SPRINGFIELD – The proposed overhaul of Illinois' pension system could cost the state $62 billion more than the current system over the next three decades, according to a report prepared for the Teachers' Retirement System.
The report raises questions about whether the major pension bill, which is supported by House Minority Leader Tom Cross, R-Oswego, House Speaker Michael Madigan, D-Chicago, and Chicago's top business leaders, can be ready for a vote when the legislature resumes its annual veto session this week.
A Cross spokeswoman said an amendment will be filed to deal with at least some of TRS's issues.
Senate Bill 512 would create a three-tiered retirement system for downstate and suburban teachers, state workers, university employees, lawmakers and judges.
Those hired before Jan. 1 would be in Tier 1. Those hired after that would be in Tier 2, which would provide reduced benefits for employees. Both Tier 1 and Tier 2 are classic defined-benefit pension plans, while Tier 3 would be a 401(k)-style defined-contribution plan.
Employees could migrate down the tiers, but not up.
'Money purchase' option
The Cross amendment will address the TRS report's contention that, in its current form, SB512 will add to the state's pension burden instead of subtract from it. Supporters of the bill say it would save taxpayers tens of billions of dollars in the coming decades.
The primary reason that SB512 would add to the pension burden, according to the TRS-commissioned report by Buck Consultants, is because of an alternate formula for determining a TRS pension called the "money purchase option."
Normally, when a teacher retires, his or her pension is calculated based on this formula: The retiree receives 2.2 percent of his or her final average salary for each year of service, up to a maximum of 75 percent of the final average salary. Final average salary is calculated by the adding the four highest years of pay together in the last 10 years and dividing by four.
The money purchase option is typically for teachers who taught for extraordinary lengths of time. A member is eligible if the sum of his or her contribution and his or her employer's contributions, plus interest determined by state statute, would provide a greater monthly benefit.
For example, an 81-year-old teacher recently retired who was eligible for the money purchase option after teaching for 58 years. That teacher would receive a pension of roughly $68,000 a year under the regular formula. Under the money purchase option, he would receive $174,000 a year, according to TRS spokesman David Urbanek.
"Inflation for certain groups of teachers eats away at their benefit," Urbanek said. "It gets them a pension more in line with the amount of time they worked."
SB512 would increase the employee contribution for those choosing to stay with Tier 1 benefits from 9.4 percent to 13.77 percent. The contribution rate is expected to climb further as the years go on.
More eligible for higher pension
The contribution increase would make more teachers eligible for higher pensions under the money purchase option, even though they will not have worked as long and will have a longer life expectancy than the 81-year-old in the previous example.
"Your contributions will be accumulating in your account faster at a higher rate than under the old law," Urbanek said. "When the time comes to calculate, more people will have a higher pension. That is the biggest driver of the increased cost to the state."
Increased use of the money purchase option would cost the state $46 billion more between 2011 and 2045 than if the current system was left alone, according to the report.
Cross spokeswoman Sara Wojcicki Jimenez said the issue has been worked out in the Cross amendment by basing all future money purchase benefits on the current contribution rate instead of the new, higher contribution rate.
"In the original version of SB512, we closed this loophole in SURS (the State Universities Retirement System) but TRS was an oversight," she said.
But tinkering with the money purchase option might raise a constitutional issue. Drafters of the bill have tried to satisfy the state constitution's prohibition of diminishing pension benefits by simply increasing employee contribution rates. They say increasing what teachers and state employees pay for pensions does not diminish the benefits themselves.
But if current teachers start paying more but get less from the money purchase option, does that mean the legislature has diminished the benefits?
Jimenez said Cross had thought TRS was satisfied with the solution in the amendment.
"Leader Cross has talked to (TRS) executive director Dick Ingram this week, and Ingram has told us that our amendment would dispel the myths that this bill would cost state billions when it would instead save state billions in liability," she said.
Ingram told Cross that eliminating the money purchase option entirely would solve the cost issue, Urbanek said. TRS is still reviewing amendments to the bill, he added.
"If you eliminate it, then you do get rid of the cost, but that creates the same legal questions that the bill has had since its inception," Urbanek said.
Another reason for the projected $62 billion liability increase is the fact that the bill would link the state's contributions to pensions to state revenues.
The report said that approach is "not actuarially sound" and "could also produce unattainable contribution levels for the state in early years."
"We project a significant increase in state contributions over the next 30-plus years," the report said.
The Illinois Education Association, which believes that even increasing contribution rates runs afoul of the constitution, said the TRS report shows that SB512 is not ready for a vote.
Labor groups have seized on the report, running radio advertisements in recent weeks saying that the bill would actually cost taxpayers more than the current system.
"It's disconcerting to have some of the legislators going along with some of the lines that are being used about it as if it's going to help," said IEA President Cinda Klickna. "We're hoping that logic and reason prevails and that legislators are really looking at this proposal."
The potential for higher costs in a bill designed to cut taxpayer pension liability is not the only issue raised in the TRS report:
• SB512 could also mean that public employees would no longer make their pension contributions on a pre-tax basis, according to TRS attorneys' reading of federal law.
"Senate Bill 512 wasn't written with regard to other laws," Urbanek said. "SB512 gives every member a choice of what (contribution) rate they're going to pay. That's against IRS rules."
If SB512 were passed, teachers in Tier 1 would pay 13.77 percent and those in tiers 2 and 3 would pay 6 percent.
Jimenez said that "TRS has never identified the specific IRS regulation that concerns them."
• Tier 3 members might be forced into the Social Security system, which then would require financially strapped school districts to pay the employers' share of Social Security taxes.
"The bill uses terms that are critical to pension administration in an inconsistent manner, and it introduces new terms that are not defined at all," the TRS report said. "Article 16 (of the bill) may have the unintended consequence of forcing Tier 3 into Social Security because of a drafting error on minimum benefits."
Jimenez said the bill attempts to make sure that Tier 3 participants would not have to participate in Social Security by guaranteeing a minimum benefit. That proposal is modeled after SURS, which already has a defined-contribution option.
"SURS has a plan which works, which is qualified under the Internal Revenue Code, which permits pre-tax contributions, and which has no issue with Social Security coordination," she said. "These issues have already been solved and resolved by SURS."
Given the issues raised by TRS's report, Charles McBarron, the IEA'S communications director, said it's fortunate that the measure wasn't passed in May, when Cross and Madigan unveiled it.
"It would have been devastating not only for the pension system but for the taxpayers of Illinois," he said. "It appears this plan was slapped together with no understanding of basic pension law in Illinois."
Potential issues with SB512
• The bill could cost the state an additional $62 billion through 2045.
• Employee pension contributions might no longer be taken out of their paychecks before federal taxes are deducted.
• Teachers who opt for a defined-contribution plan may be forced into the federal Social Security system, which would cost cash-strapped school districts.
Source: Teachers' Retirement System