An unfunded liability is the difference between how much a pension fund has in assets and its accrued liabilities.[1]
An unfunded liability is the difference between how much a pension fund has in assets and its accrued liabilities.[1]
For pension funds, an unfunded liability is the gap between what a pension fund has in assets and what it owes in promised benefits (called actuarial accrued liability). It's calculated by subtracting the fund's assets from its total liabilities. Expressing the unfunded liability as a percentage of "covered payroll" (current employee salaries) shows how big the problem is relative to what the employer is already spending on staff. It helps track whether the fund is getting healthier or worse over time.[1]
A pension liability is the current "present value" of all future retirement benefits promised to participants. It’s the amount of money needed today (invested at an assumed interest rate) to cover all those future payments over the participants’ lifetimes.[2]
As an example, let's say a $10,000 payment due in one year is worth less today because the money can earn interest. At 5% interest, that money is worth about $9,520 today. At 2.5% interest, it's worth about $9,750. Thus, lower interest rates make liabilities larger, and vice versa.[2]
To calculate total liabilities, funds project future benefit payments for every participant based on the plan rules, when they retire, how long they live, and other variables. These are added up year by year. Then, funds discount those future amounts back to today's dollars using an interest rate assumption.[2]
Common causes of unfunded liabilities include:[2]
Under 5 USC § 8331(19):[3]
(19) “unfunded liability” means the estimated excess of the present value of all benefits payable from the Fund to employees and Members, and former employees and Members, subject to this subchapter, and to their survivors, over the sum of— (A) the present value of deductions to be withheld from the future basic pay of employees and Members currently subject to this subchapter and of future agency contributions to be made in their behalf; plus (B) the present value of Government payments to the Fund under section 8348(f) of this title ; plus (C) the Fund balance as of the date the unfunded liability is determined;
It is considered a good sign when unfunded liabilities decrease gradually as a percentage of payroll. However, when they increase significantly, this can be a sign that the fund may need changes like better funding strategies or lower benefits.[1]
Between FY2008 and FY2012, in Chicago, all 10 local government pension funds studied saw big increases in unfunded liabilities as a percentage of payroll. In 2012, the worst funds were the Fire Fund (733.5%) and Police Fund (696.6%). The biggest jumps were the Laborers’ Fund (+413 points) and Forest Preserve Fund (+325 points).[1]
Colorado PERA (Public Employees' Retirement Association) is a major public pension system that provides retirement and to the employees of over 500 government agencies and entities in the state of Colorado.[4]
In 2000, PERA was over 100% funded, meaning it had more than enough money to pay benefits. By 2016, that dropped below 60% funded. This led to major reforms of the program in Colorado. By the end of 2024, it improved to 69% funded.[5]
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