An OPEB trust fund is a legally separate, irrevocable pool of money that a state or local government uses to pre-fund the retiree benefits it has promised outside of pensions, most commonly healthcare, dental, vision, prescription drug coverage, and life insurance. The government contributes money, the trust invests it, and the trust pays benefits to retirees over time. Once assets are in the trust, they cannot be pulled back into the general budget, they can only be spent on retiree benefits, and they are shielded from the government’s creditors.1
Those three features are what make it a trust rather than a reserve account, and they are what unlock favorable accounting treatment under Governmental Accounting Standards Board rules. Without a qualifying trust, the same promises still exist, but they sit on the government’s books measured under harsher assumptions.
What the Trust Pays For
OPEB stands for Other Post-Employment Benefits, meaning every benefit a government provides to former employees after they leave service except pension payments. Retiree healthcare is by far the largest piece. Medical, dental, and vision coverage for retirees and their dependents can run for decades and is exposed to healthcare inflation that consistently outpaces general prices. Life insurance and prescription drug plans for retirees round out the typical list.
One item catches many governments by surprise: the implicit rate subsidy. When active employees and retirees share the same health insurance pool at the same premium, younger workers effectively subsidize the higher medical costs of older retirees. Even if the government never writes a direct check for retiree coverage, that built-in cost shift is an OPEB liability that has to be measured and reported. Letting retirees stay on the group health plan at a blended premium is providing a real economic benefit, whether the government intended it or not.
Unlike pensions, where the benefit amount is usually predictable, OPEB costs move with medical inflation, drug pricing, and shifts in the retiree population. That volatility is a large part of why dedicated trust funds exist.
The Three Structural Requirements
To qualify as an OPEB trust under GASB Statement No. 75, the arrangement has to meet three conditions:
- Employer contributions and the investment earnings on those contributions are irrevocable. The government cannot claw the money back to close a budget gap.
- The trust’s assets are dedicated exclusively to paying retiree benefits.
- The assets are legally protected from the creditors of the employer, any other contributing entity, and the plan administrator.1
Meeting all three matters because it changes the discount rate the government uses to measure its liability. A qualifying trust lets the government apply the expected long-term investment return on trust assets to benefit payments the trust is projected to cover. A government without a qualifying trust has to discount future benefit payments using a yield on high-quality tax-exempt municipal bonds, which is much lower. Lower discount rate, larger reported liability. For a mature plan, the reported number can shift dramatically based on which rate applies.
Section 115 or VEBA: Choosing a Tax Structure
Governments generally set the trust up under one of two sections of the Internal Revenue Code. Both let investment earnings grow tax-free, which is essential because decades of compounding is what makes pre-funding work in the first place. They differ mainly in setup burden and governance.
Section 115 Trusts
Most governmental OPEB trusts are organized under Section 115, which excludes from federal income tax any income that comes from performing an essential government function and accrues to a state or political subdivision. To qualify, the trust has to operate as a separate legal entity, hold its assets apart from the sponsoring government’s other funds, accept contributions only for the exclusive purpose of providing retiree benefits, and prohibit any reversion of assets back to the government. If a participating entity leaves, its allocated assets must transfer to another fund carrying the same exclusive-benefit restriction.
Governments are not required to obtain an IRS private letter ruling before creating a Section 115 trust, though some do so for added certainty. Governance is usually handled by the sponsoring government’s existing governing body, such as a city council or school board. An independent board is not required. Forming an oversight committee with relevant expertise is a common and advisable step.
Section 501(c)(9) VEBA Trusts
The alternative is a Voluntary Employees’ Beneficiary Association organized under Section 501(c)(9). A VEBA is structured as an employees’ association rather than an arm of government. It has to exist independently of both the employer and the employees, and it must be controlled either by its membership, by independent trustees, or by trustees designated through collective bargaining. At least 90 percent of its members on one day of each quarter must be employees sharing an employment-related bond, such as a common employer or union affiliation.
Unlike a Section 115 trust, a VEBA requires an IRS determination letter before it can be established, which adds time and cost. VEBAs also tend to involve employees more directly in governance, which can help where labor relations are central but adds administrative complexity. No part of the net earnings may benefit any private individual beyond the payment of covered benefits.
Funding the Trust
How much money goes in each year is driven by an actuary’s calculation of the Actuarially Determined Contribution, or ADC. The ADC covers two things: the normal cost (the present value of benefits employees earn in the current year) and an amortization payment that chips away at any existing unfunded liability.
Governments generally fall into one of three postures:
- Full pre-funding. The government contributes the entire ADC each year and systematically reduces the gap between assets and obligations.
- Partial funding. The government contributes something but less than the full ADC. Progress is made, but the liability keeps growing.
- Pay-as-you-go. The government only pays benefits as they come due and contributes nothing to a trust. The liability keeps growing and no investment returns offset future costs.
The Government Finance Officers Association recommends that every government offering OPEB commit to funding the full ADC each period, while acknowledging some employers need a transition period to get there. In practice, most state OPEB plans remain severely underfunded, with the majority holding less than a third of what they owe.
Actuarial valuations must be performed at least every two years under GASB 75, and more frequent valuations are encouraged. Each valuation recalibrates the ADC using updated assumptions about healthcare cost trends, mortality, employee turnover, and how the trust’s investments actually performed. A few bad investment years or a spike in medical inflation can push the ADC sharply higher.
Reporting: GASB 74 and GASB 75
Two GASB standards control the financial reporting for OPEB trusts and their sponsoring governments.
GASB Statement No. 74 governs the trust itself. A qualifying trust must publish a statement of fiduciary net position (its assets and liabilities) and a statement of changes in fiduciary net position (contributions and investment income, minus benefit payments and expenses). The trust also has to disclose its investment policies, any concentration of investments exceeding five percent of total assets in a single organization, and the annual money-weighted rate of return on investments.
GASB Statement No. 75 governs the employer’s books. The central number is the Net OPEB Liability: the Total OPEB Liability (the actuarial present value of projected future benefit payments attributed to past service) minus the assets accumulated in the trust. The discount rate used to calculate the Total OPEB Liability is a blended rate. The expected long-term return on trust investments applies to benefit payments the trust is projected to cover; a high-quality tax-exempt municipal bond yield applies to any projected payments that exceed the trust’s resources. A well-funded trust can use the higher investment return rate for almost the whole liability. Employers also have to publish a sensitivity analysis showing how the Net OPEB Liability would shift if the discount rate moved up or down by one percentage point.
Fiduciary Duties and Investment Governance
The board overseeing an OPEB trust owes a fiduciary duty to the plan’s beneficiaries. Every investment decision has to be made solely in the interest of retirees who depend on the trust. The governing standard is the Prudent Investor Rule, adopted in every state, which requires trustees to manage assets with the care, skill, and caution a prudent investor would use under similar circumstances.
Under that rule, trustees evaluate the portfolio as a whole rather than judging individual investments in isolation, and diversification across asset classes is required to avoid concentrated bets. The practical expression of these duties is an Investment Policy Statement approved by the governing board, spelling out asset allocation targets, risk tolerances, return benchmarks, and rebalancing rules.
OPEB trusts should not simply copy a pension fund’s asset allocation. Retiree healthcare costs tend to be front-loaded compared to pension payments, running higher in the near term and tapering as the retiree population ages. That shorter effective duration usually calls for a different mix of equities and fixed income than a pension fund covering the same workforce. Investment and actuarial teams should model the specific timing and size of projected benefit payments and build an allocation that matches those cash flows.
When selecting investment managers and service providers, the board should run a competitive process and scrutinize all fee disclosures, including any third-party compensation managers receive from the products they recommend.
Why the Funding Level Matters Beyond Accounting
Unfunded OPEB liabilities are not just an accounting figure. Credit rating agencies treat them as real debt when evaluating a government’s financial position, and a lower credit rating translates directly into higher borrowing costs on municipal bonds. That is money taxpayers pay for roads, schools, and infrastructure.
Large unfunded OPEB liabilities also crowd out current services. Every dollar spent covering retiree benefits on a pay-as-you-go basis is a dollar unavailable for police, fire, or education. Establishing a qualifying trust and consistently funding it at or near the ADC is one of the few strategies that addresses both the accounting problem and the underlying cash-flow pressure at the same time.