An Option for Members of the Public Employees' Retirement System
Final Recommendations of the Committee on Public Employee Retirement Systems
Prepared for the Committee on Public Employee Retirement System
by Sheri S. Heffelfinger, Research Analyst Montana Legislative Services Division December 1998
Committee Members
Sen. Sue Bartlett (D-Helena), Rep. Matt Brainard (R-Missoula), Chairman Vice-chairman
Sen. Vivian Brooke (D-Missoula) Rep. Patrick Galvin (D-Great Falls)
Sen. John Hertel (R-Moore) Rep. Doug Mood (R-Seeley Lake)
Sen. Mike Taylor (R-Proctor) Rep. Diana Wyatt (D-Great Falls)
Committee Staff
Sheri S. Heffelfinger, Research Analyst David Niss, Staff Attorney JoAnn Jones, Secretary
Montana Legislative Services Division
Robert B. Person, Executive Secretary Gregory J. Petesch, Legal Services Director David D. Bohyer, Research Director
Acknowledgments
On behalf of the Committee on Public Employee Retirement Systems,staff would like to extend a special thanks to Mr. Christopher Bone,Chief Actuary, Mr. Douglas Forrester, Director of Public Plan Practice,and the entire staff of Actuarial Sciences and Associates, Inc. for theirdedication and responsiveness on this project. Thanks, too, to Mr. MikeO'Connor, Director of the Public Employees' Retirement Division, andthe staff of the Public Employees' Retirement Board for theircooperation and assistance.
RECOMMENDATION SUMMARY
To comply with House Bill No. 90, which was enacted by the 1997 Legislature,the Committee on Public Employee Retirement Systems (CPERS) recommendsthat to increase the portability of retirement contributions, provide moreretirement plan flexibility, allow for individual choice regarding investment ofretirement savings, and retain a specified benefit in retirement, the PublicEmployees' Retirement System (PERS) should consist of two types of retirementplans. The two types of retirement plans should be the current PERS definedbenefit (DB) plan, which would remain essentially unchanged, and a new definedcontribution (DC) plan, which would be added to PERS as an optional plan.
Under a DB plan, all eligible members receive a specified benefit that is formula-driven, predictable, and guaranteed, and the employer has the risk, responsibility,and control. Under a DC plan, benefit levels depend on total contributions andinvestment earnings, and the employee has the risk, responsibility, and control.
Under CPERS's recommendations, all current PERS members would be given acertain amount of time in which to make a one-time choice about whether to stayin the PERS DB plan or transfer to the new DC plan. New PERS members wouldinitially be enrolled in the DB plan and would also have a certain amount of timein which to make the transfer decision. PERS retirees would not be affected bythese recommendations.
About 28,000 state, university, school district, county, and city employees areactive PERS members. Nearly 500 different employers participate in PERS. Currently, DB plan assets amount to more than $2 billion. These assets are heldin trust to pay benefits for PERS members and their beneficiaries. PERSmembership is mandatory for employees in PERS-covered positions. EffectiveJuly 1, 1998, required employee and employer contributions will be 6.9% ofcompensation. CPERS's recommendations would not increase contribution rates.
PERS is governed by the Public Employees' Retirement Board, which consists ofsix members appointed by the governor. Administration of the new DC planwould be contracted out to a private-sector vendor or vendors. The Board would,however, exercise contractual oversight and act as the trustees for the new DCplan.
ORGANIZATION OF THIS REPORT
This report contains a summary table explaining current DB plan provisions andoutlining the major provisions of the new DC plan as recommended by CPERS.
STUDY PROCESS
In developing its recommendations, CPERS hired a consulting firm, ActuarialSciences Associates, Inc. (ASA), which provided CPERS with reports, analyses,and recommendations. CPERS also sponsored a series of consultant-facilitatedfocus groups, which included PERS members as well as employers, explored 3plan design options, including a split DB/DC hybrid plan, considered DB and DCplan benefit comparisons, and examined fiscal implications. CPERS alsoconducted numerous public hearings, including three statewide public meetings,each involving 19 video conference sites across Montana.
COMMITTEE BILL STATUS
CPERS's recommendations are contained in House Bill No.79, which has beenpreintroduced by Representative Matt Brainard. The 56th Legislature willconvene on January 4, 1999. The full text of the bill and the latest legislativeactions on HB 79 may be obtained through the Legislative Branch Internet siteand bill status system. The Internet address for the Montana LegislativeAutomated Workflow System (LAWS) is as follows: < http://laws.leg/mt.gov/law/plsql/LAW0200W$.Startup>.
Or, the bill status system may be accessed through the state's main Internet homepage at <http://mt.gov>. Once at that site, click on “Legislative Info” andthen click on “1999 Session (LAWS)”.
FURTHER INFORMATION
For further information, or if you have questions about the following summary orHB 79, please contact Sheri Heffelfinger, Research Analyst, Montana LegislativeServices Division, Room 138, State Capitol, Helena, MT, 59620. Phone: (406) 444-3064 FAX: (406) 444-3036 E-mail: <sheffelfinger@mt.gov>
Summary Table of the Current Defined Benefit Plan and CPERS's Recommendations for a New Defined Contribution Plan
PERS - Plan Design as Proposed by HB 79
Issues andPlanFeatures
Defined Benefit (DB) plan (Current PERS)
Defined Contribution (DC) Plan
Plan choices
See HB 79, sec. 47
All current PERS members would be able to choose to transfer to the new DC plan orto remain in the DB plan. The choice of plans would have to be made within 12months of the effective date of the new DC plan, which is contingent on when thePERS Board certifies that the plan is ready to become operational, but by no later thanJuly 1, 2002.
Inactive PERS members (i.e., not actively employed in a covered position) on theeffective date of the DC plan, if rehired into a PERS-covered position, would be ableto elect to remain in the DB plan or to transfer to the DC plan within 12 months oftheir rehire date.
New hires: Members initially hired after the effective date of the DC plan would beenrolled in the DB plan and would have 12 months from their hire date to decidewhether to transfer to the DC plan.
Default plan: A member would remain in the DB plan if the member fails to exercise achoice.
University-system employees covered by PERS: A university-system employee in aPERS-covered position who is eligible to join the DC plan would also be able to electto transfer to the Optional Retirement Program (ORP), which is a different DC planprovided by the Board of Regents and currently administered by TIAA-CREF. Anelection to join the ORP would be a waiver of all rights under PERS. Member andemployer contributions would be the amounts required under the ORP. [see HB 79,sec. 48]
One choice: A choice to remain in the DB plan or to transfer to the DC plan (or to theORP) would be a one-time, irrevocable choice for the duration of that employmentcycle.
Plan choicesforemployeeswhowithdrawand comeback
See HB 79, sec. 49
Less than a 24-month break in service: A person who withdrew from either plan andwas rehired into covered employment after a break in service of less than 24 monthswould have to rejoin the plan from which the member withdrew.
A 24-month or more break in service: A person who withdrew from either plan andwas rehired into covered employment after a break in service of 24 months or morewould have the same plan choice as a newly hired employee (i.e., initial enrollment inthe DB plan with an option to transfer to the DC plan).
Exception for former DC plan members: A former DC plan member who received or isreceiving some type of benefit or payment distribution from money that was formerlyin the member's DC plan account would be required to rejoin the DC plan.
“Buy back” of previous service in the DB plan: An eligible former DC plan memberwho chose to join the DB plan after returning to covered employment would be ableto “buy back” previous years of service by contributing to the DB plan the fullactuarial cost for each year (or portion of a year) the person wanted to qualify.
Amountavailable totransfer tothe DC plan
See HB 79, sec. 50
Current PERS members on the effective date of the DC plan would be able to transfer all of the member's contributions and a specified portion of the employer contributionsnot used to pay past unfunded liabilities, plus interest credited at 8% annually. (SeeHB 79, sec. 50 for the table showing the portion of the employer contributions thatmay be transferred according to the member's years of service.)
A new member, who would be initially enrolled in the DB plan and given 12 months todecide whether to transfer, would be able to transfer the member's contributionsmade from the hire date and the employer contributions that would have beencredited to the member's DC account if the member had elected the DC plan on themember's hire date, plus interest at the actuarially assumed rate of return on DB planinvestments (currently 8%).
Contributionamounts
Required contributions: The statutorycontribution rate will be 6.9% ofcompensation for employees and 6.9%of covered payroll for employers,effective 7/1/99. (This is not a change.) These contribution amounts are notflexible.
Allocation to an education program: From employer contributions, 0.04% ofcovered payroll would be allocated to afund to pay for educational programs forall PERS members. [see HB 79, sec. 41]
Flexibility of contribution amountsoutside of PERS: Members participatingin a voluntary 457 deferredcompensation plan type or a 403(b) plantype may currently set their owncontribution amounts to those plans. A457 plan and a 403(b) plan allow foradditional retirement savings outside ofthe PERS DB plan. Only educationalinstitutions may offer a 403(b) plan.
Currently, some local governments, theuniversity system, and the state providea 457 plan in which employees mayvoluntarily participate. The universitysystem and some school districts alsooffer voluntary 403(b) plans. Althoughallowed, employers do not currentlycontribute to these plans.
Need to coordinate: Voluntary deferralsunder a 457 plan and a 403(b) plan mustbe coordinated with each other to ensuretotal deferrals do not exceed themaximum allowed by the IRS.
Required contributions: The statutorycontribution rate will be 6.9% ofcompensation for employees and 6.9% ofcovered payroll for employers, effective7/1/99. (The same as in the DB plan.)These contribution amounts are notflexible.
Allocation of employer contributions: Theemployer contributions to the DC planwould be allocated as follows: [See HB79, sec. 53]
-- 4.49% of compensation would bedeposited to each member's DC planaccount.
-- 2.37% of compensation would be paidto the DB plan as the “plan choice rate”to pay for past unfunded liabilityobligations and to compensate the DBplan for increased DB plan costs resultingfrom PERS members selecting the DCplan.
-- 0.04% of covered payroll would bedeposited to an educational fund (thesame as for DB plan employercontributions).
Adjustments in the allocation of employercontributions: The plan choice rate wouldbe adjusted by the Board based on astatutorily defined method to assure theactuarial soundness of the DB plan and toassure that DC plan employercontributions allocated to the plan choicerate are not too high or too low. If theplan choice rate needs to be increased,the amount allocated to member accountswould be decreased accordingly. If theplan choice rate needs to be decreased,the amount allocated to member accountswould be increased accordingly. [see HB79, sec. 54]
Vesting
Right to employee contributions andinterest: A DB plan member isimmediately 100% vested in theemployee contributions plus interest at arate set by the PER Board.
5-year vesting to be eligible for futurebenefit: A member must work in coveredemployment for 5 years to be vestedwith the right to a retirement benefitwhen the member attains retirementeligibility.
Employer contributions must stay in plan:If a vested or nonvested memberchooses to withdraw from the plan, themember may take out only the employeecontributions plus the Board-set interest,which fluctuates, but is currently about5%.
See HB 79, sec. 52
Right to employee contributions andinvestment earnings on thosecontributions: A DC plan member isimmediately 100% vested in themember's contributions and theinvestment earnings on thosecontributions.
5-year vesting for employer contributionsand investment earnings on thosecontributions: A DC plan member wouldnot be vested with the right to take outemployer contributions and investmentearnings on those contributions until themember has worked at least 5 years incovered employment. The member wouldforfeit the employer's contributions andinvestment earnings if the member leavescovered employment before completing 5years of service.
Membership termination required: Anonvested member leaving coveredemployment would be required to removehis or her contributions and investmentearnings from the DC plan. [see HB 79,sec. 56] If a vested or nonvestedmember's account balance is less than aspecified minimum when the memberleaves covered employment, the memberwould also be required to terminate planmembership. [see HB 79, sec. 60]
Allocation of forfeitures: The PER Boardwould allocate forfeited employercontributions and earnings toward theplan choice rate payments to the DB planto pay off the past DB plan unfundedliabilities. [see HB 79, sec.50(3)]
Investmentcontrol
The Board of Investments manages theinvestment of the DB plan assets.
Investment earnings in a DB plan: Thebenefit amount is defined by a statutoryformula and does not fluctuate withmarket gains or losses. In estimating thecost of defined benefits, the plan actuarymakes certain economic anddemographic assumptions, including anassumption about overall average ratesof return on investments. Currently, theassumed average rate of return over timeis 8%.
Current funding status: Based on theplan's 1998 valuation, almost 92% ofthe plan's benefit obligations are fullyfunded by current assets, leaving 8%that cannot be funded using currentassets. Based on expected futurecontribution rates and investmentearnings, the unfunded portion of theliabilities may be paid off (amortized) inabout 13 years. (The amortizationschedule fluctuates with actuarial gainsand losses, which include investmentgains and losses.)
See HB 79, sec. 55
Self-directed investments: DC planmembers would direct investment of theiraccount balances and have a set menu ofinvestment alternatives from which tochoose. Investment choices offeredwould be determined by the Board inaccordance with HB 79 provisions. Member account balances would fluctuatewith the market performance of theinvestment alternatives selected by themember.
Consult with licensed advisors: Memberswould be advised to consult licensedfinancial advisors when selectinginvestments. Personnel officers would notbe expected to and cannot legally provideinvestment counseling.
Control of employer contributions:Nonvested and vested DC plan memberswould be able to control investment ofthe employer contributions. Employercontributions and earnings would betracked separately from employeecontributions and earnings.
Educationprogram
See HB 79, sec. 41
A portion of the employer contributions (0.04% of compensation) in both plans wouldbe deposited to a fund for educational programs. The Board would coordinateeducational programs to help members decide which plan to choose. On-goingprograms would provide DB plan members with information about the DB plan, whileDC plan members would be given information about how to select appropriateinvestments and manage their individual portfolios. The educational programs wouldalso provide members in each plan with information about how to plan for retirementand coordinate their PERS savings with other savings plans outside of PERS, such asthe state's 457 deferred compensation plan.
Portabilityinto the plan
Currently, vested DB members maypurchase (i.e., qualify) certain types ofpublic service performed outside of PERSfor full cost and thus enhance theirbenefit at retirement.
See HB 79, sec. 51
The DC plan would accept rollovers fromother qualified plans such as another401(a) plan in the public sector or a401(k) plan in the private-sector.
Retirementeligibilityand benefitamounts
Eligibility for normal retirement: A member is eligible to retire with normal,unreduced benefits:
-- at age 60 with 5 years of service; or
-- with at least 30 years of service; or
-- at age 65 regardless of service if themember reaches age 65 while activelyemployed in a covered position.
Benefit amount: The member'sretirement benefit will be the greater of: the defined benefit formula: 1/56 x yrs of service x final avg. salary or the money purchase formula: the actuarial equivalent of double themember's contributions plus the board-set interest, annuitized for life.
Eligibility for early retirement (reducedbenefit): at age 50, or at 25 years ofservice regardless of age.
Eligibility for retirement: Members wouldbe able to start accessing accountbalances any time after leaving coveredemployment.
Note: Taxes and penalties on distributionsvary. Members would be advised toconsult their accountants or licensedfinancial advisors before taking money outof their accounts. Distributions prior toage 59 ½ may be subject to a 10%federal tax penalty for early withdrawal.
Benefit amount: Distribution amountswould depend on the payout optionsselected by the member and on themember's account balance.
Portabilityout
At termination of covered employment, aDB plan member wishing to withdrawfrom the plan is entitled to take outemployee contributions plus the board-set interest in one of the following ways:
(1) “cash out” of the plan i.e., take ataxable lump sum distribution.
(2) transfer the money to anotheremployer's plan, which would typicallybe a 401(k) plan in the private-sector ora 401(a) plan in the public sector, if thatplan accepted the transfer.
(3) roll the money into an IRA. (Note:only a direct rollover is protected againsta 20% federal tax penalty.)
See HB 79, sec. 56
At termination of covered employment, anemployee wishing to withdraw from theplan would be entitled to the employee's account balance* and would be able to doone or any combination of the following:
(1) “cash distribution” i.e., a taxable lumpsum distribution.
(2) transfer money to another employer'splan, which would typically be a 401(k)plan in the private-sector or a 401(a) planin the public sector, if that plan acceptsthe transfer.
(4) roll the money into an IRA. (Note: onlya direct rollover is protected against a20% federal tax penalty.)
*Account balances:
Nonvested member account balanceswould be employee contributions plusinvestment earnings.
Vested member account balances wouldbe the employee and employercontributions and all investment earnings.
Distributionoptionswithin theplan
A retiring DB plan member has aspecified monthly benefit for life, but isoffered options on beneficiary benefits(which affect the monthly benefitamount paid to the member):
(1) no benefit for a beneficiary; or
(2) a life-time benefit for thebeneficiary; or
(3) ½ the member's benefit amount forthe life of the beneficiary; or
(4) either a 10-year term-certainguarantee or a 20-year term-certainguarantee. (This provides, for example,that if the member chooses the 20-yearterm-certain guarantee and the memberdied after 15 years, then the beneficiarywould get the full benefit amount for theremaining 5 years.)
GABA: All benefits paid are, after threeyears, covered by the 1.5% GuaranteedAnnual Benefit Adjustment, i.e, anautomatic annual increase in the monthlybenefit.
See HB 79, sec. 57
After leaving covered employment, avested DC plan member who remains inthe DC plan would be able to chooseamong the following:
(1) a purchase any of the retirementbenefits offered in the DB plan, whichinclude the GABA (although benefitpayments would not start until themember reaches retirement eligibility asdefined for the DB plan members); or
(2) a choice from among variousdistribution options that the PERS Boardmay negotiate with a private-sectorvendor.
Note: The IRS requires minimum regulardistributions from member accounts afterthe member has attained age 70 ½,unless the member is actively employed.The Board would provide for a “defaultrule” so that distributions comply with IRSrequirements.
Return towork
For a member who retires under the DBplan, who is under age 65, and whoreturns to covered employment for morethan 640 hours in any calendar year, themember's retirement benefit is reducedby $1 for every $1 earned. If themember is age 65 or older, the memberis either subject to the 640-hourlimitation or may earn up to what themember's final average salary was whenthe member retired (adjusted forinflation), whichever allows the mostearnings. A retiree returning to coveredemployment may elect to become anactive member and defer furtherretirement payments. A retiree whoreturns to active employment in acovered position and who is 70 ½ yearsof age or older is not subject to theserestrictions.
No in-service distributions allowed: A DCplan member who is less than 70 ½ yearsof age and who returns to activeemployment in a covered position maynot receive distributions from the DCplan. [See HB 79, sec. 57(3)]
Disabilitybenefits
An active member with 5 or more yearsof service who becomes totally andpermanently disabled is eligible for adisability retirement. The amount of thedisability benefit depends on themember's date of hire. For membershired after February 24, 1991, (or for amember who has made an election forthis coverage) the benefit is calculatedusing the DB plan formula: 1/56 x yrs of service x final avg. salary
None. A DC plan member would be ableto voluntarily purchase a supplementarydisability plan, which may or may not becoordinated through the employer'spayroll system.
Deathbenefits
Upon the death of an actively employedmember, the designated beneficiary isentitled to:
(1) a lump-sum benefit consisting ofone month's salary, plus the member'saccumulated contributions and interest;or
(2) the above amount annuitized for thelife of the beneficiary; or
(3) if the deceased member wasvested, elect a monthly benefit based onthe salary, service, and age of themember at the time of death.
See HB 79, sec. 58
If a member dies, the member'sbeneficiary would be entitled to:
(1) a lump-sum distribution of themember's account balance; or
(2) a benefit purchased from the DB planwith the member's account balance; or
(3) a rollover of the account balance toeither an Individual Retirement Account orAnnuity.
Health planbenefits
By law, a DB plan member who retiresmay continue to participate in theemployer's group health insurance plan ifthe member pays the full premium,subject to certain restrictions. (Seesection 2-18-704, MCA.) Administrativerules covering state agencies haveallowed members who are eligible toretire to remain on the state health planeven if they have not yet received aretirement benefit. In effect, therefore, aDB plan member with at least 5 years ofservice and who is at least age 50 (i.e.,early retirement eligibility) is eligible toremain on the state plan after leavingcovered employment.
See HB 79, sec. 2, amending section 2-18-704, MCA
Same as for the DB plan participants.After leaving covered employment, a DCplan member with at least 5 years ofservice and who is at least 50 years ofage while in covered employment wouldbe able to continue to participate in theemployer's group health benefit plan if themember pays the full premium, subject tocertain restrictions provided by law.
Loans
No loans allowed.
See HB 79, sec. 59
After 5 years of covered employment, amember would be able to take a loan fromthe member's account of up to ½ of themember's account balance, but no morethan $50,000. Loans would have to bepaid back within 5 years with interestbased on the prime rate. For activelyemployed members, repayment would beby automatic payroll deduction.
Part-timeemployeesand optionalmembership
For part-time employees: Membership is determined based on the number of hoursworked. An employee working in a covered position for 960 hours or more in oneyear must become a member of PERS. (Prior to that time, membership is optional.) When an employee becomes a member, the member has the same plan choices as anewly hired employee, i.e., after initial enrollment in the DB plan, the member wouldhave 12 months to choose whether to stay in the DB plan or to transfer to the DCplan.
For employees with optional membership under current law: Certain types ofemployees, such as state legislators, other state and local elected officials, andemployees appointed by the governor have the option, under current law, of joiningPERS at any time during their employment (see section 19-3-412, MCA). When anemployee elects to join, the employee can qualify previous service by paying theappropriate employee contribution amounts for the past service and the employer isthen obligated to pay the employer's contributions for that past service. However,the IRS has raised a “red flag” on this on-going optional membership provision and theBoard, to comply with IRS regulations, is introducing legislation that would requirethese employees to make a one-time decision within a specified time period. If theemployee opts in, as a member of PERS, the employee would have the same planchoices as a newly hired employee (i.e., be initially enrolled in the DB plan and have12 months to elect to transfer to the DC plan).
Costs
New administrative costs would be incurred by the PER Board to modify existinginformation management and data systems to accommodate new DC plan reportingand tracking requirements. The CPERS bill is being introduced with a general fundappropriation of $2.93 million, $2.48 million of which would be repaid over timethrough administrative fees on the DC plan. On-going administrative costs would bepaid through administrative fees on the DC plan as negotiated between the Board andthe plan vendor or vendors. [HB 79, sec. 68]
Implement-ationscheduleand planeffectivedate
As introduced, the CPERS bill sets out an implementation schedule for accomplishingthe tasks related to contracting for DC plan administrative services, modifying thereporting and information management systems, and applying for an IRSdetermination about whether the DC plan complies with IRS regulations. A temporaryadvisory council would assist the PERS Board in selecting the menu of investmentoptions to be offered in the DC plan. The schedule would allow the PERS Board todetermine when the DC plan is ready to become operational. An implementation teamand a legislative oversight committee would also assist in the implementation process.When the Board certifies to the governor that the plan is ready, the DC planprovisions would then become effective. The CPERS bill states that the DC plan mustbecome effective by no later than July 1, 2002. The 2001 Legislature would,therefore, be able to take a “second look” at the DC plan provisions and make anynecessary adjustments to statutory provisions. [see HB 79, sec. 61]
