State budget balancing is putting pensions at risk

Some 150 state and local pension funds reported assets under $3 trillion to cover the estimated $4.1 trillion needed to pay benefits.

When it comes to the recent improvement in state finances, one retiree's pain is another one's gain.

More than five years after the Great Recession tore a giant hole in their budgets, most states have made big progress in stabilizing their finances.

That's good news for millions of state taxpayers and the millions of investors who hold state-issued municipal bonds—many of whom are retirees that depend on them for a steady stream of safe income.

But the improved fiscal health owes much to a wave of cuts that have whittled away at pension benefits for current and future retirees.

"Nearly every state since 2009 enacted substantive reform to their retirement programs—including increased eligibility requirements, increased employee contributions reducing benefits, including suspending or limiting cost-of-living increases," said Alex Brown, research manager at the National Association of State Retirement Administrators.

More than 45 states have wielded the budget knife on pension benefits, deploying a variety of these changes and resulting in overall benefit cuts averaging 7.5 percent, according to an analysis by the NASRA. That also means new employees can expect to work longer and will need to save more on their own to match the benefits paid to existing employees and current retirees.

Pressure to cut public pension benefits rose sharply in 2007, when the global economy collapsed under the weight of a massive credit bubble, and states fromMaine to Hawaii were hit by the fiscal storm of a lifetime. Surging unemployment cut deeply into income and sales taxes. Collapsing property values undermined a once reliable tax base.

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When the dust settled, state officials were left with multibillion-dollar budget gaps that had to be filled. Since the recession, states have closed some $425 billion in budget shortfalls, according to the Center on Budget and Policy Priorities, a research institute.

This week the Center for Retirement Research at Boston College reported that the health of public pensions nationwide improved last year for the first time since the Great Recession and is expected to keep improving. The study found that state-administered public pension funds now have assets amounting to about 74 percent of what they need to meet the promises they've made to current and future retirees, up from 72 percent in 2012. The researchers project those funding levels will rise to as much as 80.5 percent by 2018.

That improved fiscal outlook has helped states get better credit ratings and borrow new money more cheaply. That, in turn, has helped millions of investors who rely on municipal bond income—many of whom are retirees themselves.

The fallout effect on workers

But the improvement in state finances has eroded the personal finances of the roughly 17.5 million active members and 8 million beneficiaries covered by some 227 state-administered pensions, according to the latest Census data.

The cuts imposed on workers covered by New Hampshire's statewide retirement system were typical.

Faced with a widening gap between what the state owed current and future retirees and what it had set aside to pay them in its pension fund, state lawmakers in 2011 enacted a package of benefit cuts. Effective that year, the retirement age was raised from 60 to 65. The formula used to calculate benefits shrank the size of new retirees' monthly checks, and cost-of-living increases were trimmed. Required contributions from current and new workers were boosted to 7 percent of their paycheck from 5 percent.

Like most members, the cuts didn't set well with David Lang, 57, a retired firefighter from Concord, the state capital, who began earning benefits when he first went to work in 1980 for $4.60 an hour. Though he retired from public service in 2011, he's currently president of the statewide association of local unions, representing firefighters covered by the state's pension plan.

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For Lang the cuts—coming late in the course of careers like his—are "blatantly unfair and unreasonable." He said public employees like firefighters made a "simple bargain" with state and local governments—and the taxpayers they serve—when they first went to work.

"You come to work for your town or city and you spend the next 30 years working as a firefighter, and when you retire, you will get your retirement security in the form of this pension," he said. "The firefighters showed up and honored their end of the bargain. … [But] when it was time to pay and honor the commitment made, elected officials said these commitments are not sustainable."

The net financial loss to New Hampshire workers like Lang amounts to 11.2 percent of that promised benefit, according to the NASRA analysis.

Unlike many private workers who have seen pension benefits cut, millions of public service workers like Lang are not eligible for Social Security. To make up the lost retirement income, NASRA estimates the average New Hampshire worker will have to find a way to set aside another $68,000 in savings.

And some states likely haven't finished cutting.

Despite the benefit cuts, the New Hampshire Retirement System's funding level—the ratio of pension fund assets to liabilities—has fallen from 85 percent in 2001 to 61 percent in 2014. That means that, as of the latest accounting, there are only 61 cents set aside to cover every dollar in expected payments to current and future retirees.

Pension analysts note that, for most states, a big chunk of that shortfall resulted from the epic market collapse of 2008, which wiped out trillions of dollars in stock market value. Then the Federal Reserve's historic move to slash interest rates to the floor pushed pension and insurance funds deeper in the red. That's because record low rates mean these funds need to set aside much more money to generate the returns needed to pay benefits calculated when rates—and returns—were higher.

The hope is that the market's recovery and the expected gradual rise in rates will help close the trillion-dollar-plus state pension gap.

But for some states, the shortfall represents years of underfunding.

"It's the indirect effect of the very concerted political pressure to not raise taxes," said Monique Morrissey, an economist with the Economic Policy Institute. "People appreciate services; they want cops, firefighters; they want teachers and all that stuff. But if you're in a budget crunch, the one way you live on credit and not raise taxes as a modern politician is just not pay your pension bill."

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Some states continue to shortchange their pension funds, even as the gap between assets liabilities widen. New Jersey set aside just 28 percent of what's required in 2013, the latest data available according to Moody's. That year, Virginia, Pennsylvania, California, New York, Florida, Kentucky and Texas each set aside less than 70 percent of what was needed to fund future obligations, according to Moody's.

That may be one reason that—despite deep benefit cuts in some states—many state public pension systems are still badly under water. As of the end of the 2013 fiscal year—the latest for which full data is available—some 150 state and local pension funds tracked by the Center for Retirement Research reported assets of just under $3 trillion to cover the estimated $4.1 trillion that will be needed to pay benefits promised to current and future retirees.

Those estimates are complicated by the arcane accounting rules states and cities use to track their finances. To get a better picture of where they stand, credit-rating agency Moody's does its own math to arrive at an "adjusted" pension liability. By that estimate, the pension funds for the 50 states and Puerto Rico are short by roughly $1.4 trillion.

Some states have scaled back eligibility, leaving a smaller pool of active workers paying into a fund that has to cover pension payments to a rising number of retirees. As that ratio shrinks, the pressure mounts to add more funds to the plan or make further cuts in benefits.

While benefits may help balance the books, some analysts warn they may have a longer-term impact on the ability of state and local governments to find and keep qualified public employees.

"These retirement systems were designed as a tool to attract and retain public-sector workers," said Brown at NASRA. "On the one hand, reforms might save money. But they may also have negative workforce effect by diminishing the plans' ability to attract and retain workers."

Lang agrees.

"We are concerned about retention and recruitment," he said. "Especially with law enforcement and teachers. The quality of employee we will have is a major issue."