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 Illinois’ pension crisis is the worst in U.S. history – which
raises the question, “Why?”
First, because public employees pay very little toward their own retirement and
assume none of the economic risk for investments. Second, because workers retire
relatively young so they are drawing from the systems longer. And third, because
they receive pension benefits often in excess of $2 million during the course of
their long, generous retirements.
Ultimately, this poorly designed system is bad for the retirees. They face a
serious risk that the pension systems will go insolvent.
The state has five retirement systems it manages directly and is responsible for
contributing to:
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The Teachers’ Retirement System, or TRS, for pre-K through
12th-grade school employees outside of Chicago
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The State Universities Retirement System, or SURS, for
higher education employees
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The State Employees’ Retirement System, or SERS, for
employees of state agencies and boards
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The Judges’ Retirement System, or JRS, for judges
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And the General Assembly Retirement System, or GARS, which
manages pensions for state lawmakers and statewide elected officials
Depending on the system, between 43% and 94% of retirees are
set to receive benefits of at least $1 million during retirement. Between 18%
and 83% will receive lifetime benefits in excess of $2 million. The largest
lifetime pensions can be worth more than $10 million.
More than 50% of state workers and teachers will retire before age 60. Taking
advantage of early retirement benefits, large portions of these employees will
retire prior to age 55.
These returns on retirement investments combined with early retirement is
unheard of in the private sector.
The average Social Security benefit for 2019 is $17,532 per year. The maximum
Social Security benefit is $34,332 per year. The earliest anyone can qualify for
Social Security is age 62 and the full retirement age for anyone born after 1960
is 67. According to CNBC, the average 401(k) balance for those close to
retirement, people aged 60 to 69, is just $195,500. However, with prudent
savings and an early start, personal retirement accounts can be a secure way to
fund retirement. Fidelity Investments reported in 2018 that the number of 401(k)
and IRA millionaires was at an all-time high – up 41% from just one year
earlier.
No matter how you look at it, private sector taxpayers can rarely hope for the
generous benefits they subsidize for public employees. The typical private
sector worker would need to have saved $1.6 million in a personal retirement
account by age 60 to receive the same $82,000 base pension as the average career
teacher, or those with at least 30 years of experience. And 3% compounding
post-retirement increases are not an option for private sector retirees.
Illinois law requires public employees to set aside very little on their own
during a typical working career. This is especially true for “career employees”
with at least 30 years of service credit but applies to shorter-term public
workers as well.
While benefit payments are lower for employees in TRS, SURS, SERS and JRS who do
not work at least 30 years, the benefits are still substantial. Illinois
taxpayers subsidize the majority of the cost and assume all the risk without the
ability to modify even future promises.
For career workers who serve 30 years or more, lifetime
employee pension contributions account for between 4% and 6% of expected
payouts, other than for members of the General Assembly Retirement System. These
contributions legally guarantee employees a pension that is typically worth more
than $2 million. State employees in SERS are the exception, but they are
generally eligible for Social Security benefits and still average a generous
$1.7 million. As of the most recent report from the state, 96.3% of state
workers are also eligible for Social Security, which explains the somewhat lower
benefit.
The state implemented a less generous benefit schedule for
employees hired after Dec. 31, 2010, but the first so-called “Tier 2” employee
will not be eligible for retirement until January 2021 because they must be at
least 67 years old with 10 years of service to qualify for a pension.
Illinois pension debt exists almost entirely because of benefits for Tier 1
workers and retirees, those who began working for an eligible government
employer prior to 2011. In fact, younger workers in Tier 2 may actually be
subsidizing Tier 1 benefits by paying in more than they’ll receive, at least for
teachers. As a result, teacher advocacy groups have predicted that if the state
does not fix Tier 2 benefits, a lawsuit against the state is likely which could
force higher benefits and increase the state’s pension debt even further.
Lawmakers did recently enhance benefits for Tier 2 downstate public safety
workers. But they did so without knowing the cost or determining that it was
actually necessary.
Still, the state’s $137 billion to $234 billion in public pension debt is really
about Tier 1 benefits.
All Tier 1 retirees in the five state systems receive a 3% compounding annual
increase regardless of actual inflation. While often mistakenly referred to as a
“cost of living adjustment,” these are more accurately described as guaranteed
post-retirement raises because they are not pegged to inflation.
It is important to note that Illinoisans should not blame retirees for the way
politicians designed the state’s pension systems. In reality, their retirement
security faces the same risk as the rest of the state: insolvency.
Weren’t Illinois pensions underfunded?
One common call among government worker unions and associated advocacy groups is
that Illinois pensions were not overpromised, but underfunded.
While it’s true Illinois politicians played reckless funding games, this is a
symptom of the fact that benefits were set at a level that was too expensive to
be affordable or sustainable. Because actually making the full payments would
have been budget-busting and caused unacceptably high tax levels, both
Republicans and Democrats at the state and local levels have sought creative
ways to avoid making the full actuarial pension payments over the years.
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Republican former Gov. Jim Edgar negotiated a payment ramp
with the General Assembly that violated actuarial best practices of funding.
First, the payments were stretched out over 50 years while actuaries
typically recommend 20-year payment schedules and no more than 30. In
practice, this means payments were low during Edgar’s term and spiked
dramatically for his successors. Second, the funding target was set at 90%
rather than 100%, meaning the state’s current funding plan does not fully
anticipate paying off the debt.
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Democratic former Gov. Rod Blagojevich issued
bonds to pay off part of the pension debt but then used those
proceeds as an excuse to reduce the state’s regular pension
contributions from the operating budget. At the time, this
“pension holiday” was supported by several of the state’s
politically active public sector unions, including the Service
Employees International Union, the Illinois Federation of
Teachers and the Illinois Education Association.
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Due to the lack of a funding requirement from
the state, local mayors have regularly shorted their
contributions to downstate police and fire pension funds in
cities across Illinois. Pension benefits for local governments
are established by state law. In other words, mayors were
struggling to manage their own budgets and provide services
without an unreasonable tax burden while being forced to pay for
unsustainable pension benefits they played little to no role in
creating. Now that the state is enforcing full required
payments, local mayors in several towns have been forced to lay
off police officers and firefighters or otherwise cut municipal
services to pay for pensions.
But rather than being a core cause of the pension
crisis, these funding games are a symptom of the fact that the full
payments are unaffordable.
State and local governments in Illinois already spend the most in
the nation on pensions as both a percentage of their total revenues
– about double the national average – and compared to the size of
the state’s economy. Illinois pension debt is equal to roughly
one-third of everything the state’s businesses and residents produce
in a year.
Illinois’ ever-growing pension spending is already crowding out core
government services. The state spends about one-third less today,
adjusted for inflation, than it did in the year 2000 on core
services including child protection, state police and college money
for poor students. During that time pension spending increased 501%.
Despite these facts, some opponents of pension reform have
maintained that “underfunding” of the pension systems is a chief
cause of the debt. In a very narrow financial sense, this might be
true. The existence of any form of debt is proof that not enough
money has been set aside.
But in terms of the conclusions drawn by pension reform opponents,
nothing could be further from the truth than the idea Illinois has a
pension crisis because taxpayers haven’t been paying enough. They
already pay the most and would have to double the amount they’re
paying to eliminate the debt.
To show just how absurd the “underfunding” argument really is,
imagine you took out a $1 million mortgage on a $40,000 annual
income.
Your monthly mortgage payment — not including property taxes — would
total $3,800 using today’s standard interest rate. Problem is, your
monthly take-home pay — after accounting for state and local taxes —
is about $2,650.
As much as you wanted that house, you never would have been able to
afford that monthly cost, given your ability to pay. Before long,
the bank will come knocking to repossess the property.
You may have “underfunded” your mortgage, but only because you
originally overpromised on what you would be able to pay. Similarly,
Illinois politicians promised pension benefits that taxpayers never
could and never would be able to afford. They designed a system with
no flexibility or risk sharing, placing all the burden on taxpayers
to make up for the shortfalls of their mismanagement.
Illinois pensions were underfunded because they were overpromised.
Rather than dealing with the painful tax hikes necessary to fully
fund exorbitant benefits, politicians racked up debt, placing the
burden of pension funding on the state’s young and unborn.
Regardless, it’s clear that tax hikes are not a potential solution
going forward.
Those who deny the extravagance of current Illinois pension benefits
also elude a key question: What next? To catch up the states’ five
pension systems, Illinois median income family would have to see a
tax hike of about $1,800, per year.
Is there any way out of Illinois’ pension crisis?
Tax hikes are not a responsible or realistic solution to the worst
pension crisis in the nation. Illinois’ tax burden is already one of
the nation’s most painful and the top reason residents cite for
wanting to leave the state.
Illinois could file for bankruptcy protection under hypothetical
legislation similar to the “PROMESA” law Congress passed to deal
with Puerto Rico’s financial distress, but that scenario is extreme
and unlikely. The state’s only viable option is meaningful pension
reform. That starts with a constitutional amendment to allow changes
to unearned, future benefits.
Rather than deleting the pension protection clause entirely,
Illinois should seek to modify it to match states such as Hawaii or
Michigan which protect only “accrued benefits.” Subsequent pension
reforms should include raising retirement ages for younger workers,
capping maximum pensionable salaries, and doing away with guaranteed
permanent benefit increases in favor of a true cost-of-living
adjustment pegged to inflation.
An actuarial analysis, performed by a certified professional actuary
and commissioned by the Illinois Policy Institute, shows that reform
to unearned future benefits could save roughly $2 billion per year
in pension contributions and fully eliminate the debt by 2045. From
now until 2045, total savings would be $50.92 billion. That’s all
possible without taking away a single dollar earned to date.
The concept of future benefit reforms has been successfully enacted
in Colorado as well as in Arizona, which had support from union
leaders who realized pensions were in peril.
Pension reform is a moral imperative. The alternative is a future in
which core services are cut, taxes are raised on a dwindling number
of taxpayers and pensioners risk losing what they’ve already been
promised as the funds go insolvent.
If Illinoisans work together, common-sense pension reform can work
for everyone.
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