Public pension plans, also referred to as governmental plans, are generally plans that provide retirement or deferred income to employees of the U.S. government, a state government or its political subdivision, or any agency or instrumentality of those governments. According to a 2010 GAO report, approximately 20 million employees and over 7 million retirees and survivors are covered by state and local government pension plans, typically through a traditional defined-benefit plan. Recently, questions have been raised about the funded status of many public pension plans, as it has been reported that many of these plans are facing substantial future funding shortfalls. Concerns have been raised that these liabilities could jeopardize the fiscal stability of some state and local governments. There is considerable debate over whether this is a problem that needs to be addressed and if so, the cause and the extent of public pension plan underfunding. While it has been reported that public pension funds experienced recent gains, some of the estimates have placed the combined unfunded liabilities anywhere from hundreds of billions of dollars to over $3 trillion. In an effort to address these issues, some legislators and others have argued to reform public pension plans and the benefits they offer. In 2011 alone, over 20 states introduced or passed legislation aimed to reduce or otherwise modify pension plan benefits for current or future retirees, and more proposals have been introduced this year. This report provides an overview of how public pension plans are regulated at the federal and state levels. It discusses selected legal issues that may arise if attempts are made to remedy or prevent public pension plan underfunding, in particular, by changing plan benefits. This report will also briefly address possible federal regulation of state and local public pension plans. Employment-based retirement benefits are governed at the federal level by two main laws, the Employee Retirement Income Security Act (ERISA) and the Internal Revenue Code. In general, these two laws address two types of pension plans: defined benefit and defined contribution plans. Under a defined benefit plan, an employee is promised a specified future benefit, traditionally an annuity beginning at retirement. Benefits often are based on average pay and years of service. To fund the plan, an employer makes contributions to the common pension fund that are actuarially expected to grow through investment to cover the promised benefits. Under the terms of the plan, employees may make contributions as well. Most public pension plans are traditional defined benefit plans. A defined contribution plan (e.g., a 401(k) plan) is one in which the contributions are specified, but not the benefits. A defined contribution plan (also called "an individual account" plan) is one that provides an individual account for each participant that accrues benefits based solely on the amount contributed to the account and any income, expenses, and investment gains or losses to the account. The employee bears the investment risk in a defined contribution plan. Some state and local governments maintain defined contribution plans, and there have been proposals in various states to switch from a defined benefit to a defined contribution plan. Enacted in 1974, ERISA provides a comprehensive federal scheme for the regulation of pension and other employee benefit plans offered by private-sector employers. While ERISA does not require an employer to offer employee benefits, it does mandate compliance with its provisions if such benefits are offered. Title I of ERISA imposes various federal standards aimed at protecting the interests of plan participants and beneficiaries, including reporting and disclosure, vesting, participation, funding, fiduciary duty, and civil enforcement requirements. Title IV of ERISA created a plan termination insurance program, under which pension benefits are paid to plan participants and beneficiaries up to a statutory maximum if the benefits cannot be paid by the employer. Public pension plans are generally exempt from these provisions of ERISA, but may be subject to federal regulation under the Internal Revenue Code. The Internal Revenue Code grants certain tax benefits to "qualified" retirement plans. Among these tax advantages, employer contributions to a qualified plan on behalf of its employees are tax deductible for the employer. In addition, qualified retirement plan participants do not pay tax on employer contributions or the benefits they accrue in the pension plan until the participant (or beneficiary) takes a distribution. Given that state and local governments do not pay federal taxes, the tax benefit for employer contributions is irrelevant to them. However, public pension plans must be qualified so that the plan participants can avoid paying taxes on their pension benefits until the benefits are actually received. In order to be a qualified plan under the Internal Revenue Code, pension plans must meet several requirements. Governmental plans, however, are only subject to a subset of the qualification requirements that private-sector pension plans must meet. In many cases, public pension plans are subject to different requirements under the Internal Revenue Code than private-sector plans, including certain less stringent pre-ERISA requirements for vesting and funding. Aside from the requirements set out in the Internal Revenue Code, public pension plans are primarily regulated under state statutes, local ordinances, and state constitutions. These laws typically address the basic features of public pension plans, including eligibility, contributions, and types of benefits provided, and the laws vary widely from jurisdiction to jurisdiction. While public pension plans have no guarantor of plan benefits, states generally have constitutional or statutory provisions that dictate how pension plans are to be funded, protected, managed, or governed. In evaluating whether pension plan benefits may be modified, requirements for benefit accrual and vesting are implicated. Under federal law, both ERISA and the Internal Revenue Code provide requirements for benefit accrual, which generally refers to the rate at which benefits are earned by a plan participant. Both federal laws prohibit private-sector pension plan amendments that eliminate or reduce benefits already accrued by plan participants. This prohibition is commonly referred to as the "anti-cutback rule." However, private-sector pension plans may be free to freeze accrued benefits, reduce the rate at which benefits will accrue in the future, or eliminate future benefit accruals altogether. In other words, under the anti-cutback rule, past benefit accruals are protected, but future benefits accruals can be modified. Governmental plans are exempt from the anti-cutback rule. Therefore, analysis of the changes that may be made to accrued benefits under a public plan is a state-by-state inquiry. While accrued benefit refers to the amount of benefits earned, vesting occurs under federal law when a plan participant's accrued benefit is considered to be non-forfeitable. ERISA and the Internal Revenue Code impose two general vesting requirements on private-sector defined benefit pension plans: one depending on age and one depending on length of service. Governmental plans are exempt from these federal vesting requirements. However, in order to be qualified, governmental plans must meet pre-ERISA vesting standards under the Internal Revenue Code, which include the requirement that upon plan termination or complete discontinuance of contributions, employees' rights to benefits accrued as of the date of the termination or discontinuance are non-forfeitable, but only to the extent that the benefits are funded. States may also impose additional vesting requirements for pension benefits, and these can vary by state. Recently, in an effort to alleviate pension plan underfunding and protect state and local government budgets, governors and legislators in several states have proposed and enacted various modifications to their pension plans. Over the past few years, almost two-thirds of states have made some form of benefit and/or contribution change to their plans (e.g., reducing benefit levels, requiring higher employee contributions, or amending age and service requirements to lengthen the accumulation and shorten the distribution period of pension benefits). While the majority of changes are directed at future participants and/or benefit accruals, some of the changes affect current employees and retirees. Although states may not face obstacles in changing the pension benefits available for new employees, the issue is not as clear with respect to existing ones. As discussed below, certain legal parameters may affect the ability of state and local governments to amend their pension plans. These parameters vary by state and depend on each state's laws and constitutional provisions governing its retirement system, what these laws provide with respect to the protection of an individual's pension benefits, and when any right to a pension benefit attaches. Courts have conceptualized the legislative modification of public employee pension plan benefits in different ways. Historically, most courts viewed public pensions as gratuities that could be amended at any time. Although it may not be controlling in the interpretation of a state law, the Supreme Court has historically found that statutes providing retirement benefits to pensioners create a mere "expectancy" that may be modified, revoked, or suspended by the authority granting it through subsequent legislation. However, this view has now been abandoned in most states, and public employee pension benefits are generally afforded greater protection under current state and constitutional law. This is, at least in part, because many courts now characterize public plan pensions as deferred compensation—that an employee is entitled to these benefits for work that has already been performed. In rejecting the gratuity approach to public pensions, many state courts have found that based on common law, state statute, or state constitution, public pension benefit plans create a contract between the state and plan participant. If a contract is found to exist between the state or local government and pension plan participants, then this can limit the ability of a state to amend its pension plans. In some states, there is a specific constitutional provision addressing protection for public pensions as contractual obligations. At least six states have a constitutional provision that, in general, explicitly provides that membership in, or accrued benefits from, a state's retirement system creates a contract between the state and its employees that cannot be impaired. One lawsuit demonstrating the effect of this type of pension protection is McDermott v. Regan . In this case the New York legislature, in response to a state fiscal crisis, changed the funding method for the state's retirement systems. The change had the effect of reducing the government's contribution to the system.