Pennsylvania’s Pension Crisis

Pension plan changes under SB 1, now Act 5 of 2017, provide long-term reform

Current pension plans for public school and state employees will be changing under Act 5 of 2017, legislation introduced and adopted in June 2017. The plan is offered as a significant step toward systemic long-term reform intended to ensure the future sustainability of the pension system.

Public school employees belong to the Public School Employees Retirement System (PSERS) and state employees belong to the State Employees Retirement System (SERS). Current employees of both systems have a Defined Benefit (DB) plan, which provides them with a retirement payment determined by a formula that takes into account retirement age, years of service, and final average salary.  A Defined Contribution (DC) plan is a retirement investment program that is designed to offer employees a vehicle to save for retirement in a tax deferred environment.  The pension benefit is determined by the amount of the contributions and the investment performance of the member's account.

The plan under Act 5 of 2017 requires future employees of both systems starting in 2019 to select one of three new plan design options, either one of two side-by-side hybrid defined benefit (DB)/defined contribution (DC) plans or a stand-alone DC plan. No changes are made to retirement benefits for current employees, but they would have the option to choose one of the new plan designs.

Senate Bill 1 focuses on the long-term advantages by gradually shifting the investment, inflation and longevity risks away from the state and school districts to future employees. An actuarial analysis from the Independent Fiscal Office (IFO) estimates that the plan reduces investment risk for PSERS by 53%.

PSBA applauds the passage of Act 5 of 2017 because it focuses on the long-term advantages by gradually shifting the investment, inflation and longevity risks away from the state and school districts, thus providing the protection and relief school employers have been asking for.

Details of Act 5 of 2017

This article addresses the new legislation as it applies to members of PSERS.

The new design will offer three options for new employees hired on or after July 1, 2019, who will have 90 days to elect one of the plans. The selection is irrevocable and will cover all future non-exempt service regardless of breaks in service, terminations or withdrawals.

Option 1 (Default Hybrid): A side-by-side DB/DC hybrid with a 1.25% multiplier for the DB component. This is the default plan if no election is made by the employee within 90 days. School employees become members of a new Class T-G.

Employees contribute 8.25% of compensation split between the DB and DC components as follows: 5.5% allocated to the DB plan that has a 1.25% benefit multiplier, and 2.75% to the DC plan. The employer contribution rate to the DB plan is actuarially determined. The employer contribution rate to the DC plan is statutorily set at 2.25% of compensation.

Members would have an individual retirement account for the DC in which employee and employer contributions accumulate, and investment earnings and fees are credited and charged.

The benefit accrual rate is 1.25% of final average salary per year of service, and a 5-year final average salary. There is a 10-year vesting period for the DB component. The DC component employer contributions vest in 3 years, and employee contributions and related investment earnings vest immediately. The employer contribution rate will not drop below the normal cost, which is dependent on what the employee contributes and the investment returns gained by PSERS.

Option 2 (Alternative Hybrid): A side-by-side DB/DC hybrid with a 1% multiplier for the DB component. School employees become members of a new Class T-H.

This option includes a lower contribution rate and lower multiplier to determine benefits. Employees contribute 7.5% of compensation split with a DB component rate of 4.5% that has a 1% benefit multiplier, and 3% to the DC plan. The employer contribution rate to the DB plan is actuarially determined. The employer contribution rate to the DC plan is statutorily set at 2.0% of compensation.

As with Option 1, members would have an individual retirement account for the DC in which employee and employer contributions accumulate, and investment earnings and fees are credited and charged. The DB plan multiplier is 1% of final average salary per year of service, and a 5- year final average salary. There is a 10-year vesting period for the DB component. The DC component employer contributions vest in 3 years, and employee contributions and related investment earnings vest immediately.

Option 3: Defined Contribution Plan

This plan is a 401(k)-style defined contribution plan and does not include a DB component. Employees contribute 7.5% of compensation with an employer contribution match of 2%. Members would have an individual retirement account in which employee and employer contributions accumulate, and investment earnings and fees are credited and charged. Employer contributions vest in 3 years, and employee contributions and related investment earnings vest immediately.

Other provisions

Current employee opt-in: Current, active members of PSERS as of July 1, 2019 will be permitted a one-time, irrevocable election to opt-in to one of the three new plan designs. The member contribution rate for a member opting in will not be more or less than what the member is currently contributing.

Age for full retirement (superannuation): For Class T-G Members, superannuation is age 67 with 3 years of service or the “Rule of 97;” meaning the member has at least 35 years of service and attains an age that in combination is equal to or greater than 97. For Class T-H Members, age 67 with 3 years of service.

Early retirement: Class T-G members who retire on or after age 57 with at least 25 years of service would be able to commence benefits immediately, but benefits are reduced by 3% for each year the retirement occurs prior to superannuation. Class T-G and Class T-H members who are under age 62 and with less than 25 years of service will receive a benefit with a special two-step reduction factor: (1) one factor for a benefit received between age 62-67; and (2) another factor for a benefit received below age 62.

Cost neutral Option 4: Class T-E, Class T-F, Class T-G, and Class T-H can elect a cost neutral withdrawal of their contributions and interest at the time of retirement. For Class T-E and Class T-F members, this provision applies to all contributions and interest withdrawn at the time of retirement. For Class T-C or Class T-D members who opt into Class T-G or Class T-H membership, this option will only apply to contributions and interest credited on or after July 1, 2019.

Shared risk/shared gain: Shared risk and shared gain apply to the new hybrid classes. Every three years, PSERS will compare the actual rate of return to the assumed rate of return for the prior 10 years. For every percentage point in earnings realized in excess of or below the assumed rate of return, the employee contribution requirement will be increased or reduced by 0.75%, not to exceed a maximum of 3% above or below the initial contribution rate. Class T-E and Class T-F members will continue to be subject to the current shared risk requirement, and will also immediately be subject to the shared gain provision, but, such rate will only be increased or reduced by 0.5%, not to exceed a maximum of 2% above or below the basic contribution rate.

Employer contribution requirement: In the event the employer (Commonwealth and school employers) fails to make the annually required contribution to PSERS, the shared-risk member contributions are suspended for any fiscal year in which the employer required payments are not made.

“Footprint” rule: The “footprint rule” that was utilized in Act 120 of 2010 remains for current employees who leave and return. Therefore, members who have pre-hybrid tier membership who leave and return to service will be re-enrolled in the class of service to which they belonged prior to the new design plan.