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

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.