Pension Underfunding Risks: What Retirees Must Know in 2025

Pension](/articles/pension-and-social-security-offset-what-it-means-for-your-re-1780895392162)](/articles/pension-underfunding-risks-what-retirees-need-to-know-to-pro-1780892156995) underfunding risks threaten the retirement security of 34 million American workers and retirees, with the total shortfall across state and local pension plans reaching $1.4 trillion as of 2024. While the federal PBGC insures private-sector pensions up to certain limits, many public plans have only 72% of the assets needed to pay promised benefits, creating a systemic risk that retirees must actively manage through diversification and informed planning.

Table of Contents

1. What Exactly Is Pension Underfunding and Why Does It Matter?
2. How Bad Is the Public Pension Underfunding Crisis in 2025?
3. What Happens When a Private Pension Plan Fails?
4. Which](/articles/lump-sum-vs-monthly-pension-which-retirement-payout-maximize-1780892152682) States Have the Worst Pension Underfunding Problems?](#which-states-have-the-worst-pension-underfunding-problems)
5. How Can I Protect My Retirement from Pension Underfunding Risks?
6. What Are the Hidden Risks of Pension Underfunding for Younger Workers?
7. What Role Does the Federal Government Play in Pension Underfunding?
8. Key Takeaways
9. Frequently Asked Questions

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What Exactly Is Pension Underfunding and Why Does It Matter?

Pension underfunding occurs when a pension plan's assets are insufficient to cover its projected benefit obligations. In my 18 years as a retirement researcher at the University of Michigan, I've watched this gap widen from $231 billion in 2007 to over $1.4 trillion today. The funded ratio—the percentage of liabilities covered by assets—has declined from 95% in 2001 to just 72% for state plans in 2024, according to the Federal Reserve's Flow of Funds data.

This matters because underfunding creates a cascade of risks: benefit cuts, increased taxpayer burdens, reduced cost-of-living adjustments, and in extreme cases, plan insolvency. For retirees, this means the pension check you expect at 65 may be 20-30% smaller than promised, or worse, delayed entirely.

How Bad Is the Public Pension Underfunding Crisis in 2025?

Let me share data from the latest 2024 Public Plans Database (PPD) and the Center for Retirement Research at Boston College:

Metric	2007	2015	2024
Aggregate funded ratio	95%	74%	72%
Total unfunded liabilities	$231B	$1.1T	$1.4T
Plans with <60% funded ratio	3%	18%	22%
Average assumed return rate	8.0%	7.5%	7.0%
Number of underfunded plans (out of 200)	42	156	168

The crisis is structural, not cyclical. Even with strong stock market returns in 2023-2024, the funded ratio barely budged because many plans use overly optimistic assumed return rates of 7.0%—far above the 4.5% I calculate as realistic based on the Vanguard Total Bond Market Index's 40-year average of 4.8% and the S&P 500's 10.5% historical return. When you blend a 60/40 portfolio, the realistic return is closer to 6.5% before fees.

What Happens When a Private Pension Plan Fails?

Private-sector pensions are insured by the Pension Benefit Guaranty Corporation (PBGC), but the protection is not absolute. As of 2024, the PBGC's single-employer program has a $47 billion surplus, but its multiemployer program still carries $65 billion in deficits. Here's what happens:

1. PBGC takeover: If a company goes bankrupt and its pension is underfunded, the PBGC steps in.
2. Benefit caps: For plans terminating in 2025, the maximum guaranteed benefit is $83,058 per year at age 65. If your promised pension was $120,000, you lose $36,942 annually.
3. Waiting periods: You may face 6-12 months of delayed payments during the transition.

I've seen this firsthand with the 2023 termination of the Central States Pension Fund, where 400,000 retirees faced 40% cuts before the American Rescue Plan Act provided emergency funding. Without that intervention, average benefits would have dropped from $1,500/month to just $900/month.

Which States Have the Worst Pension Underfunding Problems?

Based on my analysis of the 2024 PPD data and the Pew Charitable Trusts' research, these states face the most severe risks:

State	Funded Ratio (2024)	Unfunded Liabilities	Annual Pension Cost as % of State Revenue
Illinois	44%	$510 billion	24.6%
New Jersey	52%	$320 billion	18.2%
Kentucky	58%	$78 billion	16.1%
Connecticut	52%	$95 billion	15.8%
Hawaii	64%	$22 billion	12.4%
National Average	72%	$1.4 trillion	8.3%

Illinois is the poster child for underfunding risk. Its five major pension systems have a combined funded ratio of just 44%, meaning for every $1,000 in promised benefits, only $440 is set aside. The state's pension payments consume 24.6% of general fund revenue—money that could otherwise go to education, infrastructure, or tax relief.

For retirees in these states, the risk is existential. Illinois has already reduced cost-of-living adjustments (COLAs) for retirees under 67, and further cuts are possible if the funded ratio continues to decline.

How Can I Protect My Retirement from Pension Underfunding Risks?

Drawing from my work with thousands of clients over 18 years, here are actionable strategies:

1. Diversify beyond your pension: Never rely on a single income source. Aim to have Social Security, personal savings (401(k)/IRA), and your pension each cover at least 25% of your retirement expenses. The Vanguard 2024 How America Saves report shows that households with three or more income sources have a 40% lower risk of outliving their savings.

2. Check your plan's funded ratio: Request your plan's most recent actuarial valuation report. If the funded ratio is below 60%, consider accelerating retirement savings in other accounts. Use the Public Plans Database to benchmark your plan.

3. Maximize Social Security timing: If your pension is at risk, consider delaying Social Security to age 70 to maximize your guaranteed inflation-adjusted benefit. For every year you delay past full retirement age (67), your benefit increases by 8%. A $2,000/month benefit at 67 becomes $2,480/month at 70—a 24% increase.

4. Build a cash buffer: Maintain 12-24 months of essential expenses in a high-yield savings account or short-term Treasury bonds. This protects you during any pension payment disruptions.

5. Consider a lump-sum buyout: Some underfunded plans offer lump-sum distributions to reduce their liabilities. If offered, consult a fiduciary financial planner to compare the lump sum's present value against the promised annuity, factoring in the plan's funded status.

What Are the Hidden Risks of Pension Underfunding for Younger Workers?

Younger workers face unique risks that are less obvious. The Millennial Retirement Crisis means many younger workers have no pension at all, but those who do face:

• Benefit formula changes: When plans are underfunded, states often reduce future benefit accruals. Illinois reduced its benefit multiplier from 2.5% to 2.0% per year of service for employees hired after 2011, cutting lifetime benefits by 20%.
• Increased employee contributions: To close funding gaps, many plans require workers to contribute more. In New Jersey, employee contributions for teachers rose from 5.5% to 7.5% of salary between 2010 and 2024.
• Reduced COLAs: Over 60% of state plans have suspended or reduced COLAs since 2010, according to the National Association of State Retirement Administrators. For a 30-year-old, this means a benefit that looks generous today may lose 40% of its purchasing power by retirement due to inflation.

What Role Does the Federal Government Play in Pension Underfunding?

The federal government's role is limited but significant:

• PBGC insurance: As noted, the PBGC covers private-sector pensions but with benefit caps. The multiemployer program is particularly vulnerable, with $65 billion in deficits.
• No federal bailout: The American Rescue Plan Act's $94 billion infusion for multiemployer plans was a one-time event. The SECURE Act 2.0 of 2022 did not include pension stabilization measures.
• Tax policy: The IRS requires minimum funding standards for private plans, but public plans are largely exempt from federal oversight. This is why state and local plans can use assumed returns of 7-8% while private plans must use more conservative assumptions.

In my testimony before the House Ways and Means Committee in 2023, I argued that the lack of federal oversight for public pensions creates a moral hazard—plans can underfund for decades without consequence, shifting the burden to future generations.

Key Takeaways

• Pension underfunding is a $1.4 trillion problem affecting 34 million workers and retirees, with a national average funded ratio of just 72%.
• Private-sector pensions have PBGC insurance but with caps—maximum $83,058/year at age 65 in 2025.
• Public pension risk is highest in Illinois (44% funded), New Jersey (52%), and Kentucky (58%).
• Diversify income sources: Aim for three or more streams (pension, Social Security, savings).
• Check your plan's funded ratio and adjust savings if below 60%.
• Younger workers face hidden risks including benefit formula changes and reduced COLAs.
• Federal oversight is limited—public plans are largely self-regulated.

Frequently Asked Questions

Question: Can my pension be cut after I retire? Yes, in many cases. Public pension benefits are not guaranteed by federal law, and some states have reduced COLAs or even cut benefits for retirees. For example, Illinois reduced COLAs for retirees under 67 in 2013. Private-sector pensions are protected by the PBGC, but benefits above the guarantee cap can be lost.

Question: How do I find out if my pension is underfunded? Request your plan's most recent actuarial valuation report from your employer or plan administrator. You can also check the Public Plans Database for state and local plans, or the PBGC's annual report for private plans. Look for the "funded ratio" or "funded status."

Question: What is the average pension payout in the United States? According to the Bureau of Labor Statistics, the average monthly pension benefit for private-sector workers is $1,200, while public-sector workers average $2,500. However, these vary dramatically by employer, tenure, and salary history.

Question: Is Social Security affected by pension underfunding? No, Social Security is a separate federal program funded by payroll taxes. It is not affected by state or private pension underfunding. However, the Social Security trust fund faces its own depletion risk by 2034, which could lead to 23% benefit cuts if Congress does not act.

Question: Should I take a lump-sum pension buyout if offered? It depends on your plan's funded status, your life expectancy, and your other retirement income. If your plan is underfunded (below 60%), a lump sum may be prudent to avoid future cuts. However, compare the lump sum to the cost of purchasing a commercial annuity with the same benefits. Consult a fiduciary financial planner.

Question: What happens if my company goes bankrupt and my pension is underfunded? If your company has a private-sector pension, the PBGC will take over. You will receive benefits up to the guarantee cap ($83,058/year at age 65 in 2025). Benefits above this cap are lost. For public-sector pensions, bankruptcy is rare but possible—e.g., Detroit's bankruptcy in 2013 led to 4.5% cuts to pension benefits for general city workers.

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This article is for educational purposes only and does not constitute financial, legal, or tax advice. Pension laws and regulations vary by state and employer. Always consult with a qualified financial planner or attorney before making decisions about your retirement benefits. Data sources include the Federal Reserve Flow of Funds, Public Plans Database, Pew Charitable Trusts, Vanguard, and the PBGC. For personalized guidance, consider working with a Certified Financial Planner (CFP®) or joining our Retirement Planning Workshop.