Location:
EDUCATION - FINANCE; EDUCATION - VOCATIONAL/TECHNICAL; SCHOOLS;
Scope:
Other States laws/regulations;

OLR Research Report


October 18, 2010

 

2010-R-0433

OLR BACKGROUNDER: PUBLIC EMPLOYEE PENSION CHANGES IN OTHER STATES

By: Janet L. Kaminski Leduc, Senior Legislative Attorney

A growing number of states face large unfunded liabilities in their public employee pension systems. The unfunded liability of a pension system is the difference between the actuarial accrued liability (i.e., pension commitments) and the valuation of assets available to meet the liability. Many states are also facing strained budgets. As a result, various states' policy makers have been considering pension system changes.

There are legal restrictions on reducing pension benefits for current employees or retirees in most states. Therefore, most of the changes in recent years have been made to new employee benefits. This report presents four categories of pension reform some states have taken in recent years to reduce or slow the growth of unfunded liabilities:

1. reducing pension benefits or increasing the retirement age,

2. increasing employee contributions toward pension benefits,

3. reducing cost-of-living adjustments to pension benefits, and

4. introducing defined contribution or hybrid (combined defined benefit and defined contribution) plans.

The report provides specific state examples for each type of action, but is not meant to be an exhaustive list of state activity. The states highlighted in the report are shown in Table 1.

Table 1: State Examples of Pension Changes

 

Reduced Benefits or Increased Retirement Age

Increased Employee Contributions

Reduced Cost-of-Living Adjustments

Introduced Defined Contribution or Hybrid Plan

Arizona

X

     

Colorado

X

X

X

 

Georgia

     

X

Illinois

   

X

 

Iowa

X

X

   

Louisiana

   

X

 

Michigan

     

X

Minnesota

   

X

 

Missouri

 

X

   

Nevada

X

 

X

 

New Hampshire

 

X

   

New Mexico

 

X

   

Rhode Island

X

     

Texas

X

X

   

Utah

     

X

Information for this report is from:

1. National Conference of State Legislators' annual legislative reports, http://www.ncsl.org/default.aspx?tabid=13399 and

2. “The Trillion Dollar Gap – Underfunded State Retirement Systems and the Road to Reform,” The Pew Center on the States (Feb. 2010) http://downloads.pewcenteronthestates.org/The_Trillion_Dollar_Gap_final.pdf.

For an overview of Connecticut's pension systems, see “State Employees and Teachers' Retirement Systems,” OFA-OLR Research Report 2010-R-0268.

REDUCED PENSION BENEFITS OR INCREASED RETIREMENT AGE

A number of states have reduced retiree pension benefits by making changes to their pension formula. One part of the benefit formula is the average salary calculation: the higher the average salary, the higher the pension benefit. Limiting how salary increases are counted toward the average salary calculation reduces the pension benefit.

States are also requiring employees to work more years before they are eligible for retirement. This delays when benefits are paid out and means contributing employees pay into the system longer before they start collecting benefits.

Arizona

Arizona law changes retirement provisions of the Arizona State Retirement system for employees who join the system on or after July 1, 2011 (Chapter 50, Laws of 2010 (HB 2389)). For affected employees, the act:

1. modifies the “average monthly compensation” used to calculate a retiring member's retirement benefit from the average of the highest consecutive 36 months in the last 120 months to the average of the highest consecutive 60 months in the last 120 months,

2. increases the normal retirement date by changing from the “rule of 80” (age plus years of service must equal 80 to receive benefits) to the rule of 85, and

3. reclassifies early retirement to require a 3% decrease in benefits for each point or fraction of a point less than 85 but equal to or greater than 82.

Colorado

Colorado law makes numerous changes in the retirement benefits the Public Employee Retirement Association (PERA) offers teachers and state and local government employees (Chapter 2, Laws of 2010 (SB1)). Among other things, the act increases the age and service requirements for a normal retirement date.

For members with less than five years of service as of January 1, 2011, normal retirement will follow the rule of 85. For members who join the system between January 1, 2011 and January 1, 2017, normal retirement will follow the rule of 88 with a minimum age of 58. For members who join the system on or after January 1, 2017, normal retirement will follow the rule of 90 with a minimum age of 60.

The law also imposes an 8% cap on the amount of salary increases from one year to the next that will be counted toward the highest average salary calculation. This change applies to vested members who are not eligible for retirement on January 1, 2011 and nonvested members. (Vested members are employees who have worked in the system long enough to have earned the right to a pension, even if the person is not yet eligible to retire.)

Iowa

Iowa law makes changes to the Iowa Public Employees' Retirement System (IPERS) (House File 2518, signed into law April 23, 2010). For employees who are not vested by July 1, 2012, the act (a) increases the vesting requirement from four years to seven years and (b) changes vesting regardless of years of service from employment at age 55 to age 65.

The act changes the final average salary calculation to a member's highest five years of salary instead of the current three years. It also imposes a 6% per year reduction in retirement benefits for each year the member receives benefits before age 65. This reduction applies to service earned after July 1, 2012.

Nevada

Nevada law changes the eligibility and benefit formula for employees who join the Public Employees Retirement System after January 1, 2010 (Chapter 426, Laws of 2009 (SB 427)). For most employees in the system before 2010, normal retirement is permitted at age 65 with five years of service, age 60 with 10 years of service, or 30 years of service. For new employees joining after January 1, 2010, the law changes age 60 to age 62 with 10 years of service.

State employees hired after January 1, 2010 will have their annual pension benefits calculated using a new formula. In the past, the benefit formula multiplied average final compensation (the 36 highest consecutive months) by 2.5% by years of service and added 2.67% for years of service earned after July 1, 2001. The law removes the 2.67% portion of the formula.

The law also increases the actuarial reduction for early retirement for new employees from 4% to 6% per year.

Rhode Island

Rhode Island made changes to its retirement eligibility and benefits provisions in 2009 (Article 7, Chapter 68, Laws of 2009 (HB 5983)). The normal retirement age for (1) new employees is age 62, up from 60, and (2) current workers depends on their length of service. The law also bases average final compensation for pension calculation on five years, up from three years, for employees eligible to retire on or after October 1, 2009.

Texas

Texas changed its retirement eligibility and benefits for members of the Employee Retirement System hired after September 1, 2009 (Chapter 1308, Laws of 2009 (HB 2559)). Normal retirement eligibility for new employees is age 65 with 10 years of service or the rule of 80 with five years of service. This is up from the normal retirement age for current workers, which is age 60 with 10 years of service or the rule of 80 with five years of service. The law also changes the calculation of final average salary from the highest 36 months to the highest 48 months.

INCREASED EMPLOYEE CONTRIBUTIONS

A number of states have increased the amount employees must contribute toward their pension benefits.

Colorado

Colorado law increases the employee contribution rates to PERA for state employees, troopers, and judges for FY 11 by 2.5% and decreases the employer contribution by the same amount (Chapter 65, laws of 2010 (SB 146)). The one-year change is expected to save the state $37 million.

Iowa

Iowa law increases contribution rates for employees and employers in IPERS (House File 2518, signed into law April 23, 2010). Under prior law, contributions will increase on July 1, 2011 to 11.95%, with members paying 4.7% of salary and employers paying 7.25%. Under the act, contributions will instead increase to 13.45% on that date, with employees paying about 40% of the total and employers paying about 60%. The act also allows IPERS to increase or decrease the contribution rate by one percentage point a year for members.

Missouri

In Missouri, a new law creates a contributory tier in the Missouri State Employees' Retirement System. Those hired after January 1, 2011 will have to contribute 4% of salary on a pre-tax basis to the retirement system (HB 1 of the First Extraordinary Session of 2010). Prior to this, Missouri pension plans did not require an employee contribution.

New Hampshire

New Hampshire law increases the employee contribution rate from 5% to 7% of salary for the New Hampshire Retirement System for employees hired after June 30, 2009 (N.H. Rev. Stat. Ann. 144.5ff (2009)).

New Mexico

New Mexico law temporarily increases the employee contribution rate under the Public Employees Retirement Act and the Educational Retirement Act for employees with an annual salary greater than $20,000 (Chapter 127, Laws of 2009 (HB 854)). The increase, 1.5% of salary, is effective from July 1, 2009 to June 30, 2011.

Texas

Texas law increases the employee contribution rate for the Employee Retirement System from 6% to 6.45% of salary (Chapter 1308, Laws of 2009 (HB 2559)). The law also establishes a contribution rate of 0.5% for law enforcement and custodial members, whose plan was previously non-contributory.

REDUCED COST-OF-LIVING ADJUSTMENTS

Pension benefits often increase annually by a set cost-of-living adjustment (COLA). A number of states have limited future COLAs.

Colorado

Colorado law reduces PERA's retirement COLA (Chapter 2, Laws of 2010 (SB 1)). For 2010, the law reduces the COLA from 3.5% to the lesser of 2% or inflation and requires the inflation calculation to be based on 2009, resulting in a 0% COLA. For 2011 and future years, the law limits the COLA to 2%. When PERA investments lose money, the law

requires the COLA to be calculated as the lesser of inflation from the preceding three years or 2%. The law also requires members who retire after January 1, 2011 to receive benefits for at least 12 months before receiving a COLA.

Illinois

A 1996 law affects most statewide pension plans, including the State Employee Retirement System and the Teachers Retirement System (PA 96-889). The law applies to people who join the plans on or after January 1, 2011. Under the act, a beneficiary is eligible to receive a COLA one year after he or she begins receiving benefits or age 67, whichever is later. The COLA is 3% of the benefit or 50% of the Consumer Price Index, whichever is less. The increase applies only to the base pension and will not be compounded. (Prior law allowed a 3% annual COLA, compounded.)

Louisiana

A 2009 Louisiana law places limits on eligibility for COLAs and changes the terminology from “cost-of-living adjustment” to “ permanent benefit increase.” Effective July 1, 2009, a beneficiary must have been retired for at least one year and be at least age 60 to receive an increase (Act 497 of 2009 (SB 296)).

Minnesota

A new Minnesota law reduces or suspends pension COLAs (Chapter 359, Laws of 2010 (SF 2918 and HF 3281)). For state-administered plans, COLAs are reduced until the plans attain a 90% funding ratio. For example, the law reduces the Minnesota State Retirement Plan's COLA from 2.5% to 2%, the State Patrol Plan's COLA from 2.5% to 1.5%, and the Public Employee Retirement Association's COLA from 2.5% to 1%. The Teachers Retirement Association's COLA is suspended for 2011 and 2012, to be followed by annual increases of 2%. The law also requires a member to have been retired for at least six months before being eligible for a COLA.

Nevada

A 2009 Nevada law reduces the COLA for people who join the Public Employee Retirement System on or after January 1, 2010 (Chapter 426, Laws of 2009 (SB 427)). For previous members, the law provides for a

gradually increasing COLA percentage until the retiree's 14th retirement anniversary when the COLA tops off at 5%. For new members, the retiree's COLA will top off on the 12th retirement anniversary at 4%.

DEFINED CONTRIBUTION OR HYBRID PLAN

Some states have sought to change from a “ defined benefit” pension plan, in which employers put aside money to guarantee retirees a certain pension payment, to a “ defined contribution” system, similar to private sector 401(k) plans, which help workers save for their own retirements. Hybrid plans, which have components of both defined benefit and defined contribution plans, are also emerging.

In a defined benefit plan, the pension's administering body invests the pension funds. In a defined contribution plan, the administering body gives the employees a choice of how to invest their money.

Under a defined contribution plan, once the employee is retired the employer is not financially responsible for making payments from the plan to the retiree. Rather, a private financial institution, such as bank or benefits firm, holds the plan account for the retiree and the retiree can draw regular payments from the account.

Georgia

Georgia introduced a hybrid plan in 2008 for employees hired after January 1, 2009. The hybrid plan offers a defined benefit portion that provides about half of the benefit of the existing plan for employees hired before January 1, 2009. But the hybrid plan also offers a defined contribution portion in which the state matches employee contributions in a 401(k)-type savings plan. New employees are automatically enrolled in the defined contribution plan at a 1% contribution rate, but may opt out at any time.

Michigan

A Michigan law provides that new school employees hired after July 1, 2010 will be enrolled in a hybrid plan (Act 75 of 2010 (SB 1227)). The hybrid plan (1) increases the minimum retirement age and service requirements for its defined benefit portion in comparison to the existing defined benefits plan for school employees and (2) adds an optional defined contribution plan.

The defined benefit portion increases the final average compensation period from three to five years, increases the retirement age to age 60 with 10 years of service (up from age 55 or 30 years of service), and eliminates COLAs.

The defined contribution plan has a 50% employer match on employee contributions of up to 2% of salary. The plan will automatically enroll new employees at a 2% contribution rate, but an employee may opt out or opt for a different contribution rate. An employee will vest in the employer match as follows: 50% after two years of service, 75% after three years of service, and 100% after four years of service.

Utah

A Utah law closes the existing defined benefit plans of the Utah State Retirement Plan Tier I and establishes the New Public Employees' Tier II Contributory Retirement Plans (Chapter 266, Laws of 2010 (SB 63)). Employees hired on or after July 1, 2011 will be offered a choice between a defined contribution plan and a hybrid plan. Those not electing a plan will, by default, be added to the hybrid plan, except legislators and governors may join only the defined contribution plan.

Defined Contribution Plan. For the defined contribution plan, employees will have an individual account to which they may make contributions. The employer will contribute 10% of employee compensation (12% for public safety and firefighter members). Employee contributions vest immediately, while employer contributions vest after four years of service. The employee can direct the investment of his or her own contributions immediately and the employer contributions after they vest.

Hybrid Plan. The hybrid plan includes defined benefit and defined contribution components. Under the defined benefit portion, a person is eligible to retire at age 65 with four years of service, age 62 with 10 years of service, age 60 with 20 years of service, or any age with 35 years of service. The benefit formula for people who retire at age 65 or who have 35 years of service will be 1.5% of final average salary (the average of the five highest years) times years of service. An actuarial reduction will be taken for those who retire early. An annual COLA applies equal to the Consumer Price Index up to 2.5% maximum.

The employer will contribute up to 10% of the employee's compensation toward the amount that is required to keep the plan actuarially sound. Employees will have to contribute any additional amount to meet the actuarial requirement. The employee's contribution, if required, is immediately vested. If the employee leaves service without collecting a pension, his or her contributions will be refunded.

Under the defined contribution portion of the hybrid plan, the employer will contribute 10% of the employee's compensation, minus the amount the employer contributed to the defined benefit component. The funds will be deposited to a 401(k)-type plan to which the employee may choose to make additional contributions. Employer contributions vest after four years of service and employee contributions vest immediately. The employee can direct the investment of the employer contributions after they vest and his or her own contributions immediately.

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