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Myth: It Is Okay For a Pension Plan to Target Less than 100% Funding

Fact: Pension plans that target a funding level of anything less than 100% will perpetually have unfunded liabilities (pension debt) and will accumulate higher and higher costs over time.

There is a misconception that pension systems function like Social Security, with contributions from today’s workers paying the benefits for current retirees. Pension systems are designed differently: They calculate the future cost of retirement benefits and then purchase them with today’s dollars. By the time an individual teacher reaches retirement, the pension fund should already have the funds needed to pay her benefits.

That requires paying for the cost of those future benefits each year, as they’re earned. When pension funds don’t do that, the system begins to accumulate debt. With costs mounting, some systems then target less than 100% funding as a way to reduce the overall payment each year. Any target less than 100%, however, merely masks the full costs of the system—a bill that will eventually come due.

Case Study:

In 1994, the Teachers’ Retirement System of Illinois (TRS) set a goal of having 90% of their pension obligations funded within 50 years. At the time, TRS had about $10 billion in pension debt and the state contributed less than $1 billion a year.

Today, 25 years later, TRS hasn’t gotten closer to its goal. In fact, the opposite has happened. While the state now contributes more than $4 billion a year, TRS has more than $70 billion in pension debt. The actuaries for TRS project that payments from the state will grow to more than $10 billion a year by 2045, the end of the 50-year funding target. At that point, TRS will still have $20 billion in pension debt.

In 1994, Illinois would have been much better off trying to pay down 100% of its pension debt. Doing so in a time frame sooner than 50 years down the road would have cost much less in the long-run.

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