Pension Reform Analysis

Understanding Impacts on School Employees
AB 340 (Furutani) [Chapter 296, Statutes of 2012]

On September 12, 2012, Governor Jerry Brown signed into law the most dramatic reform of public pension benefits in decades. The changes were born out of the perceived political necessity to address a contentious issue in order to help convince voters to pass the Governor’s tax measure on the November 2012 ballot. The reforms attempt to address long-term fiscal concerns about the solvency of public pension programs, as well as political concerns with public employee pension benefits that exceed what is usually available in the private sector.

The changes affect all public retirement systems, except the University of California.

Officials estimate the reforms could save the State and local governments between $80 and $100 billion over the next 30 years. The bulk of the savings come from two major parts of the reform: benefit changes for new employees and equal employer/employee contribution sharing.

Governor Brown had issued a 12-point pension reform in 2011 where he proposed a “hybrid plan” for new employees (75% of final pay would have been a smaller pension with a 401(k)-type plan, in addition to social security). The unions strongly opposed this model which subsequently didn’t make it into the final package. Instead, the reform includes lower pension formulas and higher retirement ages for new employees, and a cap on final compensation.

A major issue for the Legislature and the Governor was deciding whether to apply the changes to current employees, or only new employees. In the end, legislative staff believed the courts had settled the issue of vested rights for employees under contract, and that changes to those benefits could be challenged in court with a high likelihood of success. As a result, the vast majority of changes in this reform package only apply to new employees.

Following is a breakdown of the changes:

Reforms that Apply to Current and New Public Employees (hired after January 1, 2013)

  • No “in-and-out” privileges - Requires that any public employee who moves between employers and has a break in service of more than six months will be considered a "new member" prospectively (however, moves between school agencies are exempt).
  • Ends Airtime purchasing - Eliminates the ability to purchase non-qualified time (additional service credit or "air time") on and after January 1, 2013.
  • Ends Retroactive Credit - Prohibits public employers from granting to both current and future employees retroactive pension benefit increases that apply to service performed prior to the increase.
  • Prohibits Pension Holidays - Prohibits all employers from suspending employer and/or employee contributions necessary to fund annual pension costs. Contributions may not be less than their normal cost.
  • Modification to Post Retirement Earnings limitation - This reform extends the effective date of the recently enacted post-retirement earnings limitations to June 30, 2014. It also provides that an exemption to the earnings limit will not apply if the retiree participated in a retirement incentive program within the last six months, or if the need for the exemption is based upon the retired member having retired from a vacant position. The reform also adds fiscal “expert, receiver, or special trustee” to the list of allowed appointments under the exemptions, and modifies the recently adopted exemption, so that such positions may be appointed and not approved.
  • Equal cost sharing - Requires new STRS members to pay at least 50% of the normal, ongoing cost of benefits or the current contribution rate, whichever is greater. The 50/50 requirement must be bargained for current employees and must be in place by January 1, 2018.
  • Felons Forfeit Pension Benefits - Requires that a member forfeit pension and related benefits if convicted of a felony in carrying out official duties, in seeking an elected office or appointment or in connection with obtaining salary or pension benefits.

Reforms that Only Apply to New Employees

  • Age Increase/New Benefit Formula - Implements a defined benefit formula of 2% at age 62 (previously age 60) for all new school employees. The earliest all new non-safety PERS members may retire is 52 with a 1% factor and the maximum retirement factor of 2.5% is provided at age 67. A STRS member may retire at the age of 55 with an actuarially reduced formula, and with a maximum formula of 2.4% at age 65.
  • New Compensation Cap - The cap on compensation is $110,000 (the current maximum income tax cap for Social Security), or 120% ($132,120 in 2012) of that limit if the employee does not participate in Social Security. Employers may offer a 401(k)-type plan for retirement above that amount.
  • Three-year Average to Determine Final Compensation - Final compensation will be based on the highest average annual compensation earned during a three consecutive year period.
  • Limits on Compensation Types - The reforms limit the types of compensation that can be used to calculate a retirement benefit by prohibiting such things as:
    • Special bonuses
    • Unplanned overtime
    • Severance pay
    • Uniform, housing, or vehicle allowances
    • Payouts for unused vacation (note: sick leave not included here)
  • No Supplemental Defined Benefit Plans - Prohibits the employer and private provider from offering supplemental defined benefit plans. However, the reforms allow employers that offer alternate defined benefit plans established prior to January 1, 2013 that have lower benefit formulas and that result in a lower normal cost to continue offering those plans to new employees. It also allows employers that offer a retirement benefit plan established prior to January 1, 2013 that consists solely of a defined contribution plan to continue offering that plan to new employees.

STRS Golden Handshake Not Affected - Current law which allows two-years of additional service credit as an incentive to retire early is not affected by the reforms. However, members considering this option should know those taking golden handshakes are prohibited from serving in a formal role that would exempt them from performing services that are exempted from the postretirement earnings exemption. Additionally, employees taking golden handshakes cannot earn creditable compensation after retirement for 180 days, even if they would have qualified under some other exemption to the 180-day rule.

September 12, 2012
Prepared by: Barrett Snider

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