Illinois’ five major state pension systems remain the most underfunded in the nation, carrying roughly $144.6 billion in unfunded liabilities and a combined funded ratio of just 47% as of the June 30, 2025, actuarial valuations.
Into this fragile fiscal environment comes the perennial push to overhaul Tier 2—the scaled-back defined-benefit plan created in 2011 for workers hired after that year. The latest vehicle is Senate Bill 1937, the Fair Retirement and Recruitment Act (FRAA), which proposes a rollback of many of the benefit reductions made in 2011 in response to rising pension costs. The bill advanced in committee in late 2025 but remains stalled amid ongoing negotiations. Gov. JB Pritzker has publicly stated the package needs “a lot more work.”
Proponents repeatedly cite a narrow federal compliance concern—that the Tier 2 benefit formula does not meet minimum benefit requirements for non-Social Security participants—as the urgent reason to act. But the FRRA and similar proposals use these minimum benefit compliance concerns as a Trojan horse to justify a far broader, far costlier overhaul.
What is the Social Security “minimum benefit” issue?
Federal law (Treas. Reg. § 31.3121(b)(7)-2 and Rev. Proc. 91-40) allows state and local governments to exempt employees from FICA (Social Security/Medicare) taxes and coverage only if the public pension qualifies as an eligible “replacement plan.” If the Social Security replacement plan is a defined benefit pension plan, it must provide an annuity (starting no later than Social Security’s full retirement age) at least equal to the Primary Insurance Amount (PIA) the worker would have received under Social Security.
Compliance is tested via three tiers: a basic formula (1.5% multiplier × final-average compensation × service years, using Social Security wage base and 3-year averaging), a modified formula (adjusting baselines for plan differences, like longer averaging periods), or an equivalent formula (individual-by-individual comparison).
Illinois Tier 2 pension benefits typically feature a 2.2% pension accrual formula for non-Social Security employees, final average salary based on the highest eight of the last 10 years, a pensionable salary cap that grows by the lesser of 3% or one-half of Consumer Price Index – Urban Wage Earners (CPI-U), normal retirement at age 67 (with reductions earlier), and a non-compounded cost-of-living adjustment (COLA) of the lesser of 3% or one-half of CPI-U.
The clearest safe harbor compliance issue is that Tier 2’s pensionable salary cap (currently $129,192 in 2026) lags behind the $184,500 wage base of Social Security.
Under the safe-harbor test, this divergence, combined with Tier 2’s longer eight-year final-average-salary period and early-retirement reduction, drops the effective accrual rate below the required 1.75% threshold for the general formulas in the Teachers’ Retirement System (TRS), State Employees’ Retirement System (SERS), and State Universities Retirement System (SURS). The result is a technical plan-level failure that could, in theory, jeopardize the FICA exemption for affected higher-earning participants.
The Trojan Horse response
Even granting that the salary-cap issue creates a genuine compliance risk, Rev. Proc. 91-40’s mechanical tests require only that the initial annual annuity meet a baseline comparable to Social Security’s Primary Insurance Amount. Nothing in the minimum benefit framework mandates shorter averaging periods, earlier unreduced retirement, richer COLAs, or any of the rollbacks of the 2011 pension reforms now on the table. Those are discretionary policy choices. Treating federal minimum benefit compliance as a blank check for undoing prior reforms misuses a narrow regulatory concern to bypass the hard trade-offs that should govern public pension design.
Importantly, however, the Internal Revenue Service (IRS) has never issued a ruling, audit finding, or enforcement action confirming this interpretation for Illinois Tier 2. Prudent policymaking, therefore, calls for seeking formal IRS clarification or a private-letter ruling before treating the issue as settled law.
That said, even if we accept the compliance risk as valid and worth addressing, the narrow fix required is modest and targeted: simply align the Tier 2 pensionable salary cap with the full Social Security wage base each year, indexing it identically going forward. As reported by the Institute of Government and Public Affairs (IGPA) in 2025, this single change would restore modified safe-harbor compliance at a projected cost of roughly $5.6 to $6.2 billion in additional contributions through 2045, concentrated among the small share of higher earners who actually hit the cap.
Instead, the Fair Retirement and Recruitment Act of 2026 (SB 1937) and similar proposals use the safe-harbor concern as a Trojan horse to justify a far broader, far costlier overhaul. These bills bundle the necessary cap alignment with multiple enhancements that have nothing to do with federal compliance:
- Shortening the final-average-salary period from the highest eight of the last 10 years to six of the last 10.
- Lowering retirement eligibility ages and service requirements for unreduced benefits (e.g., age 62 if they have reached the 75% of covered salary cap, age 65 with 20 years of service, or age 67 with 10 years of service).
- Improving the automatic annual COLA increase to a more generous 3% simple (non-compounded) structure.
- In some variants, additional tweaks to survivor benefits, reciprocal service, or delaying funding targets to 90% funded by 2045.
Actuarial costs for these add-ons are significantly higher, with one projecting about $46 billion in additional costs through 2049 above the minimum benefit fix alone.
Leveraging compliance issues to improperly bolster benefits
Any reforms beyond the minimum cap alignment must therefore be evaluated strictly on independent benefit-policy and funding-policy grounds: retirement-income adequacy, benefit equity across cohorts, taxpayer affordability, and effective recruitment and retention. On these criteria, the broader proposals fall short without rigorous justification and pre-funding.
The adequacy of the current level of pension benefits should not be viewed as a crisis. A full-career Tier 2 non-Social Security worker with 30 years of service still replaces roughly 66% of final average salary—often competitive with private-sector 401(k) outcomes when paired with personal savings. It is important to note that the entire issue arises from the Tier 2 salary cap mechanism, so the only participants who could have a safe harbor compliance problem are high-earning employees earning more than the salary cap ($129,192 in 2026). Most Tier 2 plan participants are not affected by this situation; for example, only about 6% of SERS employees earn above the salary cap.
The minimum benefit compliance debate has become a convenient rhetorical shield. Invoking “the feds are coming” sounds more urgent than admitting a desire for richer pensions. Illinois cannot afford that sleight of hand. If the minimum compliance fix is needed, enact the narrow salary-cap alignment after seeking IRS confirmation. Any additional enhancements must stand or fall on their independent merits under the tests of adequacy, equity, affordability, and workforce needs—not on an unconfirmed regulatory theory. Sound public policy, not selective regulatory leverage, must decide the future of Tier 2.