Last month South Walton Fire District’s (SWFD) pension board of trustees received their annual actuarial valuation. While some may see a cause for celebration, hold the champagne. For the first time in six years, the pension fund is out of intensive care but barely.
The industry uses a pension’s “funded ratio” as a measure of well-being. An 80 percent funded ratio generally indicates a healthy pension; don’t put on your party dress, SWFD squeaks in at 80.22 percent.
Unlike many investment advisors, I support defined benefit pensions and our country’s drift toward defined contribution plans, a.k.a. defined chaos, portends a bad moon rising. Defined benefit plans simply require adequate funding or benefits will be unsustainable. You just have to eat your peas.
The SWFD’s board of commissioners will meet April 1 for an employee benefit/human resources review. No doubt someone will point out the pension fund earned roughly 18 percent from Oct. 1, 2011 through Oct 1, 2012 but, April Fools, the S&P 500 was up more than 30 percent over the same time.
Last year, fire district plan participants increased their deferral by 1 percent. With robust market returns and increased employee funding, the pension barely clears the 80 percent threshold. I’m not trying to bust the pension’s chops but when the market goes up people, smart people anyway, don’t reduce their 401(k) or IRA contributions.
Look on the report’s page 14 for a telltale sign.
The alleged good news relies on an 8 percent expected return, a dangerous fantasy. The retirement planning software we use, Moneyguide Pro, reduced projected returns last July per investment and retirement guru Harold Evensky’s analysis. The retirement planning community has long recognized Evensky, a noted author and Certified Financial Planner, for his acumen and insight. A Moneyguide Pro portfolio similar to SWFD’s pension allocation (60 percent) uses a 6.97 percent return. California projects 7.5 percent for their state’s pension plan (CalPERS). John Mauldin argues (February 12, 2013, Thoughts from the Frontline) a 5 percent discount rate more accurately reflects future returns for pensions.
Averaging the last three years, SWFD chalked up a 6.87 percent return, 14 percent lower than our expected return.
As logical as it seems to use a reasonable expected future return, no constituency wants change. An inflated return allows firefighters to continue the charade their plan is solvent while a realistic projected return means higher taxes, a policy staunchly opposed by the Walton County Taxpayers Association.
It’s ironic, dontcha think, to see the monetary stalwarts of the Walton County Taxpayers Association less fiscally conservative than liberal Californians. The firefighter union controls the pension board; if they continue their present policies, only bad choices will be available in the future.
Currently we over-project returns and potentially underestimate costs. While not an issue since the plan has a solitary beneficiary, as more retire cue Deep Purple’s Smoke on the Water “Some stupid with a flare gun burned the place to the ground.”
I have no antipathy toward defined benefit plans but they necessitate prudent funding, realistic assumptions and sound investment practices. In the wake of an economy on the mend and new highs on the Dow, the pension plan remains underfunded.
Buz Livingston, CFP offers hourly financial planning and fee-only investment management to clients along Florida’s Emerald Coast. Contact him at 267-1068, Buz@LivingstonFinancial.netor www.LivingstonFinancial.net.