Austin Tax Blog


Despite its fiscally conservative reputation, Texas governments are popular for managing their finances well. However, the state continues to face economic problems with underfunded public pensions. The state’s largest cities, such as San Antonio, Houston, Dallas, and Austin, struggle with increasing public-pension debt. These growing expenses make it difficult for Texas to spend on other essential services such as road repairs and public safety. 

There are hundreds of public retirement systems in Texas. Out of which, less than a hundred correspond to pre-funded defined-benefit plans, while the remaining are pay-as-you-go defined-benefit systems. In such a system, governments pay pensions from their annual budgets and do not pre-fund them. Other defined-contribution plans are the same as private-sector 401(k) plans.

Types of Retirement Plans

A large percentage of Texas’ defined-benefit plans offer an annual retirement benefit, based on the number of years an employee works. Other factors include the employee’s salary over his/her final years of service. All contributions from workers and employers provide coverage for the cost of promised benefits. Pre-funding guarantees that these benefits are fiscally sustainable and paid when due. Plus, the taxpayers and politicians who promised these benefits bear the costs of providing them. However, many Texas pensions are not fully funded.

Generally, an issue for public pensions is that the plan must assume a return rate on the invested portfolio, future health care costs, and an inflation rate, in some instances. Since many ‘unknowns’ are involved, a plan is not ‘fully funded’ if these assumptions do not hold. Public pension funds may assume investment returns of nearly 7% or above, which is very rare.

Fundamentally, there are three types of retirement plans in Texas and local governments.

DB or Defined Benefit Plans

Such plans refer to defined benefit plans in which the employer sets up a retirement fund for every employee who manages investments. In this plan, the employer utilizes a formula to determine each employee’s unique benefit amount due to retirement. Typically, participating in a DB plan is mandatory, and the employer guarantees benefit payments. The employer is responsible for all investment funds and tackles any related risk. 

DC or Defined Contribution Plans

Employers sponsor the DC plans through which they offer employees optional enrollment in an individual retirement account. For instance, the account may correspond to the private sector 401(k) plan. 

In the defined contribution plan, both employers and employees contribute. However, government employers may not contribute. In these plans, individual employees are responsible for investments and risks. Employees should choose from several different plan options, generally in annuities and mutual funds. Benefit amounts depend on the contributions and investment returns. Thus, future retirement payments rely on investment performance.

Hybrid Plans

These plans involve mandatory contributions to both a DC and DB plan. Hence, both employers and employees share risk management. The DC component provides employees a little control over their investment portfolios, whereas the DB component guarantees a monthly annuity to the employees. 

Typically, employees must participate in public hybrid plans. The cash balance plan is another variation, which resembles a DB plan. However, the employees and employer make contributions in individual accounts instead of a pooled trust fund. Many local governments in Texas use the cash balance plan. In turn, the defined benefits are an investment account balance at retirement, much like a 401(k), instead of a fixed monthly payment.

Pension Plans in Texas

Pensions help employers retain skilled employees/workers working in dangerous or low-paying public sectors. If you are a firefighter or a police officer, you receive a generous retirement fund for your service years. However, the private sector moved away from pension plans a long time ago due to rising costs and liability.

Although DB plans are nearly nonexistent in the private sector, many local and state governments continue offering these benefits. As of 2018, almost 86% of all local and state government employees in the U.S. can participate in a DB plan, as per the U.S. Bureau of Labor Statistics, while 37% could join a DC plan. Nearly 89% of all local and state employees having access to a DB plan joined the plan, versus 45% of those who have access to a DC plan.

On a state level, the Employee Retirement System (ERS) and the Teacher Retirement System (TRS) are the two most extensive pension plans. These plans comprise 72% of its total pension debt or two-thirds of Texas’s entire retirement pension plans. Both the TRS and ERS are the state’s largest public retirement systems that serve nearly 1.5 million and 360,000 members, respectively. During the past decade, the funded ratios of both systems declined considerably. 

As per the Employee Retirement System of Texas, Texas’ retired state employees and beneficiaries’ monthly pension is $1,690, on average. According to the Teachers Retirement System of Texas, a teacher with a service record of 16 to 20 years at a salary of $42,813 receives a retirement benefit of $1,292/month. Another issue with TRS is that many school districts don’t contribute to Social Security, which means the teachers do not enjoy this benefit and their public pension. 

How to Choose the Best Plan 

DC plans resemble 401(k)s and allow individuals to control their future instead of relying on government-directed DB plans. Furthermore, DC plans are sustainable and portable since they rely on retirees’ contributions and a fixed match from the government. However, the employee bears the risk of investment performance. Since retirees can evaluate and reduce these risks, DC plans give employees more freedom to meet their retirement goals. 

Final Thoughts

While a pension is a reliable income source for funding your retirement, these plans are becoming rare as more companies encourage their workers to take the lead in supporting their retirement plans. However, you can still participate in a retirement plan to get more out of your retirement fund. 

Participating in a defined contribution plan, such as a 457 plan for local and state government employees and a 403(b) for teachers, is a great idea to save more for retirement.