The United States Government Accountability Office ( GAO) considers a public pension fiscally healthy if it maintains an 80% or higher funding ratio. Today, the largest public pensions in the country average funding levels well above this benchmark, a positive indicator of their fiscal health and stability. While the GAO sets an 80% ratio as a standard for fiscal health, the American Academy of Actuaries challenges this benchmark, even calling it a “myth.”, They argue that a pension’s funding can fluctuate based on multiple factors, such as changes in the assumed rate of investment return, and the status of state operating budgets.
How Rate of Return Assumptions and Active Membership Affect Pension Funds
Changing the assumed rate of investment return higher or lower can easily change the projected funding ratio, but it’s statistical semantics. No precise level of funding should be deemed a definitive defining line between a sound and an unhealthy pension plan.
This is also supported by the fact that no employee base has the same retirement date. Retirees don’t end their careers on the same day; and every workplace has employees of different ages and tenures. Plans are designed by actuaries with real life in mind. It should also be noted that there has never been a situation in which a public pension plan could not pay its participants. Public pension benefits are sacrosanct.
How State Budgets Come Into Play
In addition to participant contributions and returns on investments, another effective method of increasing pension funding is using surplus funds from state budgets. Connecticut Treasurer Erick Russell allocated $608.2 million into the state pension fund for retired teachers and state workers in 2024. This has brought the funding ratio up to 58%. While that is short of the 80% standard the U.S. GAO has set, the state has had a continual upward trajectory, allocating surplus funds in addition to the annual 11% investment return that Connecticut has earned, strengthening the pension system annually.
In Michigan, 2024 started with a state surplus of over $9 billion. A significant amount of the proposed budget was allocated to various reserve funds, including a $900 million “Rainy Day Fund” for schools to help balance financial stability. Considering the nationwide shortage of teachers and retention problems, this could be extremely helpful in increasing pension benefits and recruiting more workers.
Kentucky has just celebrated the fourth year of a surplus of over $1 billion. Due to favorable investment returns, that income has doubled from $150 million to $300 million in just two years. House Appropriations and Revenue Chair Jason Petrie, R-Elkton was quoted as saying, “This unfailing commitment to acting as stewards of taxpayer dollars provided the opportunity to invest more than $2.7 billion over the next two years to improve road, rail, river, air, and water infrastructure. As well as make targeted investments in school facilities, public pensions, tourism, and community development.”
In contrast, Colorado has a $900 million deficit due to a series of tax cuts. A decrease in income tax and larger spending in the school budget due to lowered property taxes, along with mitigating factors such as wage growth and consumer stagnation, have helped create this shortfall. With rising costs in Medicaid and school budgets, either reducing spending or dipping into reserve funds will be necessary to pass a balanced budget. This can lead to disastrous results, mainly if public workers’ pensions are targeted, as is often the case.
Colorado’s neighbor Arizona had a contentious fight over their budget, going in with a $1.3 billion deficit. Neither party was pleased with the results and the various cuts to pass it. While there have been moderate increases in spending for public school budgets, advocates say it is not enough to keep up with inflation and that stopgap measures such as a waiver on the “Aggregate Expenditure Limit” will continue to be a problem without a permanent solution. With significant cuts to construction and water projects, it’s not unreasonable to see a future in which pension funding might be affected by next year’s budget.
A state budget surplus or a deficit can lead to several outcomes for state retirement plans. Misinformation often characterizes pension plans as unstable or as a significant financial burden on taxpayers. Still, as Connecticut shows, these plans always become healthier with smart investing and proper financing. In addition to all of the advantages that a defined benefit pension plan yields in recruitment and retention, it also provides a safe and secure retirement for workers, and every budget should have room for that.
To stay on top of pension news and more, sign up to get NPPC Daily News Clips delivered directly to your inbox, or follow us on Facebook and Instagram.