A key part of a pension reform approved by San Jose voters last week needs IRS approval, similar to an Orange County pension reform held up for three years while waiting for IRS approval.
The problem is a U.S. Internal Revenue Service rule in 2006 that could deny the usual tax-deferred status if an individual public employee chooses a retirement plan with a lower benefit.
Giving current employees the option of choosing a lower pension plan, or paying more to keep the current plan, is a key part of an agreement Orange County negotiated with employees in 2009 as well as Measure B approved by San Jose voters last week.
After talks with the IRS stalled, Orange County got U.S. Rep. Loretta Sanchez, D-Santa Ana, with Republican co-authors to introduce legislation last September giving tax-deferred status to optional public pension plans with lower benefits.
Mayor Chuck Reed said a U.S. Conference of Mayors meeting in Orlando this week is expected to consider a resolution calling on the U.S. Treasury Department and Congress to give optional lower-benefit plans favorable tax treatment.
As state and local governments struggle with soaring pension costs that are diverting scarce funds from other programs, option advocates say employees should have a choice about the retirement benefits they earn in the future.
Pension amounts already earned would be protected. But employees would have the option of paying more each year to continue earning their current pensions or choose to pay less each year and earn a lower retirement benefit.
“You might ask, why would they do that?” Orange County Supervisor Bill Campbell told a two-house legislative committee on pension reform during a hearing in April.
Campbell said that in 2005 Orange County employees wanted to boost their pensions to one of the highest levels, 2.75 percent of final pay for each year served at age 55. (By way of contrast, teachers get 2 percent at age 60.)
“We said we can’t afford to pay any more than the current plan,” Campbell said of the bargaining position of the county supervisors. “The union members took over the obligation for all of the increased cost assessed with moving to 2.75 at 55.”
As the economy declined and pension fund investments nationwide fell far short of their earning targets, the annual Orange County required contributions went up. Employee rates that had been 7 to 11 percent of pay became 11 to 15 percent.
The union agreed to the plan in 2009 that gives new hires and current employees the option of choosing the higher pension or a lower benefit. The lack of IRS approval has prevented current employees from making a choice.
The county workforce has been sharply reduced. But of 660 new hires since the option took effect, Campbell told the legislative committee, about 25 percent have chosen the lower retirement plan.
“We have no idea how many of our current employees would trade down,” Campbell said. “I believe it would be between 25 and 50 percent. It depends on each person’s lifestyle situation.”
The county has retained a well-known firm with retirement expertise, TIAA-CREF, to brief employees in detail on the consequences of choosing each of the retirement plans.
“It’s not a sales job,” he said. “It really is just the facts.”
Campbell said he was told that the IRS rule in 2006 was a response to an abuse in the private sector, apparently with 401(k) plans, and public employee plans were somehow included in the regulation.
The Sanchez bill, HR 2934, has been in the Ways and Means committee since its introduction last September. In an election year, Campbell is not optimistic about moving a bill that would allow individuals to choose lower benefits in public pensions nationwide.
“That is part of the problem,” Campbell said yesterday. “Some of the national unions don’t like this.”
In San Jose, Mayor Reed said San Jose also is seeking IRS approval under the 2006 rule for the option in Measure B. Unlike Orange County, the San Jose option was not approved in bargaining with unions.
As the city filed for approval of Measure B in federal court last week, the police and firefighter unions filed separate suits in the county superior court to overturn Measure B.
The measure gives current San Jose workers the option of choosing a lower retirement plan or keeping the current pension and eventually paying up to an additional 16 percent of pay.
The need for IRS approval of the option arose in the discussions of the option. The police union lawsuit said the city has known since at least last January the option “will not receive IRS approval in 2012 and is likely never to receive such approval.”
IRS approval is mentioned in Measure B, said Reed, and the city is not likely to try to implement the option without IRS approval. But if the option is blocked by the courts or regulators, the measure calls for equivalent savings through pay cuts.
Reed said he expects the IRS to look at the “facts and circumstances” in San Jose. Retirement costs, now about 20 percent of the city general fund, are expected to reach 24 percent in several years if there is no cost-cutting reform.
The mayor’s view that San Jose retirement costs urgently need to be cut was supported by a Santa Clara County Civil Grand Jury report yesterday, which also urged cost-cutting reforms in 14 other cities and the county.
“The grand jury concludes that until significant modifications are enacted, there is no doubt that the escalating cost of providing benefits at the current level is interfering with the delivery of essential city services and the ultimate cost to the taxpayers is an unbearable burden,” said the report.
The county and the other cities are all in the giant California Public Employees Retirement System. San Jose employees are in two city-run retirement systems, one for police and fire and the other for non-safety employees.
Before the IRS rule in 2006, CalPERS is one of the public pension systems that had some experience with option plans. In 1984 legislation gave most state workers the option of switching from “2 at 60” to “1.25 at 65.”
Under AB 529 by former Assemblyman Dave Elder, D-Long Beach, workers opting for the lower pension would no longer contribute 5 percent of their pay to pensions and money contributed to CalPERS in past years could be returned with interest.
“CalPERS found that 47 percent of new workers from 1984 to 1988 chose the lower pension tier, which did not require any payroll deductions from employees,” a Little Hoover report said last year.
Legislation during a state budget crunch in 1991 gave all new hires “1.25 at 65.” A massive pension increase sponsored by CalPERS, SB 400 in 1999, allowed state workers to switch to “2 at 55.” Recent contracts dropped new hires to “2 at 60.”
Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at https://calpensions.com/ Posted 14 Jun 12