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Capital Comments: Indiana State Balances and the Pension Stabilization Fund

The Indiana fiscal new year is upon us, having begun on July 1. The big New Year’s celebration happened on July 13, with the “closeout” announcement. That’s the state’s accounting of revenues, spending and balances as of the end of fiscal 2023. The good news: Indiana has $2.9 billion in the bank, 13.6 percent of the general fund budget. That’s enough to cover cash flow and most shortfalls in revenue below expectations.

That amount takes some explaining though, because a year ago balances were $6.1 billion. Where did that money go?

Some, you may remember, went to last year’s income tax rebate. This year the General Assembly included Section 292 at the end of the budget bill, which added appropriations for the 2023 budget. A couple billion dollars will be spent on construction of facilities for universities, parks, prisons and even the state archives. Half a billion dollars goes to the Indiana economic development corporation for a “deal closing fund,” to help attract new businesses to the state. 

And $700 million goes to the Pension Stabilization Fund, which adds to the $2.5 billion that had already been approved for 2023.That’s $3.2 billion in total. 

What is the Pension Stabilization Fund? I’m so glad you asked! 

The story goes back a hundred years. In 1921 the state created a pension program for public school teachers. With most pensions, employers make contributions during their employees’ working lives, the money is invested, and this creates a fund for employees to draw upon in retirement. That’s not what Indiana did. It created a “pay-as-you-go” pension. Teacher pensions would be paid with appropriations from each year’s state budget, funded by the taxpayers.

That must have seemed manageable back in 1921. Then came the baby boom. School enrollment exploded in the 1950s through the 1970s, and lots more teachers were hired. Between the 1990s and the 2020s, all those teachers would retire, and the state budget would be on the hook for every dollar of their pensions. One 1989 study projected that the annual bill would balloon from $200 million in 1992 to $1.7 billion and rising in 2017. Indiana, we have a problem!

So, in 1995 the General Assembly closed the old pension program to new hires. It’s now called the pre-1996 account. Teachers hired since then have been enrolled in a pension system funded by ongoing contributions. The legislature also created the Pension Stabilization Fund, to try to hold down the growth of pre-’96 pension payments in the annual budget. 

 The state adds a little to the fund each year, and the investment earnings now are substantial. But the big money comes when state balances are larger than normal. During the good times in the late-1990s, the General Assembly dropped $350 million into the fund. This was formalized several years ago so that half of all “excess reserve balances” go to the fund.

Pension payments have been stabilized. That 1989 study projected that the 2017 pension appropriation would have been $1.7 billion. The actual appropriation was half that, $841 million. Much of the saving came from closing the old pension program, so that the number of potential pay-as-you-go retirees hasn’t increased. Annual growth in the payments is restricted to 3 percent per year, with any shortfall covered by the fund. In the 2024 and 2025 budgets the pre-’96 pension payments are just over $1 billion per year. 

Total pension payments are expected to peak at $1.2 billion in the mid-2020s, then begin to decline as retirees pass away. Investment earnings on the fund’s balances will grow. At some point the earnings on the fund will match the annual pension payments and no annual appropriation will be needed. The Indiana Public Retirement System hinted at that possibility in last year’s annual report. They wrote that the pre-’96 account “is projected to reach 100 percent funded status on its base benefits in FY 2030.” That day may be closer now that there’s an extra $3.2 billion in the fund. 

That’s what the General Assembly bought with its $3.2 billion contribution to the Pension Stabilization Fund. Sometime in the not-too-distant future, a $1 billion annual pension appropriation will no longer be required.    

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