Editors note: While Pew updates its methodology and data sources, the Debt and Unfunded Retirement Indicator is temporarily unavailable.
Prior to unfunded retiree health care benefits for public employees and outstanding debt, unfunded pension liabilities represent the largest of the three major long-term obligations weighing on the finances of the majority of states. Pew projections indicate that, following a surge in financial markets in fiscal year 2021, the difference between what states collectively have set aside and what they owe in public pension benefits narrowed, though it is still significant.
States owed a total of $1. In the last year before the pandemic, fiscal 2019, there were $25 trillion in unfunded pension benefits. Pew projected in September 2021 that state pension plans would have the highest level of funding since the Great Recession and that pension debt would have dropped below $1 trillion by the end of fiscal 2021, despite a swift but severe economic downturn brought on by COVID-19.
The increase in pension plan savings, the best returns in thirty years on stock market investments made by pension funds, and the significant rise in state employer and employee contributions to pension funds over the previous ten years were the main drivers of the improvement.
Nevertheless, unfunded pension obligations continue to put a heavier burden on most states’ future revenue than debt or unfunded retiree health care promises. The $1. In fiscal 2019, the final year for which Pew has state-by-state data compiled, the total amount of pension debt was $25 trillion, or six 8% of all states’ personal income, up from 3. 0% in fiscal 2007, just before the Great Recession. Liabilities are better understood in relation to each state’s economic resources when measured as a percentage of personal income. This makes comparisons between and within states over time more meaningful.
States’ outstanding debt as a percentage of personal income, however, has somewhat decreased. States reported $534 billion in outstanding debt in 2020, which is equal to 2 7% of personal income, down from 3. 2% in 2007. In 2016, the most recent year for which Pew has collected 50-state data, unfunded retiree health care liabilities were $649 billion, or 4 0% of personal income. That’s below 4. 6% in fiscal 2008, the earliest year for which data are available
Despite the fact that states have decades to pay back these amounts, such spending commitments may have an impact on the state budget now and in the future. If states have to spend too much annually to pay off these debts, there might be less money left over for other priorities like health care or education, or for unforeseen expenses. In the context of a state’s overall financial picture, these liabilities may also have an impact on borrowing prices and credit ratings.
A pension plan is a retirement plan that promises to pay a fixed amount of money to retirees for the rest of their lives. Pension plans are typically funded by contributions from both employers and employees. However, sometimes these contributions are not enough to cover the promised benefits, resulting in an underfunded pension plan.
Understanding Underfunded Pension Plans
An underfunded pension plan is a company-sponsored retirement plan that has more liabilities than assets. In other words, the money needed to cover current and future retirements is not readily available. This means there is no assurance that future retirees will receive the pensions they were promised or that current retirees will continue to get their previously established distribution amount.
An underfunded pension may be contrasted with a fully-funded or overfunded pension.
Key Takeaways
- Underfunded pension plans do not have enough money on hand to cover their current and future commitments.
- This is risky for a company as pension guarantees to former and current employees are often binding.
- Underfunding is often caused by investment losses or poor planning.
- The opposite of an underfunded pension plan is an overfunded pension plan; one that has a surplus of assets to meet its obligations.
Causes of Underfunded Pension Plans
There are several reasons why a pension plan might become underfunded. These include:
- Investment losses: If the investments made by the pension plan do not perform well, the plan may not have enough money to cover its liabilities.
- Poor planning: If the pension plan is not properly funded from the start, it may become underfunded over time.
- Changes in demographics: If the number of retirees increases faster than the number of active employees, the pension plan may become underfunded.
- Economic downturns: During economic downturns, pension plans may be more likely to become underfunded.
Consequences of Underfunded Pension Plans
An underfunded pension plan can have several negative consequences for both the company and its employees. These include:
- Increased financial risk for the company: The company may be required to make additional contributions to the pension plan to cover its liabilities. This can reduce the company’s profits and make it more difficult to invest in other areas.
- Reduced benefits for retirees: If the pension plan is not able to cover its liabilities, retirees may receive lower benefits than they were promised.
- Increased uncertainty for employees: Employees may be concerned about the security of their retirement benefits if the pension plan is underfunded.
How to Fix an Underfunded Pension Plan
There are several things that can be done to fix an underfunded pension plan. These include:
- Increase contributions: The company and/or employees can make additional contributions to the pension plan.
- Reduce benefits: The company can reduce the benefits that are promised to future retirees.
- Improve investment performance: The pension plan can try to improve the performance of its investments.
- Extend the amortization period: The company can extend the period over which it is required to pay off its pension liabilities.
An underfunded pension plan can be a serious problem for both the company and its employees. However, there are steps that can be taken to fix an underfunded pension plan. By taking these steps, companies can help to ensure that their employees receive the retirement benefits that they were promised.
Frequently Asked Questions
What is the difference between an underfunded and an overfunded pension plan?
An underfunded pension plan is a company-sponsored retirement plan that has more liabilities than assets. In other words, the money needed to cover current and future retirements is not readily available. This means there is no assurance that future retirees will receive the pensions they were promised or that current retirees will continue to get their previously established distribution amount.
An overfunded pension plan is a company-sponsored retirement plan that has more assets than liabilities. In other words, the money needed to cover current and future retirements is readily available. This means there is a high degree of assurance that future retirees will receive the pensions they were promised and that current retirees will continue to get their previously established distribution amount.
What are the causes of underfunded pension plans?
There are several reasons why a pension plan might become underfunded. These include:
- Investment losses: If the investments made by the pension plan do not perform well, the plan may not have enough money to cover its liabilities.
- Poor planning: If the pension plan is not properly funded from the start, it may become underfunded over time.
- Changes in demographics: If the number of retirees increases faster than the number of active employees, the pension plan may become underfunded.
- Economic downturns: During economic downturns, pension plans may be more likely to become underfunded.
What are the consequences of underfunded pension plans?
An underfunded pension plan can have several negative consequences for both the company and its employees. These include:
- Increased financial risk for the company: The company may be required to make additional contributions to the pension plan to cover its liabilities. This can reduce the company’s profits and make it more difficult to invest in other areas.
- Reduced benefits for retirees: If the pension plan is not able to cover its liabilities, retirees may receive lower benefits than they were promised.
- Increased uncertainty for employees: Employees may be concerned about the security of their retirement benefits if the pension plan is underfunded.
How can an underfunded pension plan be fixed?
There are several things that can be done to fix an underfunded pension plan. These include:
- Increase contributions: The company and/or employees can make additional contributions to the pension plan.
- Reduce benefits: The company can reduce the benefits that are promised to future retirees.
- Improve investment performance: The pension plan can try to improve the performance of its investments.
- Extend the amortization period: The company can extend the period over which it is required to pay off its pension liabilities.
Additional Resources
- Investopedia: Underfunded Pension Plan
- Pew Charitable Trusts: States’ Unfunded Pension Liabilities Persist as Major Long-Term Challenge
- U.S. Department of Labor: Pension Plans
- National Institute on Retirement Security: Underfunded Public Pensions
An underfunded pension plan can be a serious problem for both the company and its employees. However, there are steps that can be taken to fix an underfunded pension plan. By taking these steps, companies can help to ensure that their employees receive the retirement benefits that they were promised.
Differences between liabilities
The magnitude of a state’s budget, economy, and population determine how much of a fiscal challenge these liabilities presented. States experiencing faster economic growth, for instance, might find it easier to fulfill their responsibilities.
The type of liability also matters significantly. Both debt and unfunded retirement expenses, such as pensions and retiree health care, are similar in that they commit a portion of future earnings to fulfilling a commitment. But states take on these obligations for different reasons. They frequently take out loans to fund infrastructure projects, which can provide services for many years and promote economic expansion. Conversely, unfunded retirement liabilities indicate that states have not set aside as much as would be required to pay for the anticipated full costs of benefits received by their workers.
During the Great Recession, unfunded pension liabilities as a percentage of 50-state personal income rose sharply and continued to rise until it peaked at 8%. 4% in fiscal 2016. This is a result of the fact that many states delayed funding pension systems during the recession and then paid insufficient amounts to prevent the growth of unfunded liabilities. Lower-than-expected investment returns and, occasionally, increased but unfinanced benefits also contributed to growth. Due to modifications to accounting standards in fiscal 2014, a number of states increased the reported amount of debt associated with 50 states by making more conservative predictions about future investment returns.
Advances in contribution policies and increases in state personal income in the years preceding the pandemic reduced unfunded pension liabilities to six 8% of states’ combined economic resources as of fiscal 2019. Furthermore, Pew estimates that state pension systems concluded fiscal 2021 in the best shape since the Great Recession as a result of the unexpected narrowing of the gap between the amount held in pension funds and the cost of benefits promised to retirees after the COVID-19 pandemic.
But the magnitude of pension challenges has varied widely. In fiscal year 2019, the pension debt of nine states was higher than the percentage of personal income from 2010 to 2019. With $20 billion, New Jersey had the highest unfunded pension liability of any state. 2% of its total personal income. Also, since fiscal 2007, the state’s liability has increased at the quickest rate. Conversely, South Dakota and Wisconsin were two of the eight states that saw a decrease in unfunded liabilities since the Great Recession and had pension assets that exceeded liabilities in fiscal 2019.
An examination of unfunded pension liabilities for the 2019 fiscal year, state by state, reveals:
- After New Jersey (20. The greatest amount of unfunded pension obligations in Illinois was 2% of personal income (19 4%), Hawaii (18. 0%), Alaska (16. 3%), and New Mexico (15. 7%).
- The only two states where the value of pension plan savings exceeded the amount owed were South Dakota and Wisconsin. While South Dakota had a small surplus, its unfunded liability, which is equal to a share of personal income, rounds to 200 percent.
- Three states had unfunded liabilities equal to less than 1% of their total personal income: Tennessee (0% 2%), New York (0. 6%), and Washington (0. 8%).
- Between fiscal 2007 and fiscal 2019, the unfunded pension obligations of forty-two states increased in relation to personal income. Three states recorded double-digit increases: New Jersey (13. 7 percentage points), Oregon (12. 7 points), and Illinois (11. 6 points).
- Since 2007, eight states have been able to reduce their unfunded pension costs relative to personal income: Oklahoma (-4 8 percentage points), West Virginia (-3. 7 points), Rhode Island (-2. 1 points), Maine (-1. 5 points), Wisconsin (-1. 2 points), Indiana and South Dakota (-0. 6 points), and Tennessee (-0. 5 points).
Despite rising by more than $12 billion, the net tax-supported debt of the 50 states decreased for the tenth consecutive year in 2020 when expressed as a percentage of personal income (2 3%), the biggest yearly gain in US dollars over the previous ten years The decrease in the share occurred as a result of a historic rise in total personal income following the government’s extraordinary assistance to people and companies in the immediate aftermath of the pandemic.
According to Moody’s Investors Service, three states drove most of the 2020 spike in debt: Illinois and New Jersey, which borrowed money to mitigate budgetary challenges in the wake of the pandemic; and New York, which took advantage of low interest rates and borrowed to upgrade some of its infrastructure. Credit rating agencies predicted early on that some of this new debt would be repaid quickly. Illinois paid off the loan by the start of 2022.
Excluding those three states, the total amount of outstanding debt, which is made up of bonds and other commitments normally paid back with funds from a state’s operating budget, remained constant from 2019 after rounding
States borrowed more heavily during and after the Great Recession, in contrast. In order to meet their spending needs, such as for infrastructure, states were reluctant to issue bonds and instead relied more on revenue from business-like activities, such as operating government-run liquor stores or utilities that provide gas, electricity, or water. This resulted in a spike in total state debt relative to personal income between 2007 and 2010, though it gradually declined over the protracted recovery.
A state-by-state review of debt for 2020 shows:
- The highest debt levels were in Hawaii (equivalent to 10. 4% of personal income), Connecticut (8. 9%), and Massachusetts (8. 0%). These states, in contrast to the majority of others, all have some debt that is owed by local governments, especially school districts.
- Nebraska and Wyoming had the lowest percentages of debt relative to personal income (both less than 0%). 1%), North Dakota (0. 1%), and Iowa and Montana (both 0. 3%). Only a few states, like Nebraska, have tight restrictions on issuing debt, and Wyoming has taken a cautious stance on debt.
- As a percentage of state personal income, debt increased in just 16 states between 2007 and 2020. The largest increases were in Connecticut (2. 5 percentage points), Hawaii (1. 7 points), Delaware (1. 3 points), and Virginia (1. 1 points). Both Connecticut and Hawaii have some debt incurred by their local governments.
- Of the thirty states that have seen decreases since 2007, New Mexico has seen the biggest drops (-2 4 percentage points), South Carolina (-2. 1 points), North Carolina (-1. 5 points), Florida (-1. 2 points), and Missouri and Wisconsin (both -1. 1 points).
- After rounding, debt as a percentage of personal income remained relatively constant in Iowa, Nebraska, New Hampshire, and Utah.
Similar to public pension liabilities, states’ debt exceeds the cost of unfunded retiree health care benefits promised to public employees. However, states have allocated far less to pay for the long-term costs of retiree health care liabilities—also referred to as other post-employment benefits, or OPEB—than they have for public pensions.
According to Pew’s 50-state data collection, between fiscal 2008 and 2016, there was a 0 percent decline in the total unfunded public retiree health care liabilities relative to personal income. 6 percentage points. Arizona and Oklahoma had the lowest claims on future revenue (both less than 0). 01%). Alaska had the highest unfunded liabilities (19. 7%), though later figures show a huge turnaround. An analysis of the state’s most recent funding data by Pew shows that as of 2019, the state reported having more assets than it had promised to public employees. Retirement benefits are not provided for health care in South Dakota or Nebraska.
Unfunded retiree health care liabilities remained a substantial challenge for most states leading up to the pandemic. And when COVID-19 hit, unlike what happened with pension debt, unfunded retiree health care liabilities edged up in fiscal 2020, according to a recent survey from S&P Global.