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Actuarial consultant says Tier 2 pension payments should rise by $5.6 billion through 2045 to put state in compliance with “safe harbor” provisions

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Illinois

* The Commission on Government Forecasting and Accountability hired the actuarial firm Segal to look at “safe harbor” questions surrounding the Tier 2 pension systems. The report was written by Senior Vice President & Consulting Actuary Matthew Strom…

As requested, we are providing narrative and analysis regarding the impact of changes to the projected costs of the Teachers’ Retirement System of the State of Illinois (TRS), State Employees’ Retirement System of Illinois (SERS), and State Universities Retirement System of Illinois (SURS), based on potential benefit formula changes needed to maintain exemption from Federal Insurance Contributions Act (FICA) taxes.

* Tier 1 survives the test, of course. Not so with Tier 2…

• The following benefit formulas do not satisfy a safe harbor under the applicable IRS regulations

– Tier 2 general benefit formula for TRS, SERS, and SURS

– Tier 2 benefit formula for SURS Police and Fire employees with less than 20 years of service

As such, individual testing may be required.

* Important point…

Note that the sample safe harbor tests shown in this letter (as defined below for FICA purposes) are included for illustrative purposes only. Neither Segal nor CoGFA is in possession of the data needed to determine the number of members who are not in compliance with the current safe harbor provisions. It is our understanding that, ultimately, it is the responsibility of the individual employers within each System to determine whether they qualify for exemption from FICA taxes.

* What that individual testing means…

The IRS has provided guidance on determining whether a system’s benefits are comparable to Social Security in Revenue Procedure 91-40. The guidance provides for three levels of testing:

• If the benefit provisions meet certain requirements, then the System qualifies under a safe harbor and no further testing is required.

• If the System does not satisfy the safe harbor requirements, then individual testing can be performed to confirm that the benefits for active members of an employer meet the minimum benefit requirements.

• Treas. Reg. 31.3121(b)(7)-2(e)(2) permits employers to compare the actual retirement benefits accrued by Tier 2 members to the estimated retirement benefits such members would receive from Social Security on an individual-by-individual basis. If the System’s benefit were greater for some or all Tier 2 members, those Tier 2 members would continue to be exempt from FICA taxes.

* Anyway, much actuarial language later, you get to the bottom line cost to put the pension systems in compliance…

Change in Total State Contributions Through FY2045 $5.606 billion

That works out to about $254.82 million a year if Illinois changed the program this year. The annual cost grows with any delays, of course, and it will grow because the budget has already been approved. A $2.1 billion up-front payment would wipe out the debt, but that isn’t likely.

posted by Rich Miller
Thursday, Jun 8, 23 @ 3:40 pm

Comments

So much for JB’s balanced budget

Comment by Sue Thursday, Jun 8, 23 @ 3:46 pm
==So much for JB’s balanced budget==

So much for those who illegally reduce pension benefits to pander to their base.

Comment by Big Dipper Thursday, Jun 8, 23 @ 3:56 pm
What are the consequences of falling outside the safe harbor?

I worked for the State for a short time and had both pension contributions (Tier 1) and FICA payments deducted.

Comment by DougChicago Thursday, Jun 8, 23 @ 4:01 pm
Big Dipper- the state didn’t illegally reduce pension benefits when the legislature enacted tier 2. That was the program. Whether if complies with IRS regulations is a wholly different matter. But this is why the new health care program for undocumented migrants was totally improper. The State would easily have the additional 250 million of may need every year had our Democratic majority and Dem Governor not agreed to an entirely new benefit program at the same time Illinois has the worst funded pension plan in the US. Talk about Stupidity

Comment by Sue Thursday, Jun 8, 23 @ 4:10 pm
==What are the consequences of falling outside the safe harbor?==

Tier One complies so it’s not an issue for you. In any event, you probably did not vest if you worked for a short time.

Comment by Big Dipper Thursday, Jun 8, 23 @ 4:12 pm
To answer DougChicago - the consequences are that the failure to comply with IRS refs could lead to a qualification issue. Doubtful the IRS would disqualify the Plan but it might require the State come into compliance. Very rare for the Service to impose penalties on public pension plans absent misconduct like using plan assets for an improper purpose ( building roads or other infrastructure)

Comment by Sue Thursday, Jun 8, 23 @ 4:14 pm
A $2.1 billion up-front payment would wipe out the debt, but that isn’t likely.

It also would be illogical, we would be “prepaying” potential liabilities for employees that may or may not continue their employment in the various pensions plans. This is the type of liability that you would want to true up and adjust on an annual basis as the liability is accrued.

Comment by Donnie Elgin Thursday, Jun 8, 23 @ 4:17 pm
==What are the consequences of falling outside the safe harbor?==

The employers (state, schools, colleges, etc) and employees would have to start paying the FICA tax. And, that would be a big hit to their budgets. For employers like K-12 schools and community colleges, they could pass along the cost to property tax payers from the uncapped pension fund if state law allows them to do so; otherwise, they would take a big hit to their ed fund. Other employers (like universities) would need to raise tuition or get more money from the state. Effected employees would experience an effective pay cut of (6.2%); they would likely bargain to be made whole - if successful, that would be another hit to the employers’ budgets.

Comment by Pot calling kettle Thursday, Jun 8, 23 @ 4:42 pm
==This is the type of liability that you would want to true up and adjust on an annual basis as the liability is accrued.==

Isn’t the purpose of the $2.1 billion to true-up the existing liability? Then, you would adjust annually.

Comment by supplied_demand Thursday, Jun 8, 23 @ 4:53 pm
The good news is this is manageable. The bad news is this is how much it costs just to reach the bare minimum.

Comment by City Zen Thursday, Jun 8, 23 @ 4:54 pm
Sue, federal regulations have the force of law so if Tier 2 violates them it is illegal.

Comment by Big Dipper Thursday, Jun 8, 23 @ 4:54 pm
Somebody tell Chicago City Council to hire that consultant to check the City’s Tier 2 pension plans under the Safe Harbor provisions too.

Civic Fed says about half of City pension plan members are in Tier 2 (and of course the Civic Fed was digging into this already). https://www.civicfed.org/civic-federation/blog/enhancing-tier-2-benefits-evaluate-financial-impact-illinois-pension-proposals

Comment by ChicagoBars Thursday, Jun 8, 23 @ 5:04 pm
==Effected employees would experience an effective pay cut of (6.2%)==

Actually, it’s much larger than that because the cost of that employer match is already accounted for in the employees’ current compensation. There is no reason the employer has to absorb that new cost, at least not entirely.

Comment by City Zen Thursday, Jun 8, 23 @ 5:07 pm
Big Dipper- the IRS impact on Public Pension Plans isn’t that straight forward as whether the Feds have any jurisdiction over State Pension programs isn’t clear- outside the qualification issue you really are on unchartered waters.

Comment by Sue Thursday, Jun 8, 23 @ 5:29 pm
@Sue: are you suggesting that Republican governors and Republican legislators would be more generous with pension funding?

Because that’s… Just not supported by recent experience.

The budget was balanced when it was passed. That’s what matters. Everything after just is just hindsight

Comment by Socially DIstant watcher Thursday, Jun 8, 23 @ 5:43 pm
I assume they will look into the current Tier 2 retirees drawing a tension to see if in compliance ?

Comment by Anotheretiree Thursday, Jun 8, 23 @ 6:26 pm
The current budget is solid enough that those looking to criticize are forced to focus on later years. Yeah we know, and there are likely approaches to these and many other known future risks. Steady deliberate progress on the fiscal front, thanks to a lot of responsible people.

Comment by Walker Thursday, Jun 8, 23 @ 6:43 pm
==I assume they will look into the current Tier 2 retirees drawing a tension to see if in compliance ==

Can’t be that many as it takes ten years to vest under Tier 2.

Comment by Big Dipper Thursday, Jun 8, 23 @ 7:00 pm
Would it be easier to go back to everyone being Tier 1 with just some pieces changed like a Tier 1a maybe?

Comment by Frida's boss Thursday, Jun 8, 23 @ 7:55 pm
==Would it be easier to go back to everyone being Tier 1 with just some pieces changed like a Tier 1a maybe?==

No need for a new tier unless they plan to reduce the benefit further. They can enhance Tier 2 any time and any way they want.

Comment by City Zen Thursday, Jun 8, 23 @ 7:59 pm
==federal regulations have the force of law so if Tier 2 violates them it is illegal==

It isn’t illegal; it just means the state loses the waiver from Social Security.

Budget-wise, this is not simply a question of whether the state can afford to improve Tier 2 to meet the threshold; if the state does not meet that threshold there is a significant cost to employers and employees that will be borne by the taxpayers. Fixing Tier 2 is probably less expensive than having to pay into Social Security.

Comment by Pot calling kettle Thursday, Jun 8, 23 @ 10:05 pm
When I was a state employee (tier 2) I also had deductions for social security. Are there tier 2 state employees outside social security or is this teacher pensions?

Comment by Original Anon Thursday, Jun 8, 23 @ 10:09 pm
I believe state university employees do not pay into Social Security.

Comment by DHS Drone Friday, Jun 9, 23 @ 6:49 am
===I believe state university employees do not pay into Social Security.===

They don’t, which is why this is a real problem.

Comment by Rich Miller Friday, Jun 9, 23 @ 7:20 am
This is a pension bomb waiting to explode. JB inherited this and will probably be blamed for it. Probably best to get ahead of it with the payments. Yep, some things in the budget will get the axe but we need to honor our debts. As a side note Tier 2 is often cited by educators leaving the profession. A Tier 1 retirement used to be the pot of gold at the end of the rainbow for underpaid educators. Tier 2 is not remotely attractive as a retirement destination.

Comment by Stormsw7706 Friday, Jun 9, 23 @ 7:37 am
I was a student worker and extra help worker at a state university for years and I remember coworkers talking about how many of them will never get social security because they never paid in for the required time.

Comment by DHS Drone Friday, Jun 9, 23 @ 7:58 am
===This is a pension bomb waiting to explode===

Tone down the drama level, please.

Comment by Rich Miller Friday, Jun 9, 23 @ 8:11 am
===how many of them will never get social security because they never paid in for the required time.===

Some SURS employees would still get “some” SS no matter if they didn’t have 40 qualifying quarters of SS contributions; if you are married and your spouse is qualified, you will get a minimum of 50% of your spouse’s benefit once you qualify (with the amount depending on when you start collecting), and definitely more than you paid in.

Comment by Six Degrees of Separation Friday, Jun 9, 23 @ 8:23 am
==It isn’t illegal; it just means the state loses the waiver from Social Security.==

They have to either comply or pay FICA, they are doing neither so that sounds illegal to me.

Comment by Big Dipper Friday, Jun 9, 23 @ 9:25 am
==They have to either comply or pay FICA, they are doing neither so that sounds illegal to me. ==

To my knowledge, the Social Security Admin has not yet made a ruling on this. If/when they do, they will start sending bills to employers who will then need to pay.

Comment by Pot calling kettle Friday, Jun 9, 23 @ 9:30 am
This situation gives rise to the saying, A penny wise or a pound foolish. $250 M today is much more manageable than $5.6 B 20 years from now.

This should be made a pressing budget agenda item next session. In between then and now, the individual testing should be done, to identify the magnitude of the problem at each institution.

Comment by H-W Friday, Jun 9, 23 @ 10:23 am
@ Six Degrees

In addition to your point, others will also collect some Social Security. Most people work 40 years or longer. In my case, I worked my first 25 years in the private sector. I became a state employee at age 47, and will retire with 20 years of service. In that context, I have accumulated some Social Security benefits that will supplement my state retirement. My SS will be docked a large percentage because I also receive state retirement, but I nonetheless will receive some SS.

Alternatively, some state employees leave state employment and enter the private sector. They too may qualify for both retirement systems (state and SS). But it does take planning at the individual level.

Comment by H-W Friday, Jun 9, 23 @ 10:33 am
I’m drawing with a broad brush here, so there are exceptions.

The whole Safe Harbor issue primarily affects members of TRS (school teachers) and SURS (university professors), plus some Law Enforcement members. Generally speaking, SERS (actual state employees) are also Social Security members although there are a few positions that don’t.

Anyway, if someone is paying into both a State pension system and Social Security (aka FICA), they aren’t affected.

If they do not pay FICA, such as teachers, then Safe Harbor becomes an issue. But it gets more complicated than a simple yes / no answer, because some people, like university professors, have the option for a self-directed retirement plan instead of straight Tier 2. It’s likely most those plans, invested and managed properly, will not run afoul of the Safe Harbor rules … which is why the report states you almost have to look on an individual basis.

Regardless of all that, we all knew this day was coming as soon as Tier 2 was enacted. As Rich and the report states, it is manageable and a fairly small amount on an annual basis.

And now a disclaimer: this report makes the assumption the Social Security System continues under the current rules. If the rules were to change, say by lifting the cap on FICA taxable earnings and raising the maximum payable SS benefit, then some greater number of Tier 2 members will be more likely to run afoul of the Safe Harbor rules. But we have no way of predicting what Congress will do with SS, so all the State can do is plan using the current rules and guidelines.

Comment by RNUG Friday, Jun 9, 23 @ 11:27 am