The truth about Illinois pension reform

iStock_000012648699MediumIt’s now 12:04am as I write this, so technically this all happened yesterday. Yesterday turned into D-Day for Illinois state pensions.

The hotly debated pension reform bill passed through the Illinois House and Senate and now sits on the Governor’s desk awaiting his signature. However, there will likely be a court date set as many view this bill as unconstitutional. But what happens if this bill gets passed? How does it affect Illinois teachers, both working and retired? In this article, which is longer than most I post, you’ll find a summary of the bill and how it will affect teachers from June 1, 2014 onwards. I have also included my thoughts in blue.

(If you’d like to read the bill (like I have), it can be found here: Pension Reform Bill)

 

- Annual Cost of Living Adjustments (COLAs) will now be based on years of service and current inflation rates, not an automatic 3% compound annual increase. COLAs are calculated as 3% of the lessor of 1) the current annuity or 2) $1,000 multiplied by years of service. This $1,000 will be adjusted annually for inflation.

~ For example, 35 years of service will result in ~$1,050 COLA (35 * $1,000 = $35,000. $35,000 * 3% = $1,050 COLA). However, the COLA calculated has to be the lessor of the years of service or the annuity being received. If the annuity is $30,000, then it will $3% * $30,000 = $900, regardless of if the years of service give a higher number.

~ The COLA for Tier 2 members is unchanged: the lessor of 3% or CPI.

This is an interesting change as a simple way of doing the COLA would be to tie it to inflation, like many other pensions do. However, having a COLA is a nice perk of a pension, as many corporate pensions do not offer this. As many teachers will be working towards their full retirement eligibility (35 years of service or age 60-65) there will little they can do to avoid a declining COLA. One thing that is important to note, this change to the COLA provision affects even teachers who are currently retired.

   

 

 

 

- For teachers yet to receive a pension, a cap will be imposed on salary that is eligible to be included in calculating a pension. Salary that is to be included in the calculation of a pension shall be capped at the rate currently assessed on Tier 2 members (2014: $110,631, adjusted annually by the lessor of 3% or the annual inflation rate). While Tier 2 employees currently experience this, this rule now applies to all Tier 1 employed teachers. This will only apply to compensation going forward, not assessed on salary already received.

Using the same number as Tier 2 teachers seems to be a smart approach to use as everyone knows what the salary cap for that year will be. However, if a teacher is within 10 years of retirement, their four highest, consecutive years of income in the last 10-year period are used in determining the initial pension amount. With this formula still being in place, the cap will seemingly affect only those under this income threshold. This salary cap will be different for teachers & administrators who are under an individual contract or collective bargaining agreement, therefore it would be best to consult with TRS to determine what your estimated pension would be. For those teachers or administrators earning substantially more than this threshold (2014: 110,631), their pension amount will far lower than expected.

EDIT 12/6/13: Here is text from TRS directly as they discuss the pension caps:

For any member covered by an individual contract or collective bargaining agreement, the cap will be the member’s annualized salary on the day the current contract expires. A contract cannot be amended or extended to increase the level of the cap.

For any member not under contract but with a current salary that exceeds the cap, that member’s salary cap would be set at their salary on the law’s effective date. Members with a “grandfathered” salary would each have their own cap.

For example, member “A” earns $110,000 at the time the law takes effect and the cap is $110,631. His/her full salary would be recorded as TRS “creditable earnings” in that year. Member “B” earns $112,000 at the time the law takes effect and would see $112,000 used as creditable earnings. In the second year after the law takes effect, and member “A” earns $111,000. Only $110,631 would be counted as creditable earnings. Similarly for member “B,” if he/she earned $113,000 in year two, only $112,000 would be counted as creditable earnings.

 

- The age of retirement will be increased for all teachers under 45. For every year a teacher is under age 45, an extra 4 months must be worked before being eligible to retire. Therefore a 34 year-old teacher must work an extra 48 months (4 years). As full retirement age is currently age 60, this will mean it will be raised to age 64 for this individual. The maximum eligible age for retirement is 65.

Again, not a surprise that the retirement age is being increased for Tier 1 members, as Tier 2 is set at 67, but the bands are voluminous (16 in total). While this will be easy to summarize in a table as to what a teacher’s new maximum retirement age will be, it still could have been made easier. This also makes years of service redundant for many teachers as they can accumulate 35 years by the time they are 60. This used to be the golden number to be eligible to receive a maximum pension, but now the teacher’s age becomes the denominator in this equation.

PENSION on calculator display

 

- Current teachers will contribute 1% less to their pension, from 9.4% to 8.4%. 0.5% of this 1% will be taken from the amount used to fund the COLA provision.

This was a big shock. No one expected that contributions would go down given the deficit that the pension fund faces, and the state’s seeming inability to make their annual contribution. However, given the language surrounding the state’s contributions in the future (discussed below), and the reduced COLA provisions, this seemed to be a logical decision.

 

- All new teachers cannot use their vacation or sick days to increase their years of service and be eligible for an increased pension benefit.

This is a favorite benefit of teachers that I talk to, as it is very lucrative. A maximum of two years of banked sick and personal days can be used to purchase pension credit. Given that some districts issue 15-20 of these days per year, it is easy to rack up a significant amount of banked days. Current teachers will still be able to do this, but new teachers as of July 1, 2014 will not be able to do this.

 

- A “Pension Stabilization Fund” has been created which will ensure annual state payments are made. These payments are now mandatory at the risk of the state of Illinois being sued in Illinois Supreme Court by pension members. In 2019, a payment of $364,000,000 shall be made to this fund and from 2020 onwards, a $1,000,000,000 (one billion) annual contribution from the general state revenue shall be placed in this fund, until the pension in 100% funded (2044 at the latest). TRS will receive the lion’s share of this amount and are in addition to any annual contributions the state must make.

This is VERY strong language regarding the State’s contributions to the pension plans and will hopefully help the state keep on track with making their contributions. The introduction of a legal avenue for pension participants is welcomed, and also listing out dollar-values for future payments makes things even clearer to fixing the problem that has arisen.

 

- No IOUs longer than 90 days will be accepted for payment. If they are not paid in 90 days or less, than legal action at an Illinois Supreme Court level can be brought against the State of Illinois.

Again, this is welcomed in the Bill. Part of the problem for the Illinois government was issuing IOUs for future payments into the fund that have still not been made years later. Now that this has almost been made illegal, it should help fix the underfunding problem. Also, with the added layer of legal protection for the pension participants, it should give them some level of comfort in the state’s attitude to fix their errors.

 

- By July 1, 2015, 5% of active Tier 1 TRS active members (about 7,000 members) will be eligible to migrate into a defined contribution (DC) plan, on a first-come-first-served basis. These employees would elect to stop accruing pension benefits, and accrue service credits in the DC plan to calculate an eligible retirement date. All state contributions would be made to the defined contribution plan as well as employee retirement contributions. Employee contributions to the defined contribution plan must remain the same as those in the defined benefit plan. State contributions to this DC plan could not be less than 3% or higher than those already being made to the pension plan. This rate will be adjusted annually.
- The decision to join the DC plan is irrevocable, and further information about the plan must be requested.
- The DC plan will require a 5-year vesting period for state contributions. If this is not reached (either by resignation, termination of employment or retirement before the fifth year a participant is in the plan), then all state contributions and earnings on these funds will be forfeited. At retirement, equal payments from the balance will be made to the member until all the funds are exhausted.
- DC participants may still be eligible for group disability benefits and this premium would be taken out of DC contributions.

This 401(k)-like plan is a nice addition, although its impact will be minimal with only 5% of participants being eligible to participate. Having a defined contribution plan will be welcomed by those who do not have any trust in the State for their retirement security, but they will now be responsible for their investment selection and managing their retirement savings. TRS will manage investment selection if directed, but that would not be advised, as everyone’s situation is unique. The attractiveness of the plan will also be affected by which companies are allowed to provide a 401(k) plan, and if the investment choices they offer will be appropriate for the participating teachers. In addition, with many teachers already having a 403(b), they may prefer the option of having some of their retirement savings being captured in a pension. As always, these decisions should be made after counsel with a financial professional especially as this decision cannot be changed once made.

 

Overall, the bill does provide a lot of changes. It changes the retirement dates for younger teachers, changes the COLA amounts for every teacher (including those who are retired), includes safe-guards for state funding, and allows for the addition of a 401(k)-like plan.

It will be interesting to see how this plays out in the state court system as to whether it is constitutional and if it will continue being law. However, for now, teachers should expect to make some changes to their retirement plans – no matter how young or old they are.

I know I have used some “jargon” in this plan. I wanted to keep my summary as true to the Bill as possible. However if you have any questions, please feel free to comment below or contact me directly.

 

Comments

  1. maureen escherich says:

    so in 40 years the teachers who are just starting as a teacher will work until they are 65! Wow So my great great grandchildren will have people who really don’t want to teach teaching them! way to go Springfield!

    • Maureen,

      A teacher is not required to stay until their maximum age (60-65), but they will not get as big a pension as a teacher who does. I would hope for the teachers and children’s sake that if a teacher doesn’t enjoy or want to do teach, they would leave.

      Dave

  2. Justin Muro says:

    Thanks for the snapshot!!

  3. How many sick days equal one year of teaching? Does the 2.2 formula stay in place and can it ever be changed?

    • Jess,

      In Illinois, 170 sick days equals one year of teaching, and will equal one year of service credit for pension requirements. The 2.2 formula does stay in place. It would be unlikely that the method surrounding 2.2 would change in calculating the pension amount, but the factor itself (2.2%) may change in the future to a lower number. Of course, this would be fought in court the same way the current pension changes are currently.

      Dave

  4. wHAT’S THE MAXIMUM PERCENTAGE OF YOUR SALARY YOU CAN GET UNDER 2.2? iS IT 70 OR 75%?

    • Jeff,

      2.2 and the maximum pension amount are seperate things. Under the Tier 1 pension structure, you can get 75% of your salary from the highest consecutive four years, out of the last ten you have worked. This will still apply if you upgrade all of your pension to the 2.2 factor or leave it in the multiple tiers.

      Dave

  5. Awesome article. grateful someone like you can explain it all in layman’s terms. especially for someone like me who has not been keeping informed and educated. if a teacher has 20 years experience and is 55 years old, making $90,000 per year (example), how does this affect the teacher if he wants to retire at 55 and doesn’t wait to wait until he is 60? it is my understanding the teacher loses 6% for each year under age 60? but if he waits until 60, he gets the full amount. I don’t understand this, can you provide an example? thanks.

    • Joe,

      You would be able to retire at age 55 if your district allowed you to retire using ERO (Early Retirement Option). This would involve you and the district paying TRS to receive a pension that is not reduced. If this is not an option and you left at 55 without 35 years of service, you would receive a 6% reduction per year you are under age 60. At age 55, this would result in a 30% reduction in your pension.

      However, if you do not need the pension to live on, you could leave teaching at 55 but not “retire” until age 60. This would allow your pension to sit where it is and then you can start it at age 60 without receiving a penalty. However, if you retire at age 55 and elect to receive your pension immediately, you will have the 30% reduction.

      I hope that’s clear!

      Dave

  6. thanks for spelling it all out!

  7. Thank you for Taking the time to explain the bill.

  8. DAVE, I have 20 years in the business sector with social security and 11 years in teaching.
    How do I determine which will benefit me when I retire?
    Thank you.
    Jeanne

    • Jeanne,

      Great question. First, make sure you check out the article here to see if you can find your answers: Can I collect TRS and Social Security?

      In addition, you may be able to collect both of these benefits, but your Social Security will be reduced by your TRS pension. By how much? That can be determined by taking a TRS estimate to the Social Security office for them to run an estimate. This should be done in the year before you retire to make it as accurate as possible.

      Dave

  9. i’d like clarification In regard to the new Tier 1 cap on pensionable income. Is the annual increase based on the lesser of (3% or the annual CPI-U), or (3% or 1/2 the annual CPI-U)? Your blog post doesn’t mention it being half of the CPI-U, but in reading the actual pension bill I see that language used several times in regard to Tier II teacher benefits.

    • Jim, great point. The Tier 1 and Tier 2 pension benefits have a different COLA amounts applied to them. For Tier 1, it is based on CPI and for Tier 2 it is based on 50% of CPI.

  10. I have taught in il for 11 years and am 44 in a couple of weeks. Dora this mean I will need to teach until 68 to receive a full pension? I also have 5 years in California strs. It is very expensive to buy that time. Since I am vested there as well would it be just as goo to draw a pension, however small, from there too? Thx.

    • Melissa,

      As of last week, the pension reform was put on hold. As of the old law, you would need to teach until 60 to receive full benefits on your pension, and under the new law it would be until 61 (if you are basing your pension on age, service credit would be a different age if you are looking at 30 years of service). With the law in flux right now, it’s hard to give you a definitive answer. If you are vested in California’s STRS, and don’t want to tranfer it, it will be paid out as a monthly pension when you retire. You would receive a check from IL and another from CA.

      I hope this helps.

      Dave