America's public pension systems have notched their strongest funded position in nearly two decades, but a $1.13 trillion shortfall and a growing concentration of bets on AI are clouding what might otherwise be an unambiguous success story.
The national funded ratio for state and local pension systems is projected to reach 85.0% in fiscal year 2026, up 3.9 percentage points from 81.2% in 2025, marking the fourth consecutive year of improvement and the best level since 2009, according to Equable Institute's seventh annual State of Pensions report, which analyzed 253 statewide and municipal retirement systems across all 50 states and the District of Columbia.
The headline number looks encouraging with total unfunded liabilities down to an estimated $1.13 trillion from $1.37 trillion in 2025, and plans are projected to earn a 9.4% average investment return, beating the 6.9% assumed target for the fourth straight year. Forty-five states improved their funded status and seven are now 100% funded or better.
But the report's fine print offers less comfort than the top line.
Employers now contribute a record 31.83 cents of every payroll dollar to pensions; more than triple the 2001 rate; and only about 9.4 cents of that covers new benefits.
The rest is going toward paying down the accumulated debt of prior underfunding, squeezing state and municipal budgets in ways that could eventually affect public services, tax policy, and the broader fiscal environment that advisors monitor for their clients.
That structural pressure is compounded by budget pressures mounting across the 50 states, where tax revenue growth has slowed as healthcare and education costs grew — pressures that are carrying over into 2026.
Among the three dozen states projecting structural budget gaps are California, Washington, Colorado, Iowa, Kentucky, and Maryland.
Perhaps the most striking finding in Equable's 2026 report is the degree to which public pension recovery has become tied to a narrow slice of the equity market.
Equable estimates that 8% to 10% of public pension assets or roughly $513 billion to $642 billion, are directly exposed to a basket of AI-related companies, likely an undercount given limited transparency in private equity and externally managed holdings.
The report cautions that pension funds increasingly look alike, making similar investments and owning the same handful of giant companies. When markets do well, nearly everyone does well, but the same bets mean a single downturn could drag almost all of them down at once.
More than 27% of pension dollars are now invested in assets whose value is estimated rather than set by an open market; the highest level on record.
That means a significant portion of the reported improvement in funded ratios rests on valuations that have not yet been tested by a market transaction. Fiscal 2026 asset allocations were estimated at 43.99% to equities, 23.79% to fixed income, 14.05% to private capital, 8.62% to real estate, 5.17% to commodities and miscellaneous assets, and 4.38% to hedge funds.
Equable executive director Anthony Randazzo was direct about the limits of the recovery.
"Public plans have steadily improved their funding over the last several years thanks to record high contribution rates and steadily positive investment returns," he said. "However, many states reporting strong funded status are relying heavily on the accuracy of private equity and real estate valuations. And all states are — intentionally or not — now relying on an AI-driven economy to propel them forward and prevent a funded status regression."
"This is a better position for the country than year over year increase in unfunded liabilities, but there is no guarantee this recovery progress will persist," he added.
Wealth managers advising clients in or approaching retirement should pay close attention to which state systems their clients participate in, and how those systems are positioned should equity markets and AI valuations in particular experience a correction.
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