As the coronavirus pandemic and resulting shutdowns help cause market turmoil and loss of tax revenue, Colorado policymakers are already evaluating their options for the difficult budget decisions on the horizon. One of the challenges they face will be continuing to make the necessary payments into the Public Employees’ Retirement Association (PERA) at a time when immediate needs appear to outweigh long-term priorities. State lawmakers should be aware, however, that what might appear to be a minor tweak today has major financial effects in the long-run when it comes to pension policy.
The state’s Joint Budget Committee is in the of deciding upon a wide range of cost-cutting proposals associated with contributions into PERA—the retirement plan that covers all of Colorado’s public workers. Most of the actions postpone or delay reforms that were enacted in a , which intended to put the plan on a path to pay off a $31 billion funding shortfall and better protect workers, retirees and taxpayers. Now, as the fund’s assets are taking a significant hit, policymakers are seeking ways to roll back some of the meaningful changes from 2018, at least temporarily.
The committee has already given its approval for a one-year break on a supplemental state contribution of $225 million to the pension fund. While this move frees up some cash in the next budget, it will create an additional long-term cost of $990 million. The committee is also considering postponing scheduled contribution increases for both employees and employers, which could add another $900 million to long-term costs. Another possible cut could come in the form of a permanent reduction in employer contributions into the plan’s State Division, an action that would add $660 million in costs over the long term.
As these cost estimates show, small reductions in contributions have big price tags when it comes to long-term pension funding for Colorado.
This is for the same reason that retirement advisors tell people to start saving as soon as possible, namely the power of compounding interest. Pension plans like PERA depend not only on contributions from the state and its workers, but also the investment returns that will multiply the fund to fulfill all retirement promises made. When a full contribution isn’t made, that choice becomes a major drain on the potential investment earnings of the fund. Just as the plan’s assets grow each year, so do the effects of payments not made.
The costs of shorting contributions don’t end there, either. Beyond the long-term dollar costs generated by cutting contributions in the short term, these actions also weaken the resiliency of the plan, increasing the chances of perpetual underfunding and never-ending shortfalls in the funds that Colorado workers depend on. It may not show up clearly on a ledger, but reducing contributions today makes PERA less able to recover from the current market turmoil and inevitable recessions in the future.
Reductions in contributions, even those that appear to be minor, can extend debt payment schedules out beyond what is responsible or fair. Prior to the 2018 reforms, Colorado was beginning to garner from credit ratings agencies, who named pension funding issues as a significant factor in their evaluation. To these agencies, the inability to reach full funding within 30 years is seen as a red flag, which could eventually affect a state’s credit rating. If contributions into PERA end up being too low, it could put the entire state’s financial standing in jeopardy.
Colorado policymakers are right to anticipate and plan for significant budget difficulties in the upcoming year. While weighing policy options to alleviate these upcoming budgetary pressures it is critical to understand not only the short-term savings but also the long-term costs that these proposals would impose.