By: Ted Dabrowski
Gov. Pritzker has no problem hitting up Illinoisans with tax hike after tax hike, but he won’t reform one of the richest public sector benefits in the country – Illinois’ automatic, compounded, 3-percent cost-of-living adjustments for pensions. Skyrocketing pension costs are overwhelming the state’s finances and COLAs are one of the biggest drivers.
COLAs drive up the cost of pensions in Illinois because they double a retiree’s yearly pension after 25 years. Since the state has nearly 500,000 active workers and beneficiaries who benefit or will benefit from this COLA, it’s easy to see why the state has racked up nearly $140 billion in officially-reported pension shortfalls.* Reducing COLAs through some form of means-testing can reduce the state’s unfunded liability by some $50 billion, depending on how that means-testing is applied. Wirepoints has laid out a baseline reform plan scored by actuaries here and here.
Illinois is a national outlier when it comes to COLA benefits. The state’s formula for increasing a retiree’s pension each year is simply overgenerous. A comparison of teacher pension benefits in Illinois vs. those in its peer states – Illinois’ five neighbors and the nation’s five largest states – makes that clear.
While there are many factors that impact a teacher’s overall pension benefits, cost-of-living adjustments have a major influence because they determine how much annual benefits grow in retirement, if at all.
Illinois’ COLA started as a simple annuity increase of 1 percent. But several boosts by lawmakers have turned the benefit into a costly, compounded yearly increase that blows past inflation.
1969: COLA increased to 1.5 percent simple
1971: COLA increased to 2 percent simple.
1978: COLA increased to 3 percent simple.
1990: 3 percent COLA increase compounded annually.
To get a quick understanding of why Illinois’ COLAs are so expensive, take a look at the below chart. It shows how a career teacher’s starting $100,000 pension grows during retirement, comparing Illinois with three states with different COLA formulas.
What stands out is how much faster benefits in Illinois grow. A $100,000 pension for a teacher who retires at 61 will become $203,000 by the time that teacher turns 86. In contrast, a teacher in Kentucky with the same starting pension would see her pension grow to $143,000 after 25 years, the result of a lower 1.5 percent compounded COLA.
New York’s COLA formula offers a simple 1 to 3 percent cost-of-living adjustment, depending on annual inflation, but only on the first $18,000 of a retiree’s pension. That means a retiree’s starting $100,000 pension can grow to a maximum of just $113,000 after 25 years.
Finally, Iowa provides no yearly COLA for members who retired after June 30, 1990. A retiree’s pension stays at $100,000 throughout retirement.
Texas, Pennsylvania, and Indiana only grant COLAs on an ad-hoc basis, meaning the legislature decides each year whether to grant an increase, also called a “13th check.” That rarely happens in some states. Last year, Texas gave its first increase in more than a decade and Pennsylvania hasn’t granted an increase since 2002. Indiana granted small 13th checks to retirees in 2019 and 2020.
Missouri provides a zero, 2 percent or 5 percent COLA depending on an annual inflation formula, but it prevents the annual pension from ever exceeding 180 percent of the retiree’s original pension.
Even big-spending California doesn’t offer COLA benefits as generous as Illinois’. California grants a 2 percent simple COLA with a special provision protecting against inflation.
COLAs vs. private sector
Illinois teachers receive far more generous benefits than their peers, but a more appropriate comparison is to the retirements of the private sector workers who pay for public sector workers. That’s where real discrepancy exists.
Private sector Illinoisans retiring today would have to have approximately $1.8 million to $2 million at the time of their retirement to get the same $2.3 million lifetime payout career state workers receive. The vast majority of ordinary Illinoisans have nowhere near that amount saved.
And the benefits provided by Social Security don’t approach the level of pensions, either. The average Social Security benefit for Illinoisans is just $17,000 a year, while the annual maximum is just $36,000. The combined benefits in the private sector from retirement accounts and Social Security don’t come close to matching the pension of a career public sector worker.
The value of COLA reforms
Illinois won’t escape the nation’s worst pension crisis without major reforms, which first requires an amendment to the Illinois Constitution’s pension protection clause. Tax hikes won’t help, they’ll only prolong the state’s reliance on the broken retirement system.
Reforms begin with tackling COLAs, the biggest driver of the state’s overpromised pensions.
Wirepoints scored a series of COLA reforms via the state’s actuary, Segal Consulting, to determine what savings the state could generate. While there are an infinite number of potential, viable COLA reforms, Segal scored three particular baseline scenarios.
The first scenario suspends COLAs for all current and retired teachers until the Teachers’ Retirement System (TRS) returns to 100 percent funding. The reduction in the unfunded liability for TRS was approximately $35 billion, a 45 percent decrease. That reduction becomes $61 billion when the reform is extrapolated to include all five state-run funds.
The second reduces COLAs for all members to 1 percent simple going forward. That reduces the TRS unfunded liability by $26 billion, a 34 percent reduction. Grossing up those savings for the five state-run funds means the unfunded liability for the state would drop to $88 billion from $134 billion.
The final scenario means-tests COLAs. Everyone with a pension below $50,000 would receive a 1 percent simple COLA, while annual increases for those with pensions greater than $50,000 would be suspended. Savings for the state comes in-between the two scenarios above: $31 billion, a 40 percent reduction in unfunded liabilities. Illinois’ debt is cut by $54 billion when extrapolated to include the five state funds.
In all, these reforms can save the state an average of about $3-$4 billion annually which makes the “need” for a progressive tax hike moot.
Illinois needs reforms, not tax hikes
Retirement costs, including the cost of pension obligation bonds, currently consume nearly 30 percent of the state’s budget, eating into all other core government programs. Without reforms, the Commission on Government Forecasting and Accountability calculates retirements will consume at least a quarter the budget for the next 25 years.
All that seems to mean nothing to lawmakers, who have Illinoisans debating tax hikes instead of structural reforms.
*Moody’s, using more realistic actuarial assumptions than officials at the state do, calculates Illinois’ pension debt is now at $261 billion. That amount makes Illinois the nation’s extreme outlier when it comes to pension shortfalls, both in outright terms and on a per household level.