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The Visual Capitalist reports The Pension Time Bomb: $400 Trillion by 2050. The above image is a small section of a huge pension infographic.

  • According to an analysis by the World Economic Forum (WEF), there was a combined retirement savings gap in excess of $70 trillion in 2015, spread between eight major economies: Canada, Australia, Netherlands, Japan, India, China, the United Kingdom, and the United States.
  • The WEF says the deficit is growing by $28 billion every 24 hours – and if nothing is done to slow the growth rate, the deficit will reach $400 trillion by 2050, or about five times the size of the global economy today.
  • In the United States, it is expected that the Social Security trust fund will run out by 2034. At that point, there will only be enough revenue coming in to pay out approximately 77% of benefits.

Worse Than You Think

Lance Roberts at Real Investment Advice added to the report in his take The Pension Crisis Is Worse Than You Think.

What follows are excerpts of Roberts' excellent presentation, without blockquotes. His name will mark the end of his report.

Problem 1: Demographics

With pension funds already wrestling with largely underfunded liabilities, the shifting demographics are further complicating funding problems. One of the primary problems continues to be the decline in the ratio of workers per retiree as retirees are living longer (increasing the relative number of retirees), and lower birth rates (decreasing the relative number of workers.) However, this “support ratio” is not only declining in the U.S. but also in much of the developed world. This is due to two demographic factors: increased life expectancy coupled with a fixed retirement age, and a decrease in the fertility rate.​

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In 1950, there were 7.2 people aged 20–64 for every person of 65 or over in the OECD countries. By 1980, the support ratio dropped to 5.1 and by 2010 it was 4.1. It is projected to reach just 2.1 by 2050.

Problem 2: Markets Don’t Compound

The biggest problem, however, is the continually perpetrated “lie” that markets compound over time. Pension computations are performed by actuaries using assumptions regarding current and future demographics, life expectancy, investment returns, levels of contributions or taxation, and payouts to beneficiaries, among other variables. The biggest problem, following two major bear markets, and sub-par annualized returns since the turn of the century, is the expected investment return rate.

Using faulty assumptions is the linchpin to the inability to meet future obligations. By over-estimating returns, it has artificially inflated future pension values and reduced the required contribution amounts by individuals and governments paying into the pension system.

As shown in the long-term, total return, inflation-adjusted chart of the S&P 5oo below, the difference between actual and compounded(7% average annual rate)returns are two very different things. The market does NOT return an AVERAGE rate each year and one negative return compounds the future shortfall.

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This is the problem that pension funds have run into and refuse to understand.

Pensions STILL have annual investment return assumptions ranging between 7–8% even after years of underperformance.

However, the reason assumptions remain high is simple. If these rates were lowered 1–2 percentage points, the required pension contributions from salaries, or via taxation, would increase dramatically. For each point reduction in the assumed rate of return would require roughly a 10% increase in contributions.

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The chart below is the S&P 500 TOTAL return from 1995 to present. I have then projected for using variable rates of market returns with cycling bull and bear markets, out to 2060. I have then run projections of 8%, 7%, 6%, 5% and 4% average rates of return from 1995 out to 2060.(I have made some estimates for slightly lower forward returns due to demographic issues.)

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Given real-world return assumptions, pension funds SHOULD lower their return estimates to roughly 3-4% in order to potentially meet future obligations and maintain some solvency.

They won’t make such reforms because “plan participants” won’t let them. Why? Because:

  1. It would require a 40% increase in contributionsby plan participantswhich they simply can not afford.
  2. Given that many plan participants will retire LONG before 2060there simply isn’t enough time to solve the issues,and;
  3. The next bear market, as shown, will devastate the plans abilities to meet future obligationswithout massive reforms immediately.

We Are Out Of Time

Currently, 75.4 million Baby Boomers in America—about 26% of the U.S. population—have reached or will reach retirement age between 2011 and 2030. And many of them are public-sector employees. In a 2015 study of public-sector organizations, nearly half of the responding organizations stated that they could lose 20% or more of their employees to retirement within the next five years. Local governments are particularly vulnerable: a full 37% of local-government employees were at least 50 years of age in 2015.

It is no surprise that public pension funds are completely overwhelmed, but they still have not come to the realization that markets do not compound at an annual return of 8% annually. This has led to a continued degradation of funding levels as liabilities continue to pile up.

The next crisis won’t be secluded to just sub-prime auto loans, student loans, and commercial real estate. It will be fueled by the“run on pensions”when“fear”prevails benefits will be lost entirely.

It’s an unsolvable problem. It will happen. And it will devastate many Americans. It is just a function of time.

Lance Roberts

2050 Gap Will Never Happen

We will never hit a pension gap of $400 trillion. Instead, one of the following will happen.

Pick Your Poison

  1. Plans will have long ago defaulted or gone bankrupt with benefits slashed. Michigan paved the way for this option.
  2. Millennials, who will undoubtedly be fed up with boomer benefits will vote for massive changes. For some states, this will require constitutional changes.
  3. At the national level, we may see revised bankruptcy laws superseding state provisions.

Some may suggest a pension bailout by the Fed. I doubt that because the numbers involved would destroy the dollar. The Fed exists to bail out banks, not pensioners.

Congress could bail out the pensions, but once millennials and younger generations are firmly in control, they will not vote to screw themselves even more.

By one means or another, baby boomers counting on public pensions will not get what they mistakenly believe they have coming.

Mike "Mish" Shedlock.