State and Local Workers’ Pensions Eat Into Their Paychecks

For public-sector employees with defined-benefit retirement plans, the future is devouring the present.

The share of compensation costs paid by state and local governments for defined-benefit plans reached 10%, its highest on record, in September 2016, according a report this week from the Labor Department. That’s up from 9.5% in 2015, and 6.3% in the same quarter a decade ago.

“Plans used to be better-funded,” said Jean-Pierre Aubry, associate director of state and local research at the Center for Retirement Research at Boston College. These increasing contributions are “to make up for unfunded liabilities.”

The quarterly release, Employer Costs for Employee Compensation, tracks how much employers from a variety of sectors and industries pay for categories including wages and salaries, paid leave and health insurance, and retirement and savings contributions.

Mr. Aubry points to two main factors that have gotten state and local governments in trouble. One is declining returns: Pensions’ expected rate of return has fallen from above 8% in 2001 to about 7.6% in 2015, according to a brief from the Center for Retirement Research. Another is that following the financial crisis, many governments didn’t pay in the full amount required to keep their pensions fully funded.

Years of rock-bottom interest rates haven’t helped. But rising interest rates—and what many economists expect to be further increases in the Federal Reserve’s benchmark federal-funds rate—could bring higher returns, perhaps lessening the need for state and local governments to set aside so much for future obligations. Economists surveyed by The Wall Street Journal forecast the federal-funds rate at an average 1.26% by December 2017, which implies four rate increases of 0.25 percentage point each between now and the end of next year. Working against that optimistic scenario, however, is the fact that many Americans are living longer.

Some states, such as Kentucky and Pennsylvania, have cut back on benefits to save money. As of early this year, Kentucky’s assets covered just 17.7% of its liabilities to retirees, compared with 120% in 2001.