Illinois’ economic future pressured by worst pension crisis in nation

Illinois’ economic future pressured by worst pension crisis in nation

Nationwide analysis from the Equable Institute reveals Illinois state pensions remain fiscally unstable, underscoring the need for systemic reform.

The urgency and severity of Illinois’ pension crisis is undeniable when compared to the rest of the nation. Reports from the Equable Institute found Illinois lags in both pension funding and performance compared to other states at the end of fiscal year 2024.

If the state fails to fix its pension issues, the budget will continue to be strained, people will continue leaving the state and future pension benefits could be at risk.

Preserving the cost savings of Tier 2, offering retirement choice to state employees and constitutional pension reform should all be seriously considered by policymakers if Illinois is to have any hope of fiscal sustainability.

Illinois pensions maintain title as nation’s worst-funded

When it comes to the funded ratio, or how much money the government has on hand compared to how much it owes pensioners, Illinois ranks dead-last among all other states for the second year in a row. It’s also one of only four states remaining below 60% funding.

This underperformance persists at the individual pension system level as well as statewide. Illinois has four of the 10 worst-funded state-level public pension systems in the nation, the most out of all other states.

In comparison, New Jersey, the state with the third lowest funded ratio in the nation, has three of the worst-funded systems. Arizona, Kentucky and California each have one. Illinois’ pension situation has worsened since 2023, when it only had three of the lowest funded state pension systems. This year, the Illinois State Universities Retirement system joined the list, and Illinois’ other underfunded state pensions dropped further in the rankings, by about three places each.

Low funding ratios mean more uncertainty, because it means the state does not have the money to pay out what it promised. If liabilities continue to grow faster than assets, this funding ratio shrinks. Eventually, the state doesn’t have enough money to pay out what’s owed at a given time. This insolvency would mean that everyone’s benefits are compromised.

But even before insolvency hits, low funding ratios still hurt the state. Just like someone who fails to pay off their credit card debt, this continual “putting off” until later signals fiscal instability and is the biggest reason behind Illinois’ bottom-of-the-nation credit rating, according to S&P. This low credit rating leads to higher borrowing costs and less appeal for people to stay here, let alone to make Illinois their home when comparing to nearby states.

Financial problems comprise a larger share of state GDP

Some argue that the funded ratio and unfunded liability are not enough to evaluate a pension system's fiscal health. The Equable Institute asserts that examining “the size of unfunded liabilities relative to the size of a state’s economy” can provide a better understanding. Analyzing pension debt from this perspective shows the scale of the local tax base required to fund the system.

Unsurprisingly, Illinois is again in last place.

Illinois’ unfunded pension liabilities make up the largest percentage of the state’s GDP, at just over 18%.

That’s driving the increasing burden on taxpayers, whose contributions to state pension systems have grown nearly 20-fold, from $614 million in fiscal year 1996 to $11.2 billion in fiscal year 2025. That’s a major reason why Illinois’ property taxes are the second-highest in the nation and more than double the nation’s median rate.

Illinois pension fund investment returns lag nation

A national comparison reveals higher-than-expected returns were not unique for Illinois: 91% of all pensions outperformed their initial estimates. Yet, Illinois still underperformed the national average. Illinois state pensions returned an average of 9.0%, while the preliminary national average return was 10.33%.

Despite greater-than-expected returns, Illinois pension debt grew by about $1.5 billion in 2024. This underscores why Illinois cannot rely on investment returns to alleviate its current pension crisis. Systemic reform is needed for the state to improve its financial standing, for pensioners to ensure their benefits are protected and for taxpayers to experience any real relief from the large burden they continue to shoulder.

Better policy can help Illinois pensions compete

To close the gap between its currently abysmal fiscal standing and better-performing states, Illinois policymakers should carefully consider:

1) Preserving Tier 2’s cost-savings

To combat its rapidly growing pension obligation, in 2010, Illinois implemented an alternative plan for new employees, dubbed “Tier 2.” This plan’s changes to the initial “Tier 1” benefits prevented costs from escalating even higher. Critics of Tier 2 have concerns about benefit adequacy and compliance with federal rules for retirement benefits. If any changes are made to Tier 2 to address those concerns, they should avoid returning to the unsustainable and overpromised benefits previously administered in Tier 1. Otherwise, Illinois risks insolvency.

2) Expanding retirement plan options for pensioners

Illinois pensioners in SURS have the option to opt-in to a defined-contribution plan. This offers more control over finances since pensioners who select this system can make their own investments. This option should be extended to members of the other four state pension plans. Actuarial projections anticipate this becoming an increasingly popular retirement choice for SURS employees in future years, which is an additional reason to expand it across all the state systems.

3) Removing constitutional barriers to potential reforms

Illinois is one of the few states with constitutional language severely restricting pension reform, making meaningful change almost impossible. Amending the state constitution would allow Illinois to adopt proven reforms implemented elsewhere, such as responsible adjustments to cost-of-living adjustments, which would enhance fiscal stability and ensure the sustainability of pension benefits.

Illinois’ poor pension standing compared to other states is a clear signal for change. The longer Illinois state pensions lag their peers, the longer the state’s financial health goes untreated, putting pensioners and taxpayers at risk.

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