Tuesday, March 18, 2014

A Review of the New Pension Benefit Law and Implementation for the Teachers Retirement System of Illinois (According to the TRS)

“Unless an injunction is filed and approved by the court to stop the implementation of PA98-0599, the following will become effective June 2014 with pension benefits being affected January 2015” —Ed Wollet.

Public Act 98-0599 (Senate Bill 1)
As of January 31, 2014

Note: A COLA Calculator is available that will help Tier I members estimate their first COLAs under the new law.

Issue: A new comprehensive plan to overhaul the Illinois Pension Code was signed into law by Gov. Pat Quinn on December 5, 2013. The goal of the new law is to stabilize TRS finances and eliminate the System’s unfunded liability by 2044, primarily by reducing benefits for retired and active members and creating funding guarantees and contribution levels that will gradually, over 32 years, fully fund TRS. The law was the product of six months of work by a joint House-Senate Conference Committee and negotiations between Democratic and Republican legislative leaders.

The Illinois House approved the law on December 3, 2013 on a 62-53 roll call with 60 votes needed for passage. The Senate vote was 30-24 with 30 needed for passage. [The first] lawsuits challenging the law as a violation of the Illinois Constitution’s pension protection clause were filed in Chicago and Springfield during December of 2013 and January of 2014. While the effective date of the new law is June 1, 2014, court challenges could delay implementation of the law’s provisions, but not necessarily the effective date, until a final ruling is made.

Discussion: For TRS alone, the law is designed to eliminate the System’s $55.7 billion unfunded liability by 2044. Eliminating the TRS unfunded liability would guarantee continuous pension payments for all generations of TRS members when they retire. With a 40.6 percent funded ratio, TRS cannot right now make that guarantee for future retirees. Because of decades of insufficient funding by the General Assembly, TRS, in effect, has less than 41 cents on hand for every $1 promised in retirement benefits to TRS members.

The law would reduce total state contributions to TRS over the next 30 years by an estimated $85 billion; money that could be used to fund other state services and programs. The law would reduce the future pensions of all active and retired Tier I members compared to pension calculated under current law. The average TRS pension is $48,216.

TRS will not take a position on the new law. It is the legislature’s job to dictate the laws and rules that govern TRS and other public pension systems. The job of TRS is to administer those laws and work to secure the System’s finances so that the promises made to generations of teachers by the General Assembly can be kept. The new law applies to all active, inactive and retired Tier I members (service before January 1, 2011). Tier II members are not affected.

Effective Date:
The effective date of the law is June 1, 2014. TRS is preparing to implement the law on that date. There are multiple court challenges to the law and a court may act to delay the implementation of the law, but there is no indication this will happen. Until a court says otherwise, June 1, 2014 is the date that the new law will take effect. No one should rely on or make plans based on the potential for a delay in the law’s implementation.

Active Tier I Members Salary Contribution Decrease:
Unless implementation of the law is delayed, active Tier I member contributions would decrease from 9.4 percent to 8.4 percent of salary beginning in the 2014-2015 school year. For a TRS member earning $70,000, the decrease reduces the contribution to TRS from $6,580 per year to $5,880, or $700.

Creditable Earnings Cap for Active Tier I Members:
The creditable earnings cap for Tier I members is equal to the creditable earnings cap for Tier II members at the time the law takes effect, which is June 1. In fiscal year 2014, the Tier II cap on creditable earnings that can be used to determine the Final Average Salary is $110,631.

·         Under state law, this salary cap rises annually by a rate that is equal to one-half of the annual rate of inflation in the previous year.
·         There are exceptions to the salary cap in the new state law that allow for a member to establish a cap that is higher than the statutory Tier I and Tier II cap. In general, if a member’s salary at the time the law takes effect is higher than the Tier II cap, then the Tier II cap does not apply to that member. Specifically:
·         For any member covered by an individual contract or collective bargaining agreement that is in effect on or prior to the effective date of the law, the cap will be the member’s annualized salary on the day that contract expires, even if that salary is higher than the statutory cap. A contract cannot be amended or extended after the effective date of the law to increase the cap.
·         For any member not under contract but with a current salary that exceeds the cap, that member’s salary cap would be set at their salary on the bill’s effective date, which right now is June 1. Members with a “grandfathered” salary would each have their own cap.
Increased Retirement Age for Tier I Active Members:
The law will gradually increase, over the next 30 years, the retirement age for all teachers by five years. The current minimum age of 55 years with 20 years of service, for instance, would over time increase to 60 years with 20 years of service.

The retirement age for members younger than 46 is set on a sliding scale based on your age at the time the law takes effect, which is June 1, 2014. Under this formula, the law essentially adds four months to the old minimum retirement age of 55 for every year that a member is under age 46 at the time the bill takes effect; until a total of five years has been added to the minimum retirement age.

·         For members aged 46 and older at the time the bill takes effect, the old retirement ages and eligibility remain in force: A member can retire between the age of 55 and less than 60 years with at least 20 years of service and receive a reduced benefit; or at age 60 or more with at least 10 years of service and receive a “full,” or non-reduced benefit.
·         At the top of the scale, for a member aged 45 at the time the bill takes effect, he/she can retire as early as 55 years and four months with at least 20 years of service and receive a reduced benefit, or as early as age 60 years and four months with at least 10 years of service and receive a “full,” or non-reduced benefit.
·         At the bottom of the scale, for a member aged 31 or younger at the time the bill takes effect, he/she can retire as early as age 60 years with at least 20 years of service and receive a reduced benefit, or as early as age 65 years with at least 10 years of service and receive a “full,” or non-reduced benefit.
New COLA Formula and Rates for Tier I Active and Retired Members:
When and if the law takes effect, there will be two formulas used to determine the size of each year’s cost of living adjustment. The COLA formula to be used will be determined each year by the current size of the member’s pension.

·         Each member, upon retirement, will multiply their total service credit by a factor that is initially set at $1,000 when the bill takes effect. This “pension threshold” will be used in the future to determine the annual COLA. For example, a member with 30 years of service upon retirement in 2016 would have an initial “pension threshold” set at $30,000.
·         Beginning in 2016 and in every year thereafter, the $1,000 threshold multiplier will be increased by the rate of inflation, but the rate will not fall below 0% in case inflation is negative.
·         As long as a member’s pension is less than their current pension threshold, when the member is eligible for a COLA it will be 3 percent compounded, which means calculated from the member’s current pension.
·         Once a member’s pension equals or exceeds their threshold, the COLA calculation changes. The COLA in every year then becomes 3 percent of the member’s current threshold amount.
COLA Calculation for Retired Tier I Members Awaiting Their First COLA:
Under state law a Tier I member that retires after attaining the age of 55 but before turning age 61 will accumulate an annual COLA. But he/she will not collect those accumulated COLAs until the January after he/she turns 61.

Under the old pension law, the COLA that accumulated for these members was 3 percent compounded.
Under the new law, if it is implemented at a time when a member is still accumulating COLAs but has not yet received any of those COLAs, and the member’s pension exceeds their current pension threshold, the calculation for the accumulated COLAs will be a combination of the old law’s 3 percent compounded increase and the new law’s increase, which is the current pension threshold multiplied by 3 percent. For these members, the separation between the old law calculation and the new law calculation will be the implementation date of the law, if the courts declare the new law constitutional.

Service Credit Used in the New COLA Formula:
The service credit that is used to determine a member’s eligibility for a TRS pension is different from the service credit used to calculate your “pension threshold” and your annual COLA.

·         TRS service credit includes:
o    All regular service
o    Any service time purchased by the member under an early retirement incentive
o    Any optional service purchased by the member, such as leaves of absence, substitute teaching and teaching service in another state
o    Unused sick time for anyone who is a TRS member prior to June 1, 2014.
·         Eligibility: The service credit that will be used to determine your eligibility for a pension will include all TRS service plus any service in a pension system that has reciprocal rights with TRS.
·         Threshold and COLA: The service credit that will be used in calculating your new “pension threshold” will be only TRS service credit and will equal the service credit that TRS used or will use to calculate your initial TRS pension at retirement.

The COLA Formula and Social Security:
Any TRS member that receives Social Security from a spouse’s benefit or from other employment will still use $1,000 as the initial “threshold multiplier” and will still receive their Social Security benefits.
Because TRS members don’t receive Social Security for their service in education and their TRS benefits are not coordinated with Social Security benefits, all TRS members will use $1,000 as the starting point for their first “threshold multiplier.” Because the members of some other state pension systems receive Social Security and have their benefits coordinated with Social Security, their “threshold multiplier” starts at $800.

Staggered COLA Forfeiture:
Tier I active members that retire on or after July 1, 2014 would forfeit at least one COLA increase, and as many as five increases, based on a sliding scale tied to the member’s age at the time the law takes effect, which is June 1. Following the prescribed forfeiture time frame, members will receive continual COLAs annually:

·         Any TRS member eligible to retire that does retire on or before June 30, 2014 will not have to forfeit any COLA increases.
·         50 years and older: Forfeit one COLA increase in a two-year time frame immediately after retirement. The second scheduled COLA would be forfeited.
·         47 to 49: Forfeit three COLA increases staggered every other year over a six-year time frame immediately after retirement, starting with the 2nd scheduled COLA
·         44 to 46: Forfeit four COLA increases staggered every other year over an eight-year time frame immediately after retirement, starting with the 2nd scheduled COLA.
·         43 and younger: Forfeit five COLA increases staggered every other year over a 10-year time frame immediately after retirement, starting with the 2nd scheduled COLA.
Actuarial Benefit Calculation Change:
In order to reduce the size of pensions determined by the actuarial calculation, the law changes the interest rates used in the formula from the mandated 6 percent and 8 percent to a single floating rate: The new floating rate is the interest rate on a 30-year U.S. Treasury bond plus 75 basis points. (0.75 percent) Under current conditions, for example, the new interest rate used in the formula would be 5 percent. The new rate changes annually.

Supplemental Pension Contributions:
When the state’s pension obligation bonds are paid off in 2019, the state will automatically earmark additional payments to TRS and the other state pension systems until the systems’ funding status reaches 100 percent. These payments will be in addition to the state’s regularly set pension contribution.

In FY 2019 the extra payment will be $350 million and $1 billion every year beginning in FY 2020. For TRS, this means a “supplemental” payment of $194 million in FY 2019 and $554 million in FY 2020 and every year after that until the unfunded liability is paid off. Also, beginning in FY 2016 the state will each year earmark 10 percent of the savings the state will realize from the law’s provisions to TRS.

Retiree Health Insurance Subsidies:
There are no changes to the administration or funding mechanism for the Teachers’ Retirement Insurance Program. The law prevents TRS from using any supplemental pension contributions from the General Assembly to help fund any state subsidies for retiree health insurance programs. TRIP will still be subsidized by state government, but not with money from the supplemental pension contributions.

Mandatory State Pension Contributions:
If the state does not pay its annual contribution to TRS within a set period of time, TRS could go to court to force the state to pay the contribution in the same way that the Illinois Municipal Retirement Fund can force local governments to pay their contributions. This provision, however, can be altered or repealed by the General Assembly in the future.

Optional Defined-Contribution Retirement Plan:
Up to 5 percent of Tier I TRS members will be able to freeze their current defined benefit pension plan benefits and join a new defined contribution benefit plan that will be in effect until the day they retire. Right now, a TRS DC plan could accept approximately 7,000 Tier I members.

The DC plan is open to active Tier I members only and would begin on July 1, 2015. Members would have one opportunity to elect membership in the new DC plan. Once members elect to join the DC plan, they cannot rejoin the DB plan unless the DC plan is ended by the legislature. A member would need to work at least 5 years in order to be vested in the DC plan.

On July 1, 2015, all members that have joined the DC plan would have their creditable service frozen on that date for purposes of determining a DB pension. To determine a member’s eligibility for a DB pension after the member switches to the DC plan, TRS would use the member’s service credit accumulated under both the DB plan and the DC plan at retirement.

Active members in the DC plan pay an 8.4 percent salary contribution. The state’s contribution would be determined annually. Upon retirement, members would receive a DB annuity, plus equal payments from an accumulated DC retirement account until those funds are exhausted.

Dear Reader:

This blog has more than three dozen pension analyses. To read any of them, click on the link “pension analyses” below the masthead, or navigate the right column of the blog. The link can also be found under “Taxonomies.”

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