Indiana, with a hybrid plan reaching back to 1955, and Orange County, Calif.s new defined benefit/defined contribution (DB/DC) formula are examples how states and localities tackle pension funding.
In the 1950s, public entities were deciding whether to be part of Social Security and Indiana opted into the system, explains Steve Russo, executive director of the Public Employees' Retirement Fund (PERF) and the Indiana State Teachers Retirement Fund (TRF), Indianas two largest public pension systems with combined assets of more than $22 billion and membership of more than 380,000.
The state wanted to gauge its retirement benefits helpfulness to employees over and above Social Security, he says, a better defined benefit plan than was previously provided.
Indiana also wanted employees to pay part of the benefit. What was decided was a benefit layered on top of the DB plan, called an Annuity Savings Account (ASA), seen as part of the DB plan, a 401a plan, says Russo. Although structured like a hybrid, it was viewed as one giant DB plan, with the ASA allowing members to accumulate money by making contributions and receiving a modest interest rate.
Three changes have ensued: in 1957, the employee contribution was dialed back from four percent to three percent and in 1985 changes in state law allowed employers to contribute the employees contribution of three percent. Of course, any pickup came at the cost of salary increases, he notes. At that time, employees were allowed to take a lump-sum withdrawal and roll it over into another account. This was a first step towards giving the employee a say-so with the money. Then, in 1995, the low-risk, low-yielding fixed-income accounting of the annuity was opened up to introduce investment alternatives, including equities.
Employees must work 10 years before being instated into the plan. If you dont make it to 10 years you lose all benefits, he explains. The ASA portion is portable the three percent contribution can be taken with you. This is why the DC portion may be preferable to some who dont want to work their for 10 years its got portability.
Impressed that Indianas hybrid plan has been working all these years, other plans have been visiting to see how it works, notes Russo.
I believe Indiana is in pretty decent shape; it has one of the most modest defined benefit formulas in the U.S., he says. Indiana, however, shows up on some folks lists of problem plans, Russo admits, even though all its plans are in extremely healthy shape. But the states been eyeing more traditional defined contribution plans as an alternative and have sent the issue to a legislative study committee to be proactive.
The annuity portion of Indianas plan can be folded into the employees defined benefit account. The longer time horizon means the annuity can absorb the risk/volatility and a more equitable product is offered. The DB plans pooled dimension also works in employees favor because money not divvied out is left in to keep the pot bigger, he says.
These two elements of annuities are helping Orange County to choose a hybrid plan to offer employees investments with less risk, more opportunity for a stable retirement. Still, theres the same risk as any 401k only the defined benefit plan is not subject to market risk like DC plans are at least not as directly for the employee, says Carl Crown, director of human resources. An annuity is just one of the options offered employees.
Orange Countys Board of Supervisors looked at its unfunded liabilities and negotiated with labor. The contributions were so high on employees partsbetween 11 percent and 15 percent of their paycheckswe thought theyd want to select a lower formula to increase take-home pay, says Crown.
June 2009 is when the county signed the contract with the largest labor organization, the Orange County Employee Retirement System. Its the lowest formula allowed by law1.62 percent at 65, he notes, explaining thats why the county was looking to supplement the db plan, figuring that it would not be enough to retire on. Thats how the Board came up with a hybrid plan including a 401k component.
We were adamant about including a counseling portion for employees as they attempt to make a decision to ensure they understand that it isnt a defined benefit plan but a 401k plan, Crown continues. Thats what TIAA-Cref does; it lays out the differences, offering options, not selling products.
An important factor is that employees make informed decisions because they cant change their minds and go back into the DB plan. To offer the defined contribution plan, we had to lobby for amending state laws, he recalls.
The Board of Supervisors looked at the mounting unfunded liabilities and first dealt with the retiree medical issue, reducing that by $800 million and then tackling the pension issue. Were still working on it we started by looking at the formula and contribution issues.
About 25 percent of new employees are choosing the 1.62 percent formula. Due to the economy, the county is hiring fewer new employees today than in previous years. They have the ability to determine how much they want to contribute to the defined contribution portion of the plan or if they want to contribute at all.
But a wrinkle has stopped the whole system in its tracks: for employees to change retirement options, all county workers would be forced to pay taxes on retirement deductions whether they switched plans or not. The county is still waiting for an IRS ruling. This is why were working with the IRS to get some ruling to make it possible to offer the defined contribution plan for current employees, notes Crown. The county, legislators, the IRS, the Treasury Department are all involved. Labor organizations are side-by-side with the county and we all realize that the impact will go farther than just Orange County. Were still waiting weve been waiting since last year. There are implications to their ruling nationwide, thats why the IRS is taking its time.
Orange County declared bankruptcy in the mid-1990s and it was pretty bad for the county, says Patti Gilbert, assistant director of employee benefits. The DC plan couldnt have happened without the cooperation of labor organizations. Both sides felt that the existing DB contribution was so high on the employees and the countys part that if there would be some way to reduce it, we had to try. It was a mutual desire, a meeting of the minds."