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Many government pension systems are on the verge of collapse — here's how it could affect you

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Many state and local governments are starting to face a looming financial crisis that is the direct result of pension obligations. The problem is expected to get worse in the next 10 to 15 years. (Photo Illustration by Justin Sullivan/Getty Images)

What's going on?

Many governments — federal, state, and local — have made pension promises that are already straining budgets. The problem is expected to grow exponentially worse over the next 10 to 15 years.

Most experts agree that it is inevitable that a massive wave of state and local governments will soon be totally unable to meet pension obligations. It is not a question of "if," it's a question of "when." The federal government will likewise feel the strain of federal employee pensions, but since the federal government can print its own money and (apparently) borrow money indefinitely, the effects will not be as severe.

What caused this?

There are a number of factors that have contributed to the looming crisis, but they all boil down to governments' failure to apply proper financial forecasting to the cost of defined pension benefits.

The way pensions work, in theory, is that workers contribute a set amount in order to become eligible for payouts. The government then often hires a management company to invest the contributed funds so that when workers retire, they will theoretically be eligible to receive more in payout than they put in. However, government forecasters regularly vastly inflate the expected rate of return on pension investments, and underestimate expected risk.

In some cases, the problem is even worse: governments have regularly made pension promises that are unrealistic under any set of financial assumptions, no matter how faulty.

How will this affect me?

If governments do not address their pension liabilities with meaningful reform now, state and local governments will soon be faced with a difficult choice: drastically reduce pension payments (in violation of agreements with retired government employees) or pass massive tax hikes to fund the liability.

Failure to make pension payments for retired workers will likely result in political and civil unrest. In many cases, retired employees will be solely dependent on their pensions for income. Some foreign governments have recently found themselves unable to meet pension obligations and have experienced massive protests. Things could get ugly.

In order to make payments, state and local governments will be forced to pass massive tax increases. Expect to see a major hike in all your tax bills if your state and local government isn't seriously discussing pension reform already.

On the federal level, expect this problem to add to the ballooning federal debt.

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