Pension Reform Plan - Senate Bill 1
Senate Bill 1 would reform the benefits and improve the State funding for four State retirement systems: Teachers, Universities (including community colleges), State Employees and General Assembly.
The plan includes a reduction in annual cost-of-living adjustments on pension benefits (but no reduction in base benefits), creation of an optional defined-contribution plan, and improvements in the State’s funding of the systems.
Below is a summary of the proposed pension reform legislation for Illinois, Senate Bill 1:
These proposed reforms are expected to reduce the State’s pension payments by $160 billion over the next 30 years. Under these reforms, the state’s payments will be almost half of what we are projected to pay under current law (without reforms) over the next 30 years.
The State’s pension debt (our unfunded liabilities) would be reduced by more than $21 billion under this plan. That is a 20% reduction in our $100 billion debt, and would reduce that debt to $79 billion.
The savings (shown in a reduced payment) in the first year would be around $1.2 billion, which is about a 20% cut in the current-law payments. Annual savings would grow over time.
The State’s funding formula would be strengthened to meet national standards, reaching 100% funded (assets covering the liabilities for all earned benefits) in 30 years. The state is expected to hit 100% funded in about 25 years, leaving room under the formula to easily accommodate changes in investment and other assumptions and still reach full funding in 30 years. The current-law funding formula is to hit just 90% funded over 50 years (reaching that goal in 31 years, FY45). Right now, the State’s systems are only 40% funded.
As the State’s 2010 and 2011 pension bonds are paid off, the state will take the money that had been spent on those bond payments and use it to make extra payments to the pension systems. This would be $364 million in FY19 and $1 billion a year starting in FY20 until full funding is reached. (The State will continue to make the rising payments on the $10 billion in pension bonds sold in 2003 by Gov. Blagojevich. The 2003 bonds are not paid off until 2033.)
The State will further “prepay its mortgage” beginning in FY16 by devoting about 10% of the annual reform savings to another set of extra payments to the pension systems. (This funding improvement is a new idea, not included in any previous bills.)
All reforms apply to “Tier 1” retirees and employees, who are those first hired or elected before Jan. 1, 2011. Tier 2 employees (post-2010) have a different set of benefits which are less generous than these Tier 1 benefits will be under reforms.
Defined Contribution Plan: An optional defined-contribution plan (401k) would be created July 1, 2015 for all Tier 1 employees. The first 5% of employees in each system would be allowed to opt in. Those who opt in will keep their future defined benefits already earned (frozen as of the date of the opt-in) and going forward will get the investment value of their defined-contribution plan at retirement.
Employees who opted in would contribute to their account the same amount they would pay as employee contributions under reforms. The State would pay in a percentage of salary that each system determines will be cost neutral—so total State payments don’t increase and the defined-benefits plan is not harmed. Universities and State Employees project that the State’s contribution would be 7% (with a minimum of 3%). Teachers expect a lower State match, with a minimum that may go below 3%. Employees would get a wide range of investment options.
Reduction in COLA: COLA changes deliver most of the savings. Under the proposed reforms, the COLA paid annually for current and future retirees’ benefits would be lowered. Right now the systems pay 3% compounded on full benefits. Using the COLA reform framework from SB1, going forward the State would pay 3% not compounded (simple) on just a portion of benefits, not full benefits. The COLA would be paid only on a portion of benefits based on the retirees’ years of public service. This framework was suggested as a way to target COLA dollars at lower-wage, longer-term employees rather than high-wage earners and short timers.
COLAs would be paid on benefits equal to an initial $1,000 for every year of service for those without Social Security (teachers, college and university employees, legislators, and some State employees). For someone with 30 years of service, the COLA would be paid on the first $30,000 in benefits, with no COLA paid on benefits paid over that years-of-service base. (There is no limit on the years of service, so the base for someone with, say, 40 years’ service would be $40,000. Short timers would get a small COLA – for example, with 5 years service, a COLA would be determined on $5,000. Those with Social Security (most State employees) would get a COLA on benefits equal to $800 for every year of service.
These initial $1,000 and $800 amounts would grow each year by full inflation. In the first year of reforms, COLAs would be paid on $1,000 or $800 per year, but in future years the COLA would be applied to these amounts as they have been increased by inflation.
COLA Example: Using the example of the average retired teacher who has total benefits of $50,000, with a COLA base of $30,000 for 30 years of service, the first-year COLA would be $900 ($30,000 times 3%), for total benefits paid of $50,900. If inflation in the next year is 2%, the base would increase to $30,600 and the 3% COLA would be paid on $30,600 (or $918), with total benefits paid of $51,818. Each year’s new COLA will be paid on top of the previous year’s total benefits. Each year’s years-of-service base will be compounded, with any new inflation applied to the previous year’s base, but the COLA will not compound. So if there is 1% inflation in the third year, the COLA base would increase to $30,960 (the previous year’s base of $30,600 multiplied by 1%) and the 3% COLA paid would be $929 ($30,960 multiplied by 3%), with total benefits paid of $52,747.
Under current law, the COLA is 3% compounded on full benefits, so compared to the reform example above, the benefit with COLA in the next (first) year will be $51,500 (compared to $50,900 under reforms), in the second year, $53,045 the second year (compared to $51,818 under reforms) and $54,637 in the third year (compared to $52,747 under reform).
The result is that under reforms, the COLA rises gradually over time if there is inflation. In the rare case of initial benefits not reaching $1,000 per year, the COLA will be compounded until the full benefits reach the years-of-service base.
This COLA change applies to future benefits of current retirees and the benefits of current employees upon their retirement. The bill will provide that the reduction in COLA begins with the next COLA paid after July 1, 2014. But litigation may delay that reform start date to January 1, 2015, and perhaps longer.
COLA Skips & Delays: COLAs on future benefits of employees (not retirees) would be skipped every other year under the following schedule: Age 50 as of the effective date: miss one COLA; ages 49-47, miss three COLAs, ages 46-44, miss four COLAs, age 43 and under, miss five COLAs.
Increased Retirement Age: Retirement age would be raised by 5 years gradually for future benefits of employees age 45 and younger as of the June 1, 2014 effective date of the bill. Retirement age will not change for those 46 and older. Four months would be added to retirement age for each year of the employee’s age, reaching a total of 60 months more (5 years) for those now age 31 and younger. The increase in retirement age will apply to both full and early retirement ages which now range from 50 to 60 (with the vast majority at age 60). Here is the year-by-year scale, with examples for those with a current retirement age of 60:
o Age 46 and above: No change in retirement age.
o Age 45: current retirement age increased by four months, so employee with a current-law full retirement age of 60 could retire four months after their 60th birthday;
o Age 44: eight months added;
o Age 43: 12 months added, so employee could retire at age 61;
o Age 42: 16 months added;
o Age 41: 20 months added;
o Age 40: 24 months added, so employee could retire at age 62;
o Age 39: 28 months added;
o Age 38: 32 months added;
o Age 37: 36 months added, so employee could retire at age 63;
o Age 36: 40 months added;
o Age 35: 44 months added;
o Age 34: 48 months added, so employee could retire at age 64;
o Age 33: 52 months added;
o Age 32: 56 months added;
o Age 31: 60 months added so employee could retire at age 65.
Cap on high-dollar benefits: The bill would put a cap on high-dollar benefits (also known as the pensionable salary cap). This cap would say that benefits would be paid only based on a final average salary of $110,00 or less, even if the actual salary is higher. This $110,000 would grow by the lesser of 3% or half inflation (same as the Tier 2 cap).
Lowering of alternative benefits: Under current law, colleges’ staffers and teachers’ retirement initial benefit is the higher of (1) the regular-formula benefits or (2) an alternative “money purchase” benefit. Most colleges’ retirees (and a few teachers) get the higher alternative benefits. The reform would lower the “effective rate of interest” used to calculate the alternative benefits, which would in turn lower the alternative benefits to a level below regular benefits in most years. The new rate would be 75 basis points above 30-year Treasuries. This is projected to drop the current rate from 7.0% down to 4.0% for colleges’ retirees.
Employee contributions would be reduced by 1% of salary (so teachers go from 9.4% to 8.4%, most State employees go from 4% to 3%, etc.) This adds “consideration” and should improve the prospects of the reforms being upheld as constitutional.
Funding Guarantee: Each system (not individuals) could sue to enforce timely payment of the amount appropriated in each year by statute through the General Assembly.
Collective Bargaining of Pensions: The State would no longer be required to collectively bargain pension benefits.
Findings of Fact: Findings (legislative intent) will be included in the bill.
Pension Abuses: Pension abuse reforms previously included in SB 1 and SB2404 will be included. These include preventing future hires in several non-governmental organizations from getting public pension benefits. Also, new hires will not be able to include the value of travel vouchers in their final average salary, or have their years of service include unused vacation and sick days.
Using Pension Funds for Healthcare: The State systems will be specifically prohibited from using pension funds to pay for retiree health insurance.
NOT INCLUDED IN THE BILL:
Healthcare Guarantee: No guarantee of future retiree health care. There were concerns that, under SB 2404, healthcare benefits would be guaranteed as part of the choice process. That is not the case in this bill. No changes in health care will be included in this bill.
Cost-Shift: There is no pension cost shift to local property taxpayers in school districts and community college districts or to universities in this bill.