Budget Solutions 2014: Pension reform
By Ted Dabrowski, Benjamin VanMetre
Budget Solutions 2014: Pension reform
By Ted Dabrowski, Benjamin VanMetre
State Reps. Tom Morrison (R-Palatine) and Jeanne Ives (R-Wheaton) have proposed House Bill 3303, which is based the Institute’s pension reform plan.
State Sen. Jim Oberweis (R-Sugar Grove) introduced a floor amendment to Senate Bill 2026, which is identical to House Bill 3303.
Summary of the problem
Illinois has the worst-funded pension systems in the nation. The unfunded liability currently stands at more than $96 billion according to official government numbers, and that number grows by $21 million every day lawmakers fail to enact reform. The problem at the root of Illinois’ pension crisis is the unmanageable, unsustainable defined benefit system.
Summary of our solution
The only way to end Illinois’ pension crisis is to empower government workers by transitioning benefits for all future work to a defined contribution system. The Illinois Policy Institute’s solution cuts unfunded pension debt in half and includes a defined contribution plan as the main pillar of its reforms while protecting already-earned benefits for government workers.
Summary of why this works
This is the only proposal that ultimately solves Illinois’ pension crisis. This plan also modernizes the state’s retirement system by eliminating political control and giving government workers the secure retirement they deserve. Ultimately, these reforms restore fiscal order to the state by eliminating unsustainable pensions and unfunded liabilities. This paves the way for the economy to flourish, fostering an environment where businesses can thrive and create the jobs Illinoisans need.
Here are the plan’s major outcomes:
- Reduces fiscal year 2014 unfunded liability by $46 billion. This 46 percent reduction brings the unfunded liability down to $55 billion from $101 billion, the government’s fiscal year 2014 projection.
- Reduces fiscal year 2014 state contributions to $4.7 billion, a nearly 30 percent drop from $6.7 billion under current law.
- Protects constitutionally guaranteed benefits already earned by retirees and current workers.
- Empowers current workers to control their retirement savings going forward with 401(k)-style plans modeled after the existing State Universities Retirement System’s 401(a) plan.
- Reduces the state’s annual pension contribution by more than $2 billion in the first year and eliminates the state’s unfunded liability by 2045. Ends the irresponsible repayment ramp and instead moves to level annual payments.
- Freezes cost-of-living adjustments until retirement systems return to healthy funding levels.
- Aligns the retirement age with Social Security’s retirement age while still protecting workers who are nearing retirement under current law.
- Promotes accountability and fiscal responsibility by requiring local governments to pay the employer share of their employees’ retirement savings plans.
- Makes government workers’ retirement savings plans portable, giving workers more flexibility and freedom to move their plan from job to job.
The problem: defined benefits lead to out-of-control state pension debt
Illinois has the worst-funded pension systems in the nation. The unfunded liability currently stands at more than $96 billion according to official government numbers, and that number grows by $21 million every day lawmakers fail to enact reform.
Illinois’ largest and most troubled pension system is the Teachers’ Retirement System, which has $52 billion in debt and only 42 percent funding overall.
Numbers like these are impossible to ignore. investors and analysts alike see lawmakers’ inaction on pension reform as a sign that the state’s leaders won’t be able to improve Illinois’ finances. the state’s massive pension debt crisis has led credit rating agencies to downgrade Illinois to the worst credit rating in the nation.
These numbers and actions by outside agencies tell a disturbing story and lead to one undeniable conclusion – the problem at the root of Illinois’ pension crisis is the defined benefit system.
This structure not only gives politicians control over government workers’ retirement dollars, but it also puts taxpayers on the hook when these politicians promise overly generous benefits the state can’t afford and when the pension systems fail to hit their optimistic investment targets. there is no way for state bureaucrats to predict how much the systems will cost from year to year.
And state taxpayers are tapped out. in 2011, the state raised taxes by a record $7 billion, and almost all the money generated by the tax hike went to pensions. the past two decades are replete with other failed pension “fixes.” Former Illinois Gov. Jim Edgar’s widely hailed plan to fund state pensions by 2045 flopped within 10 years of its inception, and to date taxpayers have paid $8 billion more into the pension system than the ramp originally called for. Former Gov. Rod Blagojevich used a bond issue to borrow $10 billion to pay for pensions. Current Illinois Gov. Pat Quinn has borrowed more than $7 billion to make pension payments. All of this money still hasn’t plugged the hole. Things have only gotten worse. the unfunded pension liability is nearly five times larger than when Edgar enacted his reforms. None of the ideas lawmakers have presented to date would end Illinois’ pension crisis because they keep in place a broken defined benefit system. Most proposals on the table today also include a repayment ramp. minor reforms that try only to patch up the problem by making minor, temporary fixes won’t end Illinois’ pension crisis.
The harsh truth is that continuing to rely on the defined benefit system and dangerous repayment ramps inflicts massive pension debt onto future generations and will only perpetuate Illinois’ cycle of fiscal self-destruction.
Our solution: cut pension debt in half and empower employees with defined contribution plans for all future work
The only way to end Illinois’ pension crisis is to move benefits for all future work to a defined contribution system. The Illinois Policy Institute’s solution cuts unfunded pension debt in half and includes a defined contribution plan as the main pillar of its pension reforms while protecting already-earned benefits for state workers.
This is the only plan that ends Illinois’ pension crisis. This plan gives government workers control of their own retirement plans and protects taxpayers by removing the burden of funding a failed system – giving them financial security. the end result is government workers with retirement security, a stable budget and taxpayers free from the burden of funding a failed system.
Protect already-earned benefits for all workers
Government workers, unions and taxpayers alike have long decried politicians’ mismanagement of the state’s pension funds. It’s time to take control over retirement savings away from the politicians and give it back to the workers.
The only way to do that is to move away from the state’s broken defined benefit structure. this outdated structure is unaffordable and unpredictable, which is why 85 percent of private sector employers have moved away from it during the past few decades. Under the current defined benefit structure, true costs are never realized until after the fact, when the pension funds come back asking for more money to make up for lower investment returns and mistaken assumptions.
Each year lawmakers fail to move to a defined contribution system is another year the state accrues more debt, as government workers continue to earn more service credit and higher salaries. The Illinois Policy Institute’s plan moves away from the defined benefit structure, freezing the defined benefit plan at current levels to ensure the state’s pension liability stops growing.
Doing this provides security for government workers who have already earned these benefits and also gives them control over their retirement savings for future work. Likewise, this protects taxpayers from facing an even larger bill for unearned future benefit accruals. Government workers will still receive already earned pension benefits, but future benefits will accrue in 401(k)-style plans.
Empower employees with defined contribution plans for all future work
The cornerstone of the Illinois Policy Institute’s pension reform plan is moving future benefits to defined contribution plans for all government workers. This gives government workers control over their retirement savings and doesn’t rely on taxpayers for a bailout. More than 10,000 government workers in Illinois already manage their own retirement plans through the State Universities Retirement System’s, or SURS, optional, self-managed 401(a) plan.
The Illinois Policy Institute’s plan bases its defined contribution structure on the self-managed plan currently operating in SURS. Under the SURS plan, the employee contributes 8 percent of his or her salary toward retirement savings, while the employer matches 7 percent of salary.
Under the Illinois Policy Institute’s plan, all members whose benefits are not coordinated with social security will receive this generous match. these employees will contribute 8 percent of their salary toward retirement savings, while the employer will match 7 percent of salary.
Members whose retirement benefits are coordinated with social security would be required to contribute less and receive a lower employer match. These workers will be required to contribute 3 percent of salary, while the employer will match 3 percent of salary. Workers are allowed to contribute the maximum amount permitted under federal law. This money is deposited into personal accounts, through which workers can invest in multiple funds that meet their needs and retirement objectives.
At retirement, the employee can roll the money over to another qualified plan, take a lump-sum withdrawal or purchase a lifetime monthly annuity. If he or she leaves government service before retirement, the worker has several options available, including leaving the money in the self-managed account, moving the money to another qualified plan or taking a lump-sum refund.
The Illinois Policy Institute’s self-managed plan gives workers real control over their retirement savings. They control investment decisions based on their individual preferences and circumstances, rather than being forced to watch politicians squander their money. Workers are also free to make different career moves with portable retirement plans.
This plan creates greater budget certainty for taxpayers, empowers government workers with control over their own retirement savings and ultimately moves retirement costs to a more sustainable path.
Freeze future cost-of-living adjustments for all retirees
Under current law, Illinois pensioners receive a 3 percent compounded, annual increase to their pensions. This cost-of-living adjustment functions as an automatic raise and makes the current defined benefit plan even more unaffordable.
Given the severity of the crisis, the Illinois Policy Institute’s plan suspends all cost-of-living adjustments until the pension funds are fully funded. Retirees will still receive the cost-of-living adjustments they have earned to date, but all future adjustments will be frozen at least until the funds are healthy again. thereafter, the cost-of-living adjustment formula may be restructured to better reflect inflation and actual pension fund returns.
Equitably raise the retirement age for future retirees
Workers are living longer and the labor force’s demographics are changing, meaning that retired workers are collecting more retirement benefits for longer periods than in the past. State lawmakers recognized the need for increasing the retirement age when they enacted changes to the pension program for new employees starting after January 2011 (tier 2 employees). It’s also one of the biggest drivers of the state’s current unfunded liability.
The Illinois Policy Institute plan is modeled after the Rhode Island pension reforms and aligns the retirement age with the social security retirement age, while still protecting workers who are nearing retirement under current law. In order to protect near-retirees, this change will be done in direct proportion to the percent of service credit completed toward the current retirement age. The closer a worker is to the previous state retirement age, the less his or her new retirement age will increase. This ensures that older workers near retirement will be affected less, but that the retirement age is equitably increased to protect the systems from insolvency.
Enact local retirement accountability
Teachers and university employees are not state employees, but for decades the state government has paid and continues to pay the employer’s share of teacher pensions. The state pays more than $632 million in retirement costs for public school employees and another $440 million for state university workers. This means that one unit of government hands out benefits while another pays for them, leading to abuse and the elimination of spending accountability.
Under the Illinois Policy Institute’s plan, going forward school districts will be required to pay the employer contribution to their employees’ defined contribution plans. Many have claimed that this shift will result in property tax increases. this is simply untrue. The shift to defined contribution plans will cost districts, on average, an amount equal 3 percent of their total education expenditures.
Costs should be paid where they are incurred. School districts will better manage their overall compensation costs and improve
the security of the retirement system under this plan. The same requirement applies to state universities, which also dole out pension benefits without having to incur the costs.
The shift to defined contribution plans will make employer annual retirement costs predictable and affordable. In order to ensure school districts and state universities can manage these costs, however, the state should provide them with greater flexibility to operate more efficiently and reduce unfunded state mandates. Additionally, the state should give government employers the freedom to exit the state’s retirement systems in the future. Local school districts and state universities should be free to stay in the new defined contribution plan for future work or to design their own retirement plans from the ground up. The state, however, should make clear to them that state taxpayers will not be responsible for those plans. If a school district chooses to create a new retirement plan, there will be no bailout from state taxpayers down the road.
The Illinois Policy Institute’s plan also provides more flexibility to school districts and universities to manage costs by taking away the prevailing wage requirement, project labor agreements and other unfunded mandates.
Eliminate the irresponsible repayment ramp
Under current law, the state’s pension payments grow larger and larger in the future, which overloads future taxpayers. This repayment ramp is irresponsible because it lowers today’s payments at the expense of future costs.
In fiscal year 2014, the state’s annual pension payment for Illinois’ three major pension systems is scheduled to be $7 billion, which is set to grow under current law until it reaches $17 billion in 2045. Even after these ever-increasing contributions, the systems will have an unfunded liability of $34 billion in 2045.
The Illinois Policy Institute’s comprehensive pension reforms reduce the fiscal year 2014 payment to approximately $4.7 billion, which then stays level through 2045. this would enable the systems to become 100 percent funded by 2045.
How the Illinois Policy Institute’s plan affects the Teachers’ Retirement System
The Commission on Government Forecasting and Accountability recently scored a plan to reform the Teachers’ Retirement System, or TRS, by freezing the defined benefit plan in place, creating a new defined contribution plan for all future work, freezing all future cost-of-living adjustments and aligning the retirement age with the social security retirement age. They found the following results:
- The unfunded liability for fiscal year 2014 is reduced to $30 billion, a 48 percent drop from $58 billion under current law.
- Total liability for fiscal year 2014 is reduced to $68 billion, a 31 percent drop from $98 billion under current law.
- By 2045, the total liability in TRS will be just $46 billion, compared with $224 billion under current law.
Based on this scoring, the Illinois Policy Institute’s plan:
- Increases the funding level of the plan in fiscal year 2014 to 56 percent, up from 41 percent under current law.
- Reduces the state’s fiscal year 2014 state contribution to $2.5 billion, a 25 percent drop from $3.4 billion under current law.
- Reduces the state contribution for fiscal year 2045 to $2.5 billion, a 75 percent drop from $10 billion under current law.
- Cuts the amount the state will pay to TRS between now and 2045 to $81 billion, compared with $211 billion under current law.
- Eliminates the payment ramp and makes all future pension contributions on a level-dollar basis.
- By 2045, the state will no longer have an unfunded liability, compared with the $22 billion unfunded liability under current law
The impact of the Illinois Policy Institute plan on the three major systems – TRS, SERS and SURS
An extrapolation of COGFA’s scoring of the TRS plan to the other two major systems reveals the following results:
- The fiscal year 2014 unfunded liability is reduced to $55 billion, a 46 percent drop from $101 billion under current law.
- The fiscal year 2014 funding ratio is increased to 54 percent, up from 41 percent under current law.
- The fiscal year 2014 total liability is reduced to $118 billion, a 31 percent drop from $170 billion under current law.
- The fiscal year 2014 state contribution is reduced to $4.7 billion, a 29 percent drop from $6.7 billion under current law.
- The fiscal year 2045 state contribution is reduced to $5.2 billion, a 70 percent drop from $17 billion under current law.
- By 2045, the total liability will be just $80 billion, compared with $345 billion under current law.
- By 2045, the unfunded liability will be $0, compared with $34 billion under current law.
- Between now and 2045, the state will pay $146 billion to the pension systems, compared with $374 billion under current law.
- The payment ramp is eliminated and all repayment of existing pension debt is made on a level-dollar basis.
Why this works
The Illinois Policy Institute’s pension reform plan immediately cuts the state’s unfunded pension liability in half and ultimately eliminates the unfunded liability. This is the only proposal that solves the pension crisis. this plan also modernizes the State’s Retirement System by eliminating political control and giving government workers the secure retirement they deserve. This type of plan is already working in Illinois. The state currentlyoffers self-managed retirement plans to workers in the State Universities Retirement System – and more than 10,000 workers have chosen to participate in this option.
Protecting already-earned benefits and offering state workers choice and mobility by creating 401(k)-style retirement plans also creates greater budget certainty for the state moving forward, ending the pension repayment ramp and replacing it with level annual payments.
Ultimately, the Illinois Policy Institute’s pension reform plan restores fiscal order to the state by eliminating unsustainable pensions and unfunded liabilities. This paves the way for the economy to flourish, fostering an environment where businesses can thrive and create the jobs Illinoisans need. Based on COGFA’s recently scored plan to reform TRS, the Illinois Policy Institute’s plan brings down Illinois’ unfunded pension liabilitiesmore than any other proposed plan.
Government workers and taxpayers deserve a sustainable plan that provides security and protection – and that’s what the Illinois Policy Institute’s pension reform plan provides.