Basics of Government Pensions

Understanding Government Pensions

Government pensions, typically provided through a Defined Benefit (DB) plan, guarantee a fixed payout upon retirement, regardless of contributions. These payments are secured by taxpayers. In contrast, Defined Contribution (DC) plans, like 401(k)s, depend on contributions from both employees and employers, with retirement payouts based on investment performance, and no guarantees.

Most government entities provide pensions for full-time employees, with the largest system being the California Public Employee Retirement System (CalPERS). CalPERS serves over 2 million members in its retirement system and 1.5 million in its health program, holding $464.6 billion in assets against $645 billion in liabilities, leaving it only 72% funded as of July 2023.

Some agencies and local governments either contract with CalPERS or operate their own systems. For instance, 20 independent county retirement systems in California, created under the County Employees Retirement Law of 1937 (CERL or 37 Act Counties), manage their own defined benefit plans.

Other Post-Employment Benefits (OPEB), such as retiree healthcare, are typically funded separately from pensions. Actuaries set annual contribution levels (ARCs) based on multiple factors, including workforce size, salary, retirement age, and mortality rates. These contributions consist of normal costs and payments to cover shortfalls from lower-than-expected investment returns.

Governance and Financial Challenges

Pension funds are governed by boards of directors responsible for overseeing investment strategies. These boards work with professional staff to ensure the financial health of the pension system, adhering to standards set by the Governmental Accounting Standards Board (GASB), which promotes transparency.

Despite efforts to manage these systems, experts warn of growing financial risks. Edward Ring, co-founder of the California Policy Center, notes that pension obligations often go unnoticed by the public until elected officials are forced to cut services due to the cost of pensions. Warren Buffet similarly emphasized the growing financial burden of pensions in his 2013 Berkshire Hathaway report, comparing them to a “gigantic financial tapeworm” threatening local and state budgets.

Several cities, including Vallejo, Stockton, and Detroit, have declared bankruptcy in part due to unsustainable pension costs. In other places like Providence, RI, and Pritchard, AL, pensions have been cut to stabilize budgets. Pension reform efforts have been implemented in cities like San Diego, San Jose, and states like Rhode Island, Utah, and Alaska.

Why Is This Happening?

  1. Deferred Responsibility: Elected officials often make pension promises that outlast their terms in office, leaving future leaders to address the financial consequences.
  2. Political Leverage: Pensions are used as bargaining chips in negotiations, often without sufficient concern for long-term sustainability.
  3. Underfunding: Actuarial assumptions, such as retirement age and discount rates, are often flawed. Additionally, many municipalities fail to make full ARC payments each year.
  4. Systemic Risk: DB plans are supposed to be pre-funded, but shifting workers to DC plans highlights the unsustainable nature of current systems, with active employees effectively subsidizing retirees.

This has led to an intergenerational conflict. Younger workers, especially in public safety roles, question whether the benefits will still exist when they retire. Millennials, meanwhile, are less willing to pay higher taxes for services and benefits they may never receive.

As Thomas Jefferson warned in 1813: “We shall all consider ourselves unauthorized to saddle posterity with our debts and morally bound to pay them ourselves.”

The Path Forward

Public workers and taxpayers deserve a retirement system that is fair, fiscally sound, and transparent. Pension reform should prioritize:

  • Affordable, sustainable retirement plans.
  • A clear, actionable plan to quickly eliminate pension debt.
  • Practices that ensure governments properly fund their promises.

Six Steps to Pension Reform

  1. Research the pension issue.
  2. Explore reform options.
  3. Build a coalition for reform.
  4. Make the case for change.
  5. Engage elected officials and unions.
  6. Take the case public.

For more information, visit the California Policy Center’s website under “Pensions” or refer to the Reason Foundation Pension Reform Handbook by Lance Christensen and Adrian Moore.