Federal, State, and Local Public Pensions

Background

Public pensions are not governed by the Employee Retirement Income Security Act (ERISA). Although benefits are substantially paid for by investment income, they are also funded by general revenue, by state employers, and by the contributions of participants (a key defining characteristic that distinguishes public defined-benefit plans from those in the private sector).

The two federal civil-service retirement systems (Civil Service Retirement System and Federal Employee Retirement System) and military pension systems are operated largely on a pay-as-you-go basis, whereas most state and local systems are intended to be advance-funded, although they may constantly struggle to achieve that status.

Underfunding of state and local pensions has become a significant issue. The collapse of the stock market in 2008 and early 2009 had a significant negative effect on these funds. Despite the recovery in equity prices since 2009, many states are still facing a substantial difference between projected future revenues and anticipated liabilities. According to the National Conference of State Legislatures, more than 43 states have enacted pension reforms in recent years.

A substantial reduction in underfunding is a priority, but the measures to achieve this reduction could be contentious. One possible reform is to increase employee contributions or funding from the employer (i.e., the state and local governments), which will ultimately require some combination of increases in taxes and cuts in spending.

Another option is reducing pension amounts, which could affect retired, active, and future plan members. Reducing benefits for new hires is much easier than reducing it for the other two groups. The basic principle underlying efforts to increase the solvency of pensions should be to avoid changes that harm the most vulnerable people. At the same time, however, any reform plan will need to be judged as a whole.

For more information about retiree health plans, see Chapter 7, Health: Health Care Coverage—Retiree Health Coverage.

Federal, State, and Local Public Pensions: Policy

Defined-benefit plans

In this policy: FederalLocalState

Government workers should continue to have access to defined-benefit plans.

Changes to defined-benefit plans should not discriminate against older workers and should maintain important benefit protections.

Retirement plan reform

In this policy: FederalLocalState

Modifications to retirement plans or plan formulas should have as a key objective to hold harmless current beneficiaries and employees, as well as to ensure the retirement security needs of future retirees. Any modifications should be fiscally responsible, ensure the long-term viability of existing plans, and protect the retirement security of workers, especially those who are vested or who are close to retirement. AARP will evaluate reform packages in their totality for their overall potential effect on beneficiaries and the future of the program.

Vesting

In this policy: FederalLocalState

Public retirement systems should establish a maximum vesting period of five years.

If states implement a defined-contribution or hybrid plan, the maximum vesting period for employers’ matching contributions should be no more than one year.

Cost-of-living adjustments

In this policy: LocalState

Public retirement systems should provide prefunded, annual, automatic, and full cost-of-living adjustments based on an accurate inflation index.

Improving reporting and disclosure

In this policy: LocalState

States and localities should:

  • Encourage pension disclosures that are straightforward and understandable for participants, beneficiaries and taxpayers, and
  • examine the feasibility of improving the fiduciary reporting and disclosure standards of their plans as a first step in strengthening their soundness, and
  • regularly report to a central government review agency reliable and consistent information on the nation’s public-employee retirement system obligations.

States should monitor carefully the reporting, disclosure, and funding practices of local public retirement systems under their jurisdiction and, where appropriate, administer the plans on behalf of local governments.

Full funding

In this policy: LocalState

States and localities should move toward full funding of their retirement systems, strengthen the funding of their plans, consider the short- and long-term costs of benefit improvements, and enact such improvements only if accompanied by clearly spelled-out funding plans

Funding holidays

In this policy: State

States should make full contributions to retirement plans, as actuarially determined, and avoid taking funding holidays, which can contribute to underfunding when economic conditions deteriorate.

Consumer representation

In this policy: LocalState

State and local retirement systems should include active workers and retirees on their investment boards to enhance disclosure and expand participation in decisionmaking.

Prorated benefits

In this policy: FederalLocalState

Employee benefits applied to full-time federal, state, and local government workers should be available to part-time workers on a prorated basis.

Retirement benefit enhancement

In this policy: LocalState

Retirement funds holding assets exceeding obligations to active employees should consider improving benefits for retirees and their spouses and giving special consideration to the financial needs of those who have been retired longest and whose benefits are likely to have suffered significant erosion of purchasing power.

State and local retirement systems should avoid making long-term benefit enhancements with short-term budgetary surpluses, and should address plan design features that allow end-of-career enhancements that negatively affect the long-term health of the plan.

Integration with Social Security

In this policy: LocalState

Integration of state and local retirement benefits with Social Security, which penalizes lower-income people, should be limited and include no more than the 50 percent of benefits allowed under federal guidelines for private pensions.

Health and life insurance

In this policy: LocalState

Adequately funded state and local systems that have no or inadequate health and life insurance coverage for retirees should initiate or expand and appropriately fund such coverage.

Education

In this policy: FederalLocalState

Public employee retirement systems should educate their employees about what their retirement income is likely to be from their public retirement plans as well as from Social Security.

Hybrid and cash-balance plans

In this policy: LocalState

States should ensure that cash-balance and other hybrid plans do not discriminate against older workers and maintain important benefit protections of defined-benefit plans.

States and localities should require that in a plan conversion, employers provide each affected individual with a personalized benefits statement that compares the projected benefits under the old and new plans. Such information must be shown in a comparable form (e.g., life annuity compared with life annuity) and provided well in advance of the effective date of any plan change.

Protections from default

In this policy: LocalState

In state proceedings for insolvency or receivership by municipal entities and state agencies and instrumentalities, retirees should enjoy statutory priority for all or a part of their earned retirement benefits, in amounts sufficient to ensure that their basic needs can be met.