth.

Which is why some advisors discount the amount a pension plan might actually throw off in the future. Some advisors tell high-salaried clients to discount future annual benefits by 30 percent to 50 percent — or more. You almost have to act like a bondholder, analyzing the financial health (and not just the business fundamentals) of the company for whom your client works. For financial advisor Robert Kramer's clients, an impairment or loss of a pension is “the big fear.” And a reality. That's because Kramer, executive vice president and managing director of Cleary Gull, in Milwaukee, specializes in airline pilots (of his 550 clients, about 450 of them are American airline pilots).

When a private DB plan is terminated, the Pension Benefit Guaranty Corp. (PBGC), a government entity that protects the pensions of 44 million American workers and retirees in 30,000 DB plans, takes over. While it is a “backstop,” pre-retirees can expect a much smaller annual benefit as a result. On average, the PBGC pays about 84 percent of retirees' pensions. But if you make “too much” money — as did many United Airlines, USAirways and Delta Air Lines pilots when those companies filed for bankruptcy and reorganized — you receive a fraction of your promised annual benefits. Obviously, the discount is different for each employee, but pilots, who on average make more than other airline employees, usually get just about half of what they'd expected — or even less.

“If you're an airline pilot making $250,000 a year and your calculated lifetime benefit is $150,000, you're going to take a hit,” Kramer says. A big hit. Consider this real example of a Cleary Gull client: A United pilot was expecting $150,000 annually but was told by PBGC, which had assumed the United pension, that he's only guaranteed $34,000; he may get more, but that's all PBGC can guarantee him. Kramer says there is no across-the-board fix for everyone and that savings goals and spending projections are unique to each client. The flipside is that you have to be careful about forcing clients to live a parsimonious existence needlessly. But, on the other hand, Kramer says, “We tell all of our clients to be careful and not depend too much on contributions to a DB plan. What if it isn't there in the end?”

One shouldn't necessarily count on PBGC's solvency, either. Because of economic contraction in certain industries that traditionally pay out pensions, inadequate minimum contributions and other challenges, “PBGC has been in a deficit position for most of its existence [since 1974],” Charles E. F. Millard told a U.S. House of Representatives committee this September. While PBGC had an accumulated deficit of $14.1 billion at the fiscal year end of 2007, the agency is fine for now. Said Millard: “Fortunately, the current deficit does not pose an imminent threat; PBGC has sufficient funds to meet its obligations for a number of years. Nevertheless, over the long term, the deficit must be addressed.”

Millard also told the assembled House committee members that even by PBGC's own 10-year forecast, it would be in the hole by about $10 billion a year, on average. “Even more significantly, the model indicated that there was only a 23 percent chance that PBGC could reach full funding at the end of that 10-year period.”

PBGC is funded by premiums from corporate pension plans. “As the premiums rise,” says McKeehan, “more DB plans are terminated. This becomes a death spiral. Today, there are no provisions for funding the PBGC with additional tax dollars.”

In short, as the private sector goes, so too will government backstops such as PBGC. The problem may even be worse, more widespread than just individual agencies. “The one sector where DB plans have remained is for government workers, but those plans are in jeopardy as state and county revenues come under intense pressure,” says McKeehan.

Many state and local governments' obligations have swollen even as their options for raising money have narrowed (think of California's current troubles funding its operations). Not even the almighty federal government is immune. (One wonders how long Treasuries will be considered risk free?) The federal government, as we all know, is groaning under war debt and future entitlement spending. On a gross level, the U.S. federal debt passed the $10 trillion dollar mark on October 9 of this year, several months before projections. But that's just the beginning. Passage of the Paulson rescue plan required the national “debt ceiling” to be raised — for the second time in 2008 — to $11.3 trillion. When the debt breaks that threshold, it will represent more than 70 percent of the nation's GDP. In the depths of the Great Depression, the government's debt-to-GDP level only reached 45 percent. Never in the history of the nation has the U.S. faced such high levels of debt during times of relative peace.

SOCIAL INSECURITY

By 2017, just nine short years from now, the Social Security Trust Fund will itself begin running a deficit. Congress will no longer be able to tap Social Security to pay its bills. In fact, “All we have in [the trust fund] is a bunch of liabilities,” Peterson told me.

At the current rate, it's inevitable: Most Americans are going to have to rethink what they expect from their government. Do politicians need to be held accountable for the promises they make during election campaigns? Seems like a no-brainer, but individuals need to take responsibility for their own financial futures, too. Private citizens are going to have to plan better, save and invest prudently. For the first time in a generation, Americans are going to have to readjust their expectations of what the government can provide, and learn how to pay for what they expect the government to.

The answer is probably not higher taxes. The government would have to raise income tax rates across the board by about 2.5 times today's levels to close the financing gap. Besides, in the future, there will be fewer workers to tax. Along with much of the Western world, the United States is entering a demographic transformation to an older society. Between 2010 and 2030, the 65-and-older population will spike. By 2030, when the last of the baby boomers turns 65, nearly one in five U.S. residents will be 65 or older. The percentage of the population in the working ages of 18 to 64 is projected to decline to 57 percent, from 63 percent today.

“The facts aren't Democrat or Republican,” says Walker, the former U.S. comptroller general, “the facts aren't liberal or conservative — the facts are the facts. Our financial condition is worse than advertised. We need to act soon because time is working against us.”

Ultimately, it means an unprecedented level of belt-tightening for government and citizens alike. Americans are going to have to begin saving for their own retirements out of their regular earnings rather than just counting on, say, a home-run appreciation of their houses.

“Generally, people don't change their behavior until they're forced to. With respect to the fiscal crisis looming out there in the future,” former chairman of the Federal Reserve Paul Volcker says in I.O.U.S.A., “We'll see whether a democracy can deal with an obvious problem that's going to be present in not too many years. The earlier we take action to deal with it the better.”

For now, McKeehan, senior vp of National Retirement Partners, says, “Our advice to clients is to assume that there is risk to these plans' solvency and to supplement retirement savings through DC plans or IRAs. While there is concern that deferring today's income for retirement may result in taking distributions in a higher tax environment, the employer matches attributed to these plans is a known and clearly mitigates that risk.”


Addison Wiggin, the editorial director of The Daily Reckoning, an investment newsletter, is the co-author of I.O.U.S.A. and Empire Of Debt.

WHO WILL RESCUE THE RESCUERS?

To put it bluntly, the U.S. government is going broke. At this rate, the Federal government won't be able to do what it promises. One study, conducted by the National Center for Policy Analysis (NCAP), suggests that without meaningful increases in government revenues and reform of the entitlement programs:

  • TEN LARGEST PLAN TERMINATION LOSSES IN THE HISTORY OF THE PENSION BENEFIT GUARANTY CORP.

    By 2010, the federal government will stop doing one in 10 things it's doing now.

  • By 2020, the federal government will stop doing one in four.

  • By 2030, the federal government will stop performing half of the services it provides.

  • By 2050, Social Security, Medicare and Medicaid will consume nearly the entire federal budget.

  • By 2082, Medicare spending alone will consume nearly the entire federal budget.

Nine out of 10 have occurred since 2001, primarily in the airline, metals and other manufacturing industries.

Firm # of Plans Year(s) of Termination Claims Participants Vested Claims (1975-2007) Vested Claims as % of Total
1. United Airlines 4 2005 7,503 122,541 21.5%
2. Bethlehem Steel 1 2003 3,654 91,312 10.5
3. US Airways 4 2003, 2005 2,684 57,000 7.7
4. LTV Steel 6 2002, 2003 2004 2,134 83,094 6.1 2004
5. Delta Airlines 1 2006 1,740 13,028 5.0
6. National Steel 7 2003 1,275 33,737 2.4
7. Pan American Air 3 1991, 1992 841 31,999 2.4
8. Trans World Airlines 2 2001 668 32,275 1.9
9. Weirton Steel 1 2004 640 9,410 1.8
10. Kaiser Aluminum 7 2004, 2007 602 18,402 1.7
Top Ten Total 36
$21,745 492,000 62.2%
All Other Total 3,747
13,939 1,087,787 37.8
TOTAL 3,783
34,939 1,508,587 100
Source: PBGC