NASRAFact Sheets

• Public Pension Portability
• Flexibility and Simplification for State and Local Government Deferred Compensation Plans
• Support of the Voluntary Affiliation of State and Local Governments with Social Security
• Lifting Limits on Benefits and Contributions

Public Pension Portability

Members of the National Association of State Retirement Administrators support legislation that would provide portability of pension assets by allowing rollovers of retirement benefits between and among various types of deferred compensation and defined contribution plans (457, 403(b), and 401(k) plans and certain types of IRAs) when employees switch jobs. Pension portability, however, must also enhance what currently is provided in many public sector defined benefit pension plans by allowing assets from all deferred compensation and defined contribution plans to be transferred or rolled into public sector defined benefit plans in order for employees to purchase permissive service credits. Such legislation would assist employees in building their retirement savings, especially those employees who have worked among various public, non-profit and private institutions.

Background

Public, non-profit and private employment sectors generally offer distinct deferred compensation and/or defined contribution plans to their workers. State and local government employers traditionally offer plans under section 457 or 403(b) of the tax code, Universities and non-profit employers typically offer 403(b) arrangements, private employers offer 401(k) plans, and many self-employed individuals participate in Individual Retirement Accounts (IRAs). Under current federal tax law, workers are unable to move retirement benefits between and among these different varieties of retirement savings vehicles. Although a worker today may well move from a non-profit hospital or university (with a 403(b) plan) to state or local government (with a 457 plan), or to the private sector (with a 401(k) plan), they currently are unable to move benefits between these plans.

Proposal

Members of the National Association of State Retirement Administrators support legislation that would allow workers to take their deferred compensation and defined contribution savings with them when they change jobs. Such legislation would:

• Permit rollovers between and among 457, 403(b), 401(k) plans and certain types of Individual Retirement Accounts upon separation from service; and
• Provide that the assets in these accounts would take on the characteristics of and be subject to the rules and requirements of whatever retirement vehicle they are in (or whichever vehicle to which they are rolled).

Background

Defined benefit plans cover over 93 percent of state and local government employees. Most public employees are also provided with a supplemental retirement plan through a section 457 or a section 403(b) arrangement. Some governments (which were grandfathered in 1986) provide a 401(k) plan as a supplement.

Portability Provided in Public Sector DB Plans. Many public employee defined benefit plans have historically permitted extensive portability of service, especially within a state, as it can make a substantial difference in retirement benefits under these programs. Portability of service is most often provided through reciprocal agreements or transfers between public defined benefit systems, and also by allowing participants to purchase service credit for prior periods of service in other jurisdictions. Some jurisdictions, in an effort to assist employees in preparing for retirement, also allow the purchase of service credit in other situations, including previous employment with private sector entities, periods of unemployment, and maternity/paternity leave.

Through purchases of service credit, employees who have forfeited pension credit in some way (i.e., left employment before reaching the vesting period or took leaves of absences) may buy back the credit. A recent survey by the National Council on Teacher Retirement found that 47 out of 50 state-wide retirement systems that serve public school teachers offer this opportunity to some or all of their teachers. Thus, an overwhelming number of public plans have this option.

Federal Barriers to Service Credit Purchases. Usually, public sector employees purchase service credit through employee contributions sufficient enough to cover all or part of the long-term cost to the retirement system providing increased benefits (full actuarial value). These are often costly purchases and are typically made with after-tax dollars, which makes the purchase even more expensive.

Some states have begun to allow for purchases of service credits with pre-tax dollars through a 414(h) employer pick-up arrangement that allows a certain amount to be deducted from a member’s paycheck over a period of time. This arrangement is very effective, but does not assist employees who need to make a lump sum purchase. Employees often cannot plan for unforeseen events such as losing a job due to a Reduction in Force (RIF) or another dramatic occurrence. Such employees may significantly benefit from purchasing service credit to reach a certain level of benefit (i.e. qualifying for a rule of 75, vesting, a 20-year retirement, an unreduced benefit, etc.). Often, however, employees do not have the means to make such a purchase and would either have to take out a loan (if they can qualify) or cash-out their supplemental plan and pay for the service credit with what is left after penalties and taxes. Unlike those public employees with access to qualified supplemental plans, such as those who have grandfathered 401(k) plans, employees with 457 or 403(b) plans are not permitted under federal tax law to directly transfer money from these plans to their defined benefit plan to purchase the service credits.

Proposal

Members of the National Association of State Retirement Administrators support legislation that would enhance portability in public sector defined benefit plans by permitting employees to use assets in their deferred compensation and defined contribution plans as a means to purchase permissible service credits. Such legislation would:

• Allow trustee-to-trustee transfers from 457 and 403(b) plans to public sector defined benefit plans to purchase service credit as defined in section 415(n)(3)(A), thereby affording these plans transfer capabilities similar to those currently allowed under law between qualified plans. By definition, such transfers would have to be agreed to by the transferor and the transferee, so by no means would this be a mandate on 403(b), 457 or public defined benefit plans/administrators.
• Permit lump sum distributions from defined benefit plans to be rolled into 457 and 403(b) plans. Currently, public employees who separate from service are only allowed to roll distributions from their defined benefit plan into an Individual Retirement Account or take the money as income.

Flexibility and Simplification for State and Local Government Deferred Compensation Plans

The National Association of State Retirement Administrators supports legislation that would provide needed flexibility to and simplification of state and local government deferred compensation plans (Section 457 plans). Such legislation would lessen the restrictive rules on distribution payments, simplify calculations of contribution limits, and enhance contribution levels. In addition, it would afford Section 457 plan distributions made pursuant to a domestic relations order the same tax treatment as similar distributions from qualified governmental plans.

Background

Many state and local governmental entities sponsor a Section 457 supplemental deferred compensation plan in addition to the general retirement plan to allow participants to defer some portion of their salary in anticipation of their retirement needs. Some entities also provide limited matching contributions to encourage Section 457 plan participation. However, the administration of governmental 457 plans, and the ability of public employees to take advantage of these arrangements, is often hampered by the complex rules that are currently in place:

Restrictive Distribution Rules. State and local government Section 457 plans currently have very restrictive rules regarding the distribution of individual account balances. Unlike other salary reduction plans, participants in governmental 457 plans have little flexibility in determining the date of first distribution and in changing their distribution amounts once they have begun. This makes it very difficult for employees to structure the receipt of their payments to meet changing retirement needs.

Lower, More Complex, and Compensation-Based Contribution Levels. The contribution levels to governmental Section 457 plans are lower than other salary reduction plans, more complex to calculate, and based on a percentage of compensation, which unfairly curtails the retirement savings of relatively non-highly paid workers. Compliance with the complex calculation used to determine the compensation-based limits is also burdensome for employers and individuals covered by the arrangement.

No Indexation of Catch-up Contribution Level. While governmental 457 plans are permitted to allow catch-up contributions for individuals approaching retirement, the catch-up amount has never been indexed for inflation over the 20 years that it has been in place. For individuals who have been unable to take advantage of retirement savings vehicles throughout their career due to lack of disposable income or periods of leave from the workforce, catch-up provisions afford such individuals the opportunity to make up for those past contributions. This opportunity is available at a point in their lives when they are more likely to have the assets and the commitment to retirement savings. However, because the 457 catch-up amount has not been indexed for inflation, the level at which participants may utilize this provision is considerably limited.

Inconsistent Tax Treatment of Domestic Relations Orders. Finally, unlike a qualified plan or other salary reduction arrangement, an active employee's benefit under a governmental 457 plan may not be paid to a former spouse pursuant to a domestic relations order without violating the otherwise applicable restrictions on in-service distributions. In addition, it is unclear whether the former spouse is taxed on the distribution, as in other plans, which has led to inconsistent practices and frustrated participants.

Proposal

The National Association of State Retirement Administrators supports legislation to provide greater clarity, flexibility and equity to the tax treatment of benefits and contributions under governmental 457 plans. Such legislation would:

• Allow greater flexibility in determining the date of first distribution and allow beneficiaries to change their distribution amount and/or pattern once it has begun;
• Remove the compensation-based limits on these plans and increase contribution levels to those of other salary reduction plans;
• Increase and index catch-up contribution levels; and
• Provide Section 457 plan distributions made pursuant to a domestic relations order the same tax treatment as similar distributions from qualified governmental plans.

Support of the Voluntary Affiliation of State and Local Governments with Social Security

The National Association of State Retirement Administrators (NASRA) supports the affiliation of public pension plans with Social Security on a voluntary basis, however, it opposes the mandatory coverage of state and local government employees under the system.

Background

With the aging of the baby boom population and the growing strain on federal entitlement programs, officials at all levels of government must work together to address all areas of our national retirement policy. In addition to fostering employer-provided pensions and personal savings, national policy must also address the financial solvency of the Social Security system. However, it will be a delicate balance to ensure that fixing one leg of the proverbial retirement security stool does not break one or both of the other two.

The Social Security system is a vital program, and its financial well being must be preserved. Numerous proposals intended to extend the life of Social Security have been forwarded with far ranging and reaching proposed revisions. One provision that has appeared in various proposals is to mandate Social Security coverage for all newly hired state and local government employees. While NASRA supports the voluntary affiliation of public pension plans with Social Security, it opposes the mandatory coverage of state and local employees under the Social Security system.

State and Local Governments Were Originally Excluded from Participation in Social Security. It is important to remember that at the time the Social Security system was established in the 1930s, public employees were barred from participating in the system based on the constitutional interpretation that the federal government had no legal authority to impose taxes on states and localities. State and local plans at that time designed their own retirement plans in reliance on that exclusion, and benefits were structured and funded on that basis. It was not until the 1950s that state and local government pension plans were given the voluntary option to elect Social Security coverage. While many public employers elected to complement their own pension programs through coverage under Social Security, other units of state and local government decided not to participate in Social Security but rather provide their own independent programs of retirement benefits, which they believed (and continue to believe) best suited the needs of their workforce and their citizens.

State and Local Retirement Systems Provide Comparable Benefits, with Flexibility to Specific Classifications of Employees. The State and local retirement systems that do not participate in Social Security must provide comparable benefits to the retirement, disability, and survivors' benefits provided by Social Security. In addition, many provide flexibility to specific classifications of employees who are ill-suited to participate in a program which does not allow for normal retirement until age 62 or later and also provide supplemental benefits in the health care area.

Mandatory Coverage Would Cause Serious Financial Impacts on State and local Governments, Their Taxpayers, Their Millions of Workers, and Their Retirement Systems. Mandatory coverage of newly hired state and local government employees will seriously disrupt the financial standing of these public retirement systems, requiring reductions in benefits, increased costs, or both. Public employer contributions to these plans already average between 13 and 14 percent of payroll, and employee contributions to these plans average between 8 and 9 percent of pay. The added Social Security payroll tax of 6.2% on each, on top of what they already contribute to the pension fund, would simply be untenable for many employers and employees. Most State and local governments placed in this situation will find it necessary to raise taxes and/or cut spending on other essential government services. Ironically, these fiscal demands will have an enormous impact on services such as elementary and secondary education and public safety, at a time when political leaders at all levels in this country are looking to improve such services.

Mandating Coverage Does Not Assist in Making the Social Security System Solvent. The coverage of newly hired state and local government employees does nothing to solve the long-term solvency of the Social Security system. Current projections by the U.S. General Accounting Office (GAO) estimate that such coverage would, in the short-term, provide additional cash flow to pay current beneficiaries. However, such coverage also imposes additional liabilities on the system and ultimately results in increasing the expenditures that must be paid out of the Social Security program. These state and local systems effectively manage retirement funds on behalf of public employees, and are model programs for effective management of retirement savings. They should not be raided as a short-term and short-sighted fix for Social Security.

Current Law Already Addresses "Double-Dipping" Concerns. Those who espouse the unfairness of public sector employees "double dipping" by qualifying for Social Security benefits from either a second career or as a spouse, are simply uninformed. Current law already addresses this issue through the "windfall elimination" and "government pension offset" provisions that reduce Social Security benefits for those receiving a pension from non-covered government employment. The true issue of unfairness surrounds the federal government attempting to "change rules in the middle of the game" as they relate to these retirement systems, participants and taxpayers.

Mandating Coverage Infringes on State and Local Government Authority, and Their Ability to Meet the Needs of Their Employees and Citizens. State and local employees, in partnership with their employers and taxpayers, contributed to and successfully managed these plans for the range of retirement benefits offered, with a commitment to long-term retirement savings and security. They should not now be punished for their planning and initiative. NASRA supports efforts to work with the national government as partners in our federal system, however, federal intervention into or preemption of the legitimate role of State authorities would be a drastic departure from the principles of federalism. There are serious constitutional and administrative problems with mandatory coverage, including the encroachment on State sovereignty, and the usurpation of State governments’ and their political subdivisions’ authority to perform their responsibilities and meet the needs of their workforce and their citizens.

NASRA Resolution

The National Association of State Retirement Administrators supports current law, which provides for the voluntary affiliation of state and local governments with Social Security, and opposes efforts to mandate the coverage of state and local government employees under the Social Security system.

Lifting Limits on Benefits and Contributions

Members of the National Association of State Retirement Administrators support legislation that would restore the limits on maximum retirement benefits to levels that would be in effect if there had been no reductions in the past, remove compensation-based limitations, and increase the amount that participants may contribute to their pension plans as they near retirement.

Minimal Accommodation for Make-up Contributions. Finally, not all salary reduction plans are permitted to allow catch-up contributions for those individuals approaching retirement. For those plans that have catch-up provisions in place, the value is diminishing as the catch-up amount has never been indexed for inflation. For individuals who have been unable to take advantage of retirement savings vehicles throughout their career due to lack of disposable income or periods of leave from the workforce, catch-up contributions afford such individuals the opportunity to make up for those past contributions. This opportunity would be available at a point in their lives when they are more likely to have the assets and the commitment to retirement savings.

Proposal

• Restore and index for inflation the increased annual dollar limits on benefits for defined benefit plans, contributions under defined contribution plans, and the amount of compensation that may be taken into account under qualified retirement plans;
• Repeal the compensation-based limits on contributions to defined contribution and deferred compensation plans, and increase the dollar amount of elective deferrals to all salary reduction plans; and
• Increase and index the catch-up contributions under state and local 457 plans, and allow catch-up contributions under all salary reduction plans for anyone age 50 and older.