Dive Brief:
- Public pension systems are severely underfunded, with state governments holding $1.29 trillion in unfunded liabilities and local governments $187 billion, according to the second annual Reason Foundation's 2025 Pension Solvency and Performance Report. State pension systems account for more unfunded liabilities because most local governments participate in statewide systems instead of managing their own plans, said Mariana Trujillo, managing director, government finance, for the Reason Foundation and co-author of the report.
- Unfunded liabilities in public pensions have dropped 9% since the previous report, from $1.62 trillion to $1.48 trillion, a 9% decrease. This was largely driven by fiscal year 2024's higher-than-expected investment returns, according to the report.
- Public employers may need to look at changing benefit plans to help resolve the problem, Trujillo said.
Dive Insight:
Underfunded pensions constrain budgets and make governments vulnerable to “fiscal shock,” Trujillo said. If the market drops or crashes, governments may have to increase their contributions by as much as 40%, which means finding new revenue streams or incurring new debt, she said.
In underfunded plans, today’s pension contributions must be used to pay for past underfunding instead of current benefits, Trujillo said. About 60% of pension funding comes from investment earnings, but governments can’t invest when they’re paying for past benefits, she said.
For about 24 years, local and state governments have calculated investment earnings at 8%, but the return has actually been 6.6%, Trujillo said.
“This overestimation of returns has been slowly recognized and not even fully recognized yet,” Trujillo said. “That’s partly because if you just recognize it all at once, you're going to have a really big hit on your balance sheet, and you're going to have this big debt that used to be so much smaller. So, it makes some sense that local officials will try to delay that recognition.”
Governments need to reform how benefits are calculated and implement additional cost-sharing with employees, Trujillo said. Increasing employees’ contributions by even a few percentage points could prevent billions of dollars in underfunding, she said, but aligning government benefits with private sector plans might have the biggest impact.
“In many cities, what that looks like is converting from a defined benefit to a defined contribution plan, which is similar to a 401K,” she said. “Pensions have vesting requirements, and in many places, public employees leave their job before they are vested in pension benefits. With a 401K, if you leave you take that with you. Converting from a defined benefit to a defined contribution can not only lower costs for cities and state governments, but [lead to] better retirement benefits for most employees.”
An interactive state rankings map with details of each state’s pension plan can be found here.
