One in a series explaining key terms and concepts of Pennsylvania government. Today’s topic: pensions
Seeking a better understanding of Pennsylvania’s issues and proposed solutions? Sometimes, complicated jargon and concepts can get in the way. That’s why we started Explainers, a series that tries to lay out key facts, clarify concepts and demystify jargon. Today’s topic: Pensions.
What is a pension?
A pension is a set amount of money paid regularly to a retired worker. The money comes from a fund that has been financed by an employee and/or their employer over several years. Pensions are available in both the public and private sectors.
There are two main types of pensions: “defined benefit” plans and “defined contribution” plans.
A “defined benefit” plan guarantees monthly checks to a retired worker, usually for life. This type of plan is also called a “traditional” pension. An employee’s pension benefits are determined by a formula, which typically takes into account a person’s salary, age and number of years worked.
In a “defined contribution” plan, such as a 401(k), an employee and/or their employer put aside a specific amount of money into a retirement fund each year. What makes this different than a traditional pension? The employer does not guarantee that the employee will ultimately receive a set amount of benefits under this option. That makes it riskier for workers.
There are also “hybrid” plans, in which an employee has both a traditional pension and a defined contribution plan.
Both public and private employers, faced with mounting retirement costs, have pushed in recent years for employees to adopt defined contribution plans instead of traditional pensions. Workers, especially in the government, have pushed back against these efforts.
Are Pennsylvania’s cities facing a pension crisis?
A whopping 573 municipalities in Pennsylvania have pension plans that have been deemed “distressed,” according to the state Auditor General.
That means those cities and towns have saved less than 90 percent of the money needed to pay for the pension benefits they’ve already promised to their workers.
Together, as of 2011, Pennsylvania’s municipalities were short nearly $7 billion they should have in their pension funds so they could pay employees what they will eventually owe them in pension payouts. That was the last year data was readily available.
While Pennsylvania cities both large and small have underfunded pension systems, Keystone Crossroads looked specifically at the state’s 20 biggest cities and boroughs. We found that 18 of those pension funds were deemed “distressed” in 2011.
Pennsylvania’s municipalities are not at all unusual: A study by the Pew Charitable Trusts found that 61 large cities across the United States had a combined pension shortfall of $99 billion in 2009. These local governments had the money to pay only 74 percent of the pension benefits owed to workers.
It’s worth noting that some liberal advocacy groups argue that Pew and others have overblown America’s pension woes.
The Washington, D.C.-based Institute for America’s Future wrote in a 2013 report, “Conservative activists are manufacturing the perception of a public pension crisis … according to Pew, public pensions face a 30-year shortfall of $1.38 trillion, or $46 billion on an annual basis. This is dwarfed by the $80 billion a year states and cities spend on corporate subsidies.”
Last year, Pew responded to critics who say the organization has not addressed such tax breaks: “It is not surprising that some stakeholders will want to solve the pension shortfall only with tax increases. Others will want to solve it only with spending cuts. Each state and city will address the issue differently and we know there is no one-size-fits-all solution.”
What are the consequences of underfunding a city’s pension system?
Having an underfunded pension system can make it more expensive for a city to borrow money to build schools, improve roads and make other investments. That’s because agencies like Moody’s and Standard & Poor’s can downgrade a city’s credit rating if its pension system is not adequately funded.
Failing to save enough money to pay for pension benefits also puts retired workers at risk. When pension systems have become too costly, some U.S. cities have cut benefits. In a few cases, retirees have even stopped receiving checks because their cities’ pension systems have run dry.
Of course, taxpayers can also be impacted. The less a city saves to pay for upcoming pension benefits, the more future taxpayers will have to foot the bill.
Did this article answer all your questions about pensions? If not, you can reach Holly Otterbein via email at email@example.com or through social media @hollyotterbein. Have a topic on which you’d like us to do an Explainer? Let us know in the comment section below, or via Twitter @Pacrossroads.