Guest Post: If Lawmakers Take it Up, Tier 2 Pension Reform Must Be Responsible
Public employees seeking to change Illinois’ “Tier 2” pension system rally outside of the statehouse in November. (Photo: Chicago Tribune)
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OPINION
By Amy Korte, Illinois Policy Institute
At the center of Illinois’ challenges – rising property taxes, budget gaps, outmigration – lies a topic that stirs emotions and debate: public pensions.
Public pensions are a central component of retirement security for thousands of Illinois teachers and government workers, especially those who do not participate in Social Security or other ways of saving for retirement.
Yet, the status quo is not working for pensioners or taxpayers.
Right now, the state only has about 46 cents on hand for every dollar of promised benefits. A significant market downturn could wipe out money people are counting on. Meanwhile, state spending on pensions has grown 2,000%, or by about $10.5 billion, since 1996, which has led to a slew of tax and fee hikes. In local communities, pension costs are outpacing funds for services and pushing up the nation’s second-highest property tax burden. In Chicago, property taxes have nearly doubled since 2014, driven entirely by pension spending.
Despite claims of “making full payments,” Illinois leaders have never met the amounts pension actuaries have calculated is required to meet obligations and fully fund pensions within the next 20-30 years. The only way to do that would be to drastically increase total state tax collections – which would be detrimental for both businesses that employ Illinoisans and the families who reside here.
Now, lawmakers are poised to discuss and act on issues surrounding Tier 2 pensions – the retirement plans covering employees hired after Jan. 1, 2011. Considering the fiscal mess state pensions are already in, it’s vital lawmakers tread carefully and deliberately.
The story behind Tier 2
The Tier 2 system was adopted through bipartisan legislation as a response to Illinois’ staggering state unfunded pension liabilities, now near $144 billion. By creating a plan with less pension spiking, lower annual pension benefit increases and higher retirement ages, lawmakers aimed to curb escalating costs.
Tier 2 has generally succeeded in slowing the growth of liabilities, preventing Illinois’ fiscal health from being even worse than it would have been, while still providing valuable retirement benefits. But questions have since arisen about its compliance with federal regulations known as Safe Harbor provisions, or the minimum benefits that must be provided to avoid having to pay into Social Security.
Critics argue the system’s reduced benefits are at risk of falling short of Safe Harbor, particularly the differing maximum pensionable salary between the Social Security wage base and the Tier 2 pay cap. If workers receive benefits that are deemed inadequate, this could trigger financial penalties for the state and the need to pay Social Security taxes.
While Safe Harbor violations would be a serious issue, no independent study has been completed on an individual basis, nor has it been ascertained that specific workers’ pension benefits are falling short of the federal requirement, nor exactly what the penalties would be for failing to comply. Before we do anything, we should understand the scope of the problem and the cost to fix it through a more in-depth actuarial study and a thorough assessment of legal risk. Lawmakers owe it to taxpayers and public employees to conduct thorough analyses before taking any legislative action.
It’s also important to bust any myth that Tier 2 is somehow less valuable than Social Security – a claim often repeated but untrue.
Evaluating Tier 2 for compliance with the federal requirements massively underestimates how much more valuable Tier 2 pensions are than Social Security benefits. Under Tier 2, virtually all employees with 30 years of service are guaranteed 66% of their final average salary for life, with a current cap of $83,010 worth of disbursements today – equivalent to a $127,283 salary. This is much more than most working Illinois residents earn and far exceeds the $48,216 maximum Social Security benefit for a 64-year-old, the average retirement age in Illinois.
A call for calculation
As lawmakers consider ways to change Tier 2, it’s crucial to remember the lessons of Illinois’ pension history. Rushed or ill-considered decisions have contributed to the current crisis, and repeating those mistakes would be costly.
If a thorough study shows changes are necessary, the state must proceed carefully and work to satisfy compliance requirements.
Taking a chainsaw unnecessarily to important cost-savings features of the program seems to be the approach some lawmakers – with government union backing – are apt to take. A bill introduced by state Sen. Robert Martwick last year goes far beyond what would be legally necessary to comply: reducing the retirement age by varying amounts, increasing the cost-of-living adjustment to a guaranteed, simple 3%, and other changes that boost pensions. Recent analysis by the consulting firm Segal estimated these changes to state pension systems alone would cost taxpayers nearly $30 billion through 2045.
The only prudent Tier 2 reform would be to adjust benefits in a way that addresses federal compliance concerns. Lawmakers should stop there.
In the event an actuarial study and legal risk assessment confirm the need to alter benefits, the fix should be simply pegging the Tier 2 pensionable salary cap to the Social Security wage base. Illinois would increase its pensionable base cap, providing top Tier 2 pensioners with a maximum disbursement check of $111,276 annually – up from the $83,010 maximum today.
That’s less costly and more reasonable than what state lawmakers are considering at the urging of government unions. And it still gives pensioners a massive boost worth more than two times what similar retirees would get in Social Security.
Any benefit that goes beyond this change exposes the whole system to undue risk of insolvency, threatens all participants’ retirement security, and burdens taxpayers with excessive costs.
Protecting the future
Illinois’ pension history is littered with shortsighted decisions. The Illinois Constitution currently makes it nearly impossible to backpedal on benefits.
The decisions we make about Tier 2 pensions will have far-reaching consequences for public workers, taxpayers and the state’s fiscal health. If reform is necessary, it must be approached carefully. We cannot afford to gamble with Illinois’ future by enacting poorly conceived fixes that exacerbate the very problems they pretend to solve.
Preserving retirement security requires a thoughtful, deliberate approach. In responsibly tackling any needed Tier 2 reforms, Illinois can best honor its commitments. Let’s get it right.
Amy Korte is the executive vice president of the Illinois Policy Institute. Prior to joining IPI, Amy worked for several years as a bankruptcy attorney at a major law firm in Chicago.
