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Underfunded Public Sector Pension Plans, Social Security Participation, and the Retirement Decisions of Public Employees

Authors

Abstract

I analyze the effects of public pension parameters, Social Security coverage, and state pension fund sustainability on the retirement of public employees. I use data from the Health and Retirement Study, including personal early and normal retirement eligibility and state of residence. I develop a state-level measure of effective public pension plan sustainability that reflects both the degree of public plan underfunding and a state’s ability to fund the plan with its own resources. Using the Public Plans Database and the Treasury Department’s estimate of Total Taxable Resources, I calculate the state tax rate that, applied to a state’s total taxable resources, could fund the state’s unfunded actuarial accrued liability. This effective tax rate varies by Social Security status of the plan. I model retirement probability as a function of public pension eligibility, Social Security coverage in the public sector job, and effective underfunding. I find that becoming eligible for early or normal retirement, or receiving an early-out offer, significantly increases the probability of retiring beginning at age 50. Having Social Security coverage approximately doubles this probability. Public sector workers without Social Security coverage are estimated to have a lower probability of retirement at key eligibility ages. I find that the probability of retirement falls with the degree of underfunding or effective plan risk, but this effect is small compared to the response to plan features. These findings suggest that state legislative action to affect retirement decisions would be most effective operating through plan eligibility rules.

Key Findings

  • Public employee retirement is most responsive to program eligibility focal points – becoming eligible through meeting age and service requirements – at all ages beginning at age 50. Becoming eligible for early retirement or normal retirement between the ages of 50 and 54 increases the probability of retirement by about .05 and .06.
  • Participants at the key pre-retirement age categories that are also covered by Social Security are much more likely to retire than those without Social Security in the same age group. The economic magnitude of the effect is on par with the increased probability of retirement due to poor health. Depending on the particular age group, having Social Security coverage approximately doubles these retirement probabilities.
  • Special early-out provisions also encourage earlier retirement, over and above the plan’s early retirement provisions, particularly for public employees with Social Security coverage.
  • Public employee retirement decisions are sensitive to plan underfunding and sustainability – the probability of retirement falls as plan underfunding increases. This effect is smaller than the influence of plan features.
  • At retirement, public employees in the Health and Retirement Study without Social Security coverage (and wealth) have significantly higher housing and non-housing wealth, as well as deferred pension wealth, reflecting the greater generosity of these uncovered plans. Only about 20 percent of those who retire in the sample have defined contribution plans along with their defined benefit plans – the average amount in the funds is about $30,000 in 2012 dollars, although those without Social Security have about $2,000 more.
  • There is a great deal of inequality across states in taxable resources available to sustain public plan solvency. For example, in 2017 the states with the lowest level of taxable resources per capita – around $50,000 — include Mississippi, West Virginia, Alabama, Idaho and New Mexico. But states with some of the highest pension underfunding per capita also have the highest taxable resources – New Jersey, Delaware, Massachusetts, New York and Connecticut — have over $80,000 in taxable resources per person.
  • My effective sustainability measure — the rate that applied to the state’s taxable resources would equal the outstanding unfunded public pension liability — is at least 5 percent for half the states, but for Connecticut, Mississippi, Hawaii, Alaska, Colorado, New Mexico, the rate exceeds 10 percent, and for New Jersey, Illinois and Kentucky, this rate is closer to 20 percent. In calculating this rate, pension liability could be split into “legacy debt” that arose before the pension fund was substantially prefunded, and the effective tax rate calculated for “current accrued service” to reduce the intergenerational transfer of public service costs. This calculation can independently inform policy regarding which states can pay for public sector services from its own resources.

Citation

Papke, Leslie E. 2021. “Underfunded Public Sector Pension Plans, Social Security Participation, and the Retirement Decisions of Public Employees.” Ann Arbor, MI. University of Michigan Retirement and Disability Research Center (MRDRC) Working Paper; MRDRC WP 2021-420. https://mrdrc.isr.umich.edu/publications/papers/pdf/wp420.pdf

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Project

Paper ID

WP 2021-420

Publication Type

Working Paper

Publication Year

2021