Most public pension contributions go toward paying off debt, not funding benefits

State and local governments have been making higher pension contributions to their employees’ pension funds, but not because public pension benefits have become more generous. Instead, growing debt from past underfunding of pension benefits has largely driven the increase in contribution rates. Today, the majority of contributions made to public pension systems go toward amortizing unfunded liabilities rather than funding the benefits promised to current employees.

One way to evaluate the burden of pension contributions is to measure their size in comparison to payroll. Between 2014 and 2024, average pension contributions by state and local governments rose from 23% to 29% of payroll—a 26% increase, Reason Foundation’s Annual Pension Solvency and Performance Report finds.

Differences among states

The median pension contribution rate as a share of payroll in 2014 was 22%; in 2024, it was 26%.

Among states, New Jersey saw the highest increase during these 10 years, 28.5 percentage points, with the aggregate contribution rate going from 13.5% to 42%. Alaska’s 28-point increase, from 41% to 69%, was the second largest, followed by Wisconsin (+25 percentage points), Kentucky (+18), Connecticut (+15), and California (+15).

In eight states, however, thanks to some combination of fiscal discipline, additional pension contributions, strong financial returns, and successful pension reforms, pension contributions as a share of payroll actually decreased between 2014 and 2024, including West Virginia (-7.7 percentage points), New York (-6.4), and Indiana (-3.1).

Some of the observed increases in contribution rates may actually reflect fiscal prudence, not recklessness. States that have made either one-time or ongoing additional contributions to their pensions—such as Connecticut, West Virginia, and Alaska—will have higher contribution rates in the years those additional payments are made. These payments accelerate the amortization schedule and cut decades of interest costs, generating long-term savings. In subsequent years, as their debts are paid off, their required contribution rates should decline.

Amortization rises while normal cost stays stable

One might assume that the long-term nationwide increase in pension contribution rates is a result of public employee pensions becoming more generous. That is not the case. Instead, larger contributions have been needed to compensate for past underfunding—that is, to make up for decades of underestimating the true cost of providing the pensions promised to state and local employees.

There are two components of contribution rates: normal costs and amortization costs.

Normal Cost: The portion of pension contributions used to cover the cost of benefits earned in a given year. This is a forward-looking estimate of the amount that needs to be contributed to pay the benefits accrued by employees during the fiscal year.

Amortization cost: The portion of pension contributions used to pay down unfunded pension liabilities, which arise because normal costs were either underestimated or not fully funded in the past. This is a backward-looking payment, structured over a set period (e.g., 20–30 years), to gradually pay down pension debt.

From 2014 to 2024, normal costs have remained virtually flat, even declining slightly, from 14% to 13%. Meanwhile, amortization costs have increased from 9% to 16%—an 80% increase.

There are two main drivers of the significant increase in amortization costs: first, a widespread, decades-long underestimation of the true cost of the pension benefits promised to public employees; and second, retroactive benefit increases.

The underestimation of costs has been primarily driven by chronic overestimation of investment returns. Since the 2000s, public pensions have assumed that they would earn higher investment returns than they really have. Plans have been increasingly forced to reckon with this reality, and amortization costs have risen to compensate.

Normal costs have been stable. This is due to public pension reforms across the country—such as the creation of new tiers, fine-tuning of cost-of-living adjustments (COLAs), and the introduction of defined contribution plans—which have kept actuarial costs stable.

Some increases in pension benefits, however, do not manifest as increases in normal costs, which only capture actuarial and pre-determined benefits. When benefits enhancements are forward-looking and pre-funded—as they are supposed to be—normal costs increase correspondingly. But in some cases, state legislatures and cities give retroactive pension enhancements—such as increased salary multipliers or COLAs—without pre-funding them. The costs of such retroactive benefit increases show up all at once, as a debt to be amortized, and only to a small degree, as an increase in normal costs. Because amortization costs have been rising while normal costs have remained stable, the composition of pension contributions has shifted. In 2014, 60% of pension contributions were directed to fund the pension benefits that current employees accrued that year. By 2024, only 45% of contributions funded current benefits. More than half of the contributions, 55%, go toward covering previous underfunding.

State and local governments have footed the increase

In almost all defined benefit plans, employee contribution rates are fixed. If the costs of pension benefits unexpectedly increase due to the expansion of COLAs, disappointing investment returns, or readjustments to discount rates, employers—that is, the sponsoring state or local government—must cover this difference on their own.

That explains the following chart, which shows that, from 2014 to 2023, employer contribution rates increased by 31%, while employee contribution rates rose by only 14%.

State and local governments have had to absorb nearly all of the increased pension costs, because, ultimately, it is public employers—and, by extension, taxpayers—who bear full risk for any unexpected costs in funding pension benefits. The result is that a growing share of current taxpayers’ money is being used to pay pension benefits for past employees—that is, to cover the costs of services they themselves did not use. 

The nation’s estimated $1.5 trillion in government pension debt will continue to generate significant strains on budgets and taxpayers. Lawmakers should continue to prioritize strategies that accelerate amortization schedules and ensure annual contributions are sufficient to pay down existing liabilities, not just maintain them.

Looking ahead, states should adopt cost-sharing and alternative retirement plan designs for new hires that align costs and risks more evenly between employers and employees, preventing the accumulation of new unfunded liabilities.

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Source: https://reason.org/commentary/most-pension-contributions-go-toward-paying-off-debt-not-funding-benefits/