Social Security is designed to serve as the base of retirement support, to be supplemented by employer-sponsored plans. However, approximately one-quarter of state and local government employees – currently, around 5 million workers annually – are not covered by Social Security on their current job. Federal law allows these noncovered workers to remain outside of Social Security if their state or local plan provides comparable benefits. Since many public pensions have grown less generous in recent years, determining whether state and local plans currently provide comparable benefits is important.
The paper found that:
- All retirement plans for noncovered workers follow the letter of the law, but a significant number may still leave noncovered workers falling short of Social Security-equivalent resources in retirement.
- Medium-tenure workers who spend the early part of their career in noncovered government employment are at most risk.
- These workers represent only a fraction of the noncovered workforce so that, ultimately, about 16 percent of noncovered workers – representing between 750 thousand to 1 million employees annually – could be at risk.
The policy implications are:
- While only a fraction of noncovered workers are at risk of falling short, the problem is still serious. Social Security is intended to provide a minimum level of retirement income for all Americans. Thus, learning that between 750 thousand to 1 million noncovered workers annually could ultimately be at risk of not receiving that minimum is concerning.
Federal law allows certain state and local government employees to be excluded from Social Security if they are covered by an employer pension of sufficient generosity. As a result, approximately one-quarter of state and local workers are not covered by Social Security on their current job. Before COVID-19, these “FICA replacement plans” all satisfied the letter of the law in terms of providing benefits of sufficient generosity. This study has three aims. The first is to document the immediate impact of COVID-19 on the financial status of FICA replacement plans. The second is to investigate whether COVID-19 has led to cuts in benefit promises among plans, as well as the likelihood of future cuts. The third is to investigate the likelihood that FICA replacement plans will exhaust their trust fund assets and default on benefit promises.
The paper found that:
- The immediate impact of COVID-19 on noncovered public pension plans has been minimal. In fact, strong investment returns and resilient tax revenues have resulted in better funded ratios than prior to the pandemic and a positive near-term outlook.
- Given the minimal impact of COVID-19 on public plans, benefit cuts due to the pandemic have been virtually nonexistent. And recent pre-COVID trends suggest that benefit cut activity will continue to be infrequent.
- A projection of future assets levels for noncovered plans over the next decade suggests only one of 57 plans analyzed faces any real risk of exhausting its assets.
The policy implications are:
- While COVID has had little impact on noncovered plans, these plans – like other public plans – still face the same underlying financial challenges that they did before COVID.
- At the same time, though, virtually all of the noncovered plans analyzed are expected to be able to continue paying benefits over the projection period.
As state and local policymakers enact benefit cuts to reduce the cost of their pension systems, the life-cycle model suggests that workers will adjust by saving more on their own. But, whether workers actually respond to pension characteristics remains an open question. After all, income received far in the future may not be salient to young workers deciding how much of their earnings to consume in the present. To answer the question, this paper links the Survey of Income and Program Participation to the Public Plans Database and explores whether state and local workers consider the amount of their pension savings, the funded status of their plan, or their Social Security coverage when deciding whether to participate in a supplemental defined contribution (DC) plan.
The paper found that:
- Employees whose pensions provide less income are more likely to participate in a supplemental DC plan, but the effect is small.
- Members of poorly funded pension plans are not more likely to participate in supplemental plans than members of well-funded plans.
- Employees without Social Security coverage are not compensating with greater participation in supplemental plans.
The policy implications of the findings are:
- If state and local employers are forced to further curtail their pensions, employees are unlikely to replace that income with outside savings.
- In the event that poorly funded pension plans end up reducing retirement income for current employees, those employees are unlikely to have been saving more in anticipation.
- In short, states and localities – especially those whose workers are not covered by Social Security – should not count on outside savings to replace pension income.
Federal law allows certain state and local government employees to be excluded from Social Security coverage if they are covered by an employer pension of sufficient generosity. Public sector retirement systems have grown less generous in recent years, and a couple of plans could exhaust their assets in the next decade, putting benefits at risk. If pension sponsors are inattentive to federal generosity requirements when cutting benefits, current and future initiatives to curb costs may conflict with their obligations to the U.S. Social Security Administration (SSA). This project combines data from a variety of sources to assess whether state and local governments are currently satisfying the federal standards and whether the standards continue to provide benefits of equal generosity to Social Security.
The paper found that:
- Although public plans satisfy the regulations, uncovered state and local government employees do not always receive Social Security-equivalent resources in retirement because the law regulates benefits only at age 67 (rather than lifetime benefits) and allows for long vesting periods.
- State and local pensions often set very long vesting periods and are increasingly unlikely to grant full cost-of-living adjustments (COLA) after retirement. Yet, they also allow members to collect full benefits at much younger ages than Social Security. Incorporating vesting, the COLA, and the normal retirement age into a generosity test based on lifetime pension wealth shows that some plans fall short, but this finding is very sensitive to the employment patterns of the uncovered employees.
- A couple of plans that exclude their members from Social Security could soon exhaust the assets in their trust funds and revert to pay-as-you-go systems, endangering future benefits and putting them in violation of federal generosity standards.
The policy implications of the findings are:
- Federal generosity standards for state and local pensions could be updated to ensure Social Security-equivalent protections.
- Over time, mandatory enrollment of state and local government employees in Social Security would obviate the need for federal monitoring of their pensions.
It is impossible to discuss municipal finance without considering the cost of pensions and other post-retirement employee benefits (OPEB), largest of which is retiree health insurance. These costs have received enormous press coverage, usually incorporating sweeping generalities about the burden of employee post-retirement benefits for the nation as a whole. Much is made of the bankruptcies in Vallejo, California (2008), Prichard, Alabama (2010), Central Falls, Rhode Island (2011), Stockton, California (2015), and Detroit, Michigan (2015). At the state level, the pension situation in Illinois, New Jersey, and Connecticut is often described as typical. No one mentions Delaware, Florida, Georgia, Tennessee, and North Carolina – states that have done a good job of providing reasonable benefits, paying their required contributions, and accumulating assets. The point is that the picture at the state and local level is extremely heterogeneous, so it is crucial to look at the numbers state by state and locality by locality.
This paper provides a comprehensive accounting of pension and OPEB liabilities for state and local governments and the fiscal burden that they pose. The analysis includes plans serving more than 800 entities: 50 states, 178 counties, 173 major cities, and 415 school districts related to the sample of cities and counties. The analysis apportions the liabilities of state-administered cost-sharing plans to participating local governments for a more accurate picture of which governmental entity is actually responsible for funding pension and OPEB liabilities. The cost analysis calculates, separately, pension and OPEB costs as a percentage of own-source revenue for states, cities, and counties. It then combines pension and OPEB costs to obtain the overall burden of these programs. Finally, it adds debt service costs to provide a comprehensive picture of government revenue commitments to long-term liabilities.
Although states have a history of making adjustments to their workforce retirement programs, changes to public pension plan design and financing have never been more numerous or significant than in the years following the Great Recession. The global stock market crash sharply reduced state and local pension fund asset values, from $3.2 trillion at the end of 2007 to $2.1 trillion in March 2009, and due to this loss, pension costs increased. These higher costs hit state and local governments right as the economic recession began to severely lower their revenues. These events played a major role in prompting changes to public pension plans and financing that were unprecedented in number, scope and magnitude.
After its creation in the 1990s, the annual required contribution (ARC) quickly became recognized as the unofficial measuring stick of the effort states and local governments are making to fund their pension plans. A government that has paid the ARC in full has made an appropriation to the pension trust to cover the benefits accrued that year and to pay down a portion of any liabilities that were not pre-funded in previous years. Assuming projections of actuarial experience hold true, an allocation short of the full ARC means the unfunded liability will grow and require greater contributions in future years.
Many state and local governments have responded to challenges facing their pension plans by cutting benefits. Will these cuts make it harder for state and local governments to recruit and retain high-quality workers? To date, the answer has been difficult to obtain; most micro-level datasets contain information on the existence of pensions but not on pension generosity. To get around this constraint, this study uses a unique source, the Public Plans Database, to obtain data on the pension generosity of state and local workers’ pensions. These data are merged with the Current Population Survey to investigate how pension generosity affects the gap between the private sector wage of workers that states and localities recruit from the private sector relative to the workers that they lose to it. The findings suggest relatively generous pensions help reduce this “quality gap,” making it easier for state and local employers to recruit high-earning workers from the private sector and retain those workers. The effect is similar regardless of whether employer or employee contributions finance the benefits. The study suggests states should be cautious as they cut their pension benefits and that a strategy to maintain benefits by shifting some costs onto employees may help maintain states’ ability to recruit and retain high-quality workers.
The policy option of extending mandatory Social Security coverage to newly hired uncovered state and local workers is often included in packages to eliminate the program’s financing shortfall. The arguments for mandatory coverage go beyond financial considerations, though, as extending coverage would bring benefit protections that state and local workers currently lack and would improve equity by more broadly sharing the burden of Social Security’s legacy costs. The main argument against mandatory coverage is that it would raise costs to public employers and workers. The actual cost increase depends on the extent to which employers reduce their existing pensions when adopting Social Security. This paper estimates the costs under four different integration strategies: 1) no adjustment to existing pensions; 2) match the level of the first-year benefit; 3) match the lifetime benefit; and 4) match the benefit to levels in neighboring states with Social Security coverage. This analysis is conducted for 22 state-administered plans in 13 states that were identified as lacking coverage. The results show that the cost of adding Social Security varies significantly, with the smallest increase for the “match lifetime benefit” option and the largest increase for the “no adjustment” option. Presenting the additional costs as a percent of payroll may exaggerate their burden on the employer as the increases will likely be split between employer and employee. Perhaps a better way to gauge the size of the cost increase is as a share of a state’s budget; this measure shows only a very modest impact.