Pension Liability

See: Pension.

A pension liability is not that different from a liability owed by any corporation, like a debt obligation to pay back a bond, or 18 miles of tiny periscopes bought by Proctologists-R-Us. Corporations and governments both provide pensions for their employees. Very roughly, an employee making, say, 75 grand a year might get 10 percent of their salary a year in pension contributions from their employer.

Pensions are divided into two flavors. There are defined contribution pensions, one flavor of a 401(k) plan. In a defined contribution plan, the employee contributes, say, 10 percent of their salary...in this case, 7,500 bucks...and the employer might match it. That is, the employee takes 7,500 bucks off their total salary that's calculated for taxes, so instead of being taxed on $75 grand, they're taxed on $67,500, and they tax defer the $7,500 they put into their 401k plan.

They’ll still pay taxes on it eventually...but presumably when they're old and retired and poor and thus likely to pay lower tax rates than they would in their heavy working, high tax era at the peak of their careers.

So the employee saves 7,500 bucks, and the employer matches that $7,500 with $7,500 of its own. From the employer's perspective, that employee doesn't just get a $75,000 salary; they cost the employer $75k plus another 7,500 bucks of 401(k) pension matching expenses, or $82,500. And the employer pays it grumbling and wondering when the next version of robot comes out so they can replace this worker.

What happens to those savings? Well, employers usually provide employees with a menu of investment choices. They can hold all cash; they can invest in high growth relatively risky funds; they can invest in balanced growth and income funds, etc. The employee gets to choose from a supermarket of investment fund choices, or even buy individual stocks.

The key takeaway: at the end of however many years or decades of working, the employee is able to then take out from their pension whatever value that pension has accrued to be worth.

In a defined contribution fund, there is essentially no pension liability. The employee bears the stock market risk just like everyone else. The big controversies you read about in the press revolve around the second flavor of pension, called a defined benefit fund.

In a defined benefit situation, a number of irresponsible financial dealings take place where taxpayer money is often just given away with no thought of fiduciary duty. A given government worker works for the state for 30 years, eventually making $100k a year at the end, having received pension contributions all along the way, just as in the defined contribution system that corporations use, and as outlined above. But in a government defined benefit program, the employee is guaranteed a minimum rate of return in many situations. That is, they are guaranteed, say, 10% a year investment returns, even if the stock market is flat for 7 years, which happens all the time.

So that’s one flavor of pension liability that could likely bankrupt California and Illinois at some point not too far away. But it gets worse. There are other irresponsible things the states have done, like guarantee retirement return minimums or invest pension money in deadstock beanie babies.

So yeah. Pension liabilities are totally simple, easy-to-understand, uncontroversial, and can't possibly have an adverse effect on the world around us.

Hard to keep a straight face there.