Illinois Public Pensions, Municipal Bankruptcy and Illinois taxes

The unfunded liabilities facing government pension plans have gained increased public scrutiny during the past year. Governing entities and taxpayers are beginning to recognize the potential consequences of public pension liabilities.

Headlines have exposed municipal bankruptcies, such as Detroit and numerous cities in California. In some extreme cases, pension liabilities have been one of the key drivers for municipal bankruptcy filings and reduced pensions could wind up as the solution for the budget shortfall.

Current data indicates that pension liabilities are expected to persist or even get worse. In late 2012, an actuarial firm found a $1.2 trillion gap for the largest 100 U.S. public pension plans.

Morningstar has analyzed pension data managed by each of the 50 states. Overall, they found the fiscal health of state pension plans varies drastically, with some states having exceptionally strong plans, while others are facing severe funding shortfalls.

The research found that the majority of state pension systems are having problems.  The funded ratio, which is calculated by dividing the pension plan’s assets by its liabilities, serves as a good measure of the plan’s ability to meet its obligations.

The (unfunded liability per capita) represents the amount each person in the state would have to pay to fully fund the pension liability. Since many of these plans have multiple contributors, the state is not solely responsible for paying the full liability.

However, as the other pension contributors are usually local government entities, the unfunded liability will still be funded by state taxpayers, either through payments to the state or the underlying entity that contributes to the pension fund – such as the Rockford School District and the Illinois Teacher’s Retirement System.

The 2013 Morning Star report shows that state plans on average are 72.6% funded with an (unfunded liability per capita) of roughly $2,600 and has a wide variation between the individual states.

Wisconsin remains the strongest system in the nation, with a 99.9% funded ratio with an unfunded liability of $18 per capita. A total of 12 states have funded ratios of at least 80%, which is considered to be strong by Morningstar.

Illinois continues to have the worst funded system in the country with a 40.4% funded ratio and a $7,421 per capita unfunded liability.  A family of four, therefore, owes almost $30,000 for the (5) Illinois pension systems.

The poor fiscal health of the Illinois pension system is due to a combination of reasons, including historical borrowing from the plans by the state, state law requiring annual funding of less than the annual required contribution (ARC), and below-expected investment returns.

According to the Morning Star report, based on the Illinois’ current projections, the aggregate funded ratios for the state’s plans are expected to remain below 50% through 2020 unless further reforms are passed.

Morningstar believes significant reforms will be necessary for the state pension system to be solvent over the long term. Research shows that pensions play an integral role in determining a state’s fiscal health and overall credit quality.

As a result of our state’s pension systems, the credit rating has been downgraded, resulting in millions more being paid in interest on the money the state is forced to borrow to balance its budget in accordance with the state constitution.

What do you think the odds are now that the General Assembly in Springfield will reduce the income tax as planned in 2015, or even worse, force a progressive tax on the backs of Illinois taxpayers, which will result in higher taxes for anyone making over $30,000 or possibly an even lower income according to some estimates?

Retirement income, including IRAs, 401Ks and Social Security, regardless of income, is not currently taxed in Illinois. However, the subject has already been discussed in 2010 by Illinois Senate President John Cullerton, who suggested that limiting the state’s “generous” retirement income tax break “would just be a matter of fairness.”

Wouldn’t it be ironic if private Illinois retiree’s pensions would be taxed to fund the retirement pensions of public employees because of the state’s mismanagement of the state’s pension funds?