Many local governments, saddled with pension debt, have been grappling with a question: how to fund their retirement systems without gutting benefits or budgets.
The answer may be simpler than it appears, according to a new paper from researchers at the Brookings Institute, Bank of England, Federal Reserve and other entities.
Brookings summarized the findings:
Most research evaluates state and local pension plans on the assumption they should be fully funded—that is, their assets are sufficient to meet all anticipated obligations to current and future retirees. State and local pension plans, benefiting more than 11 million retirees, hold nearly $5 trillion in assets and, according to a recent estimate cited in the paper, would require an additional $4 trillion to meet all of their obligations.
However, in The sustainability of state and local government pensions: A public finance approach, the authors observe that, using the types of calculations that economists recommend, state and local pension plans have never been fully funded—meaning that they have always been implicitly in debt. Furthermore, they show that being able to pay benefits in perpetuity doesn’t require full funding. If plans contribute enough to stabilize their pension debt, that is enough to enable them to make benefit payments over the long run.
Moreover, after projecting the cash flows for a representative sample of 40 state and local pension plans, they conclude that there are generally modest returns, if any, to starting the stabilization process now versus a decade later. Also, because of already implemented reforms, such as future benefit reductions, pension funds’ cash-flow pressures should begin to recede in 20 years. At that point, under their baseline estimate, pension benefits as a percentage of gross domestic product declines sharply through mid-century and gradually after that.
“While achieving fiscal stability will require adjustments, our results suggest there is no imminent ‘crisis’ for most public pension plans,” the authors write.