Pensions are consuming local governments’ budgets, and many are struggling to make their payments.
In Walnut Creek, California, as in a lot of cities around the nation, revenues are flattening, while expenses for employee benefits and basic services are rising. Not to mention, as our cities continue to age, infrastructure needs are ever present. Even for a fiscally conservative community like Walnut Creek, consumer spending is just not keeping up like it used to, leading to flat growth and distress over how to support the financial security of its government employees.
While this all sounds negative, the city, whose pension plan is managed by the California Public Employees’ Retirement System (CalPERS), has been able to manage its pension costs better than most. But the city wanted to do better and have less volatility.
So, they turned to a budgeting tool – a section 115 trust.
The name of this tool comes from section 115 of the Internal Revenue Code, and it is meant to help governments better manage the short-term costs and long-term liabilities associated with pensions. A 115 trust is a vehicle for setting aside money to meet future pension contributions or liabilities; in other words, a pre-funding mechanism.
A huge benefit of the trust for Walnut Creek is the city’s ability to have a say on how and when the funds can be used to address pension costs. The city can adopt an investment policy and a level of risk that it is comfortable with, which it can’t do if the funds are sent directly to CalPERS. Moreover, with the trust, the city can ensure the funds are not diverted to other purposes in future years and used only for pension expenses.
The challenges Walnut Creek faces are not unique. According to some experts, the current state of pension funding in California began with the passage of a CalPERS-sponsored bill, SB 400, in 1999. This bill allowed local governments to give public safety employees a large pension increase not only for new employees but also for current employees, with retroactive back pay for active years of service. The negative effects of this bill are still being felt throughout California, and some cities are contemplating bankruptcy as a result.
But some may ask, if the state of pension funding in California is uncertain, how can California cities set aside funds if they presumably don’t have any?
It all comes down to volatility. Think of it this way – you could either incrementally save money in a college savings plan for your child over the course of several years, and potentially have an easier time paying for her tuition by the time she becomes a young adult, or you could wait until she enters college and start budgeting then. For the uninitiated, the latter might be a huge blow, creating immense volatility in their household budgets that may not be sustainable. In a similar way, saving incrementally in a section 115 trust may allow cities long-term budget flexibility and sustainability.
And cities can further benefit by working with actuaries to identify the amount of money to be invested in such a trust, the period of time over which to accumulate the necessary funds and how to use those monies to continue to preserve basic services without sacrificing the needs of the residents.
Here’s a graph that Councilman Kevin Wilk shared during a panel discussion at NLC’s recent conference, City Summit, in Los Angeles. The graph shows the city’s projected deficits through fiscal year 2027.
As mentioned, trusts are not meant to work overnight. They take time to accumulate funds. So, the city assumes use of the trust beginning in 2024, six years from now. According to the projection, the city is expected to greatly benefit from the trust.
About the Author: Anita Yadavalli is the Program Director of City Fiscal Policy at NLC. Anita leads NLC’s Public Sector Retirement initiative, with a focus on research and education for city leaders on retiree healthcare benefits, as well as research and programming on other city fiscal policy issues. Anita holds a Ph.D. in Agricultural Economics from Purdue University, an M.S. in Food and Business Economics from Rutgers University, and a B.S. in Environmental and Business Economics from Rutgers University.