State and Local Government Pension

A state and local government pension is a defined-benefit retirement plan sponsored by a state, county, city, school district, or other public employer for its workers. In United States usage a "state pension" of this kind is an employee retirement system, not a national old-age benefit as the same phrase means in some other countries. Like any defined-benefit plan, it promises a lifetime benefit calculated from a formula rather than an account balance, and the employer, not the employee, carries the risk that investments underperform. What sets public-sector plans apart is their legal category: they are governmental plans, which places them outside the federal law that governs private pensions and leaves their design, funding discipline, and guarantees to state law and each system's own rules.

The single most important fact about these plans is that there is no uniform rule to state. The United States has thousands of separate public retirement systems: the U.S. Census Bureau's Annual Survey of Public Pensions covers 304 state-administered funds and 4,632 locally-administered defined-benefit public pension systems. They range from large statewide teacher and public-employee funds to individual municipal police and fire plans, and each sets its own vesting schedule, employee contribution rate, benefit multiplier, retirement age, and cost-of-living policy. A statement like "public pensions vest after five years" is true of some systems and false of others. The useful knowledge is the mechanism the plans share, not a number.

That shared mechanism starts with legal status. Under 29 U.S.C. 1003(b)(1) the protective title of the Employee Retirement Income Security Act, the one carrying the reporting, fiduciary, and vesting rules, does not apply to a governmental plan; and 29 U.S.C. 1321(b)(2) separately excludes a plan established and maintained by a state or political subdivision for its employees from the federal pension insurance program, so the Pension Benefit Guaranty Corporation, which insures private defined-benefit pensions, does not insure government plans. So the federal minimum funding rules and the federal benefit insurance that backstop a private pension do not apply here. In their place, benefits are promised and regulated under state law, and the plans report their finances under standards set by the Governmental Accounting Standards Board. The U.S. Census Bureau's Annual Survey of Public Pensions is the standard source that frames the category as a whole.

Benefits are typically built on a final-average-pay formula: a multiplier (for example, a set percentage per year of service) times years of service times an average of the highest few years of salary. Because the sponsor bears the funding obligation, the health of a plan is read through its funded ratio, the ratio of plan assets to the actuarial value of the benefits already promised. A plan below 100 percent has an unfunded liability that the sponsor is expected to make up over time, and a persistently underfunded system can face pressure to raise contributions or adjust benefits for future hires.

A further wrinkle affects retirement planning directly: some state and local employment is not covered by Social Security. When Social Security began, it excluded government workers, and although many public employers later elected coverage, a meaningful number of teachers, police, and other public workers in certain states still earn no Social Security credit on that job. For those workers the government pension is designed to be the main retirement benefit rather than one supplement among several. Historically, such workers who also qualified for Social Security from other work faced reductions under the Windfall Elimination Provision and the Government Pension Offset. Those offsets have since been repealed by the Social Security Fairness Act, which is where the current treatment belongs.

A public pension generally works by combining employee and employer contributions into a trust that is invested, then paying a benefit at retirement based on a formula. The employee's own contribution rate, the years needed to vest, and the exact multiplier are all set by the individual system, so the same career can produce very different benefits in two different states.

A hypothetical example, with made-up figures, of how a plan's funding is read. Suppose a statewide system holds $8 billion in assets on an actuarial basis and has promised benefits with an actuarial accrued liability of $10 billion. Its funded ratio is $8 billion divided by $10 billion, which is 80 percent, leaving a $2 billion unfunded liability. That gap is not an immediate cut to any retiree's check; it is the amount the sponsoring government is expected to fund over time through higher contributions or investment returns, and it is the figure analysts watch when they judge whether a system's promises are on sound footing.

Pros

• The benefit is defined and lifetime: it is a formula, and the employer, not the retiree, bears investment risk.
• Many public plans include cost-of-living adjustments, though the size and existence of the adjustment vary by system.
• For employees in non-Social-Security-covered jobs, the pension is built to serve as the primary retirement income.

Cons

• These plans are not insured by the Pension Benefit Guaranty Corporation, so a severely underfunded system's promises rest on the sponsoring government's finances.
• Terms vary widely, and benefits for newly hired workers are sometimes less generous than for earlier hires after a system's reforms.
• A worker in non-covered employment who changes careers may find they have little Social Security of their own from that public service.