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 other than pensions: mainly retiree health insurance, but also dental, vision, prescription drug coverage, and life insurance. The money is walled off from the government’s general budget, invested for the long term, and can only be spent on those retiree benefits. “OPEB” stands for Other Post-Employment Benefits, and across the country the gap between what governments have promised retirees in these benefits and what they have actually set aside topped $550 billion as of 2022.
The point of the trust is simple. Without one, a government pays retiree benefits out of each year’s operating budget as the bills arrive, and the full weight of decades of past promises lands on future taxpayers. With one, contributions made today earn investment returns for years or decades before the benefits come due, and those returns do a meaningful share of the work.
What a Trust Has to Do to Qualify
Not every reserve account counts. Under Governmental Accounting Standards Board rules, an OPEB trust must meet three conditions:
- Employer contributions and the investment earnings on them are irrevocable. The government cannot pull the money back to patch a budget hole.
- The trust’s assets are dedicated exclusively to paying retiree benefits.
- The assets are legally shielded from the creditors of the employer, any other contributing entity, and the plan administrator.
These criteria come from GASB Statement No. 75. Meeting all three is what separates a true OPEB trust from money a government has merely earmarked. It also unlocks a significant reporting advantage, discussed below.
Section 115 or VEBA: The Two Tax Structures
Governments typically organize an OPEB trust under one of two sections of the Internal Revenue Code. The choice shapes governance, setup time, and the paperwork required to get started.
Section 115 Trusts
Most governmental OPEB trusts are Section 115 trusts. Section 115 excludes from federal income tax any income that comes from performing an essential government function and accrues to a state or political subdivision. Investment earnings inside the trust grow tax-free, which matters a great deal because tax-free compounding over decades is the engine that makes pre-funding work.
To qualify, the trust has to be a separate legal entity, hold its assets apart from the government’s other funds, accept contributions only for the exclusive purpose of providing retiree health benefits, and prohibit any reversion of assets back to the government. If a participating entity leaves the trust, its allocated assets must transfer to another fund with the same exclusive-benefit restriction. A government is not required to obtain an IRS private letter ruling before creating a Section 115 trust, though some choose to do so for added certainty.
Governance is usually straightforward: the government’s existing governing body, such as a city council or school board, oversees the trust. An independent board is not required, though forming an oversight committee with relevant expertise is a common practice.
Section 501(c)(9) VEBAs
The alternative is a Voluntary Employees’ Beneficiary Association, or VEBA, organized under Section 501(c)(9). A VEBA is structured as an employees’ association rather than an arm of government. It must exist independently of both the employer and the employees, and it must be controlled 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.
Setup is heavier. A government must obtain an IRS determination letter before establishing a VEBA, which adds time and cost. VEBAs also tend to involve employees more directly in governance, which can be an advantage when labor relations matter but adds complexity. Earnings grow tax-free, and no part of the net earnings may benefit any private individual beyond the payment of covered benefits.
How Much Goes In
The target contribution each year is called the Actuarially Determined Contribution, or ADC. An actuary calculates it to cover two pieces: 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 take one of three postures:
- Full pre-funding, where the government contributes the entire ADC each year and systematically narrows the gap between assets and obligations.
- Partial funding, where the government contributes something, but less than the full ADC, making progress without keeping pace with the growing liability.
- Pay-as-you-go, where the government only pays benefits as they come due and contributes nothing to the trust. The long-term 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, though it acknowledges some employers need a transition period to get there. In practice, most state OPEB plans remain severely underfunded, with the majority having set aside less than a third of what they owe.
Under GASB 75, actuarial valuations must be performed at least every two years, with more frequent valuations encouraged. Each valuation recalibrates the ADC based on updated assumptions about healthcare cost trends, mortality rates, 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.
Why the Trust Changes the Reported Liability
The financial reporting payoff is substantial. When a government measures its Net OPEB Liability, it has to discount decades of future benefit payments back to a present value. The discount rate used is where a qualifying trust earns its keep.
A government with a qualifying trust can use the expected long-term rate of return on the trust’s investments as the discount rate for benefit payments the trust is projected to cover. A government without one must discount using the yield on high-quality, tax-exempt municipal bonds, which is substantially lower. Because a lower discount rate produces a larger present-value liability, the two approaches can produce dramatically different reported numbers for the same set of promises.
In practice, GASB 75 requires a blended rate: the expected investment return applies to payments the trust can cover, and the municipal bond yield applies to any payments that outrun the trust’s projected resources. A well-funded trust can use the higher rate for nearly the entire liability. A poorly funded one effectively gets stuck with the lower rate.
Who Runs the Trust and How the Money Is Invested
The board overseeing an OPEB trust owes a fiduciary duty to the plan’s beneficiaries. Every investment decision must be made solely in the interest of the retirees who depend on the trust for their benefits. The governing standard is the Prudent Investor Rule, now adopted in every state, which requires trustees to manage trust 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 they must diversify across asset classes. The practical expression of these duties is the Investment Policy Statement, approved by the governing board, which spells out asset allocation targets, risk tolerances, return benchmarks, and rebalancing rules.
One warning worth taking seriously: an OPEB trust should not simply copy a pension fund’s asset allocation. Retiree healthcare costs tend to be front-loaded compared to pension payments, higher in the near term and tapering as the retiree population ages out. That shorter effective duration generally calls for a different mix of equities and fixed income than a pension fund covering the same workforce. The 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 investment products they recommend.
Why Funding Levels Matter Beyond the Financial Statements
Unfunded OPEB liabilities are not just an accounting abstraction. Credit rating agencies treat them as real debt. S&P increased the weight of debt and long-term liabilities in its municipal rating model in 2024, making pension and OPEB obligations more influential in determining whether a government keeps a strong credit rating. For governments in states with generous retiree benefit structures, holding a top-tier rating has become measurably harder.
A lower credit rating means higher borrowing costs on municipal bonds, so taxpayers pay more for roads, schools, and infrastructure. Large unfunded OPEB liabilities also crowd out current public 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 trust and consistently funding it is one of the few strategies that addresses the accounting problem and the real cash-flow pressure at the same time.