“Underfunded” is the term used to describe the difference between what the state has promised to pay retirees and the amount of money they actually have on hand to pay. According to think tank State Budget Solutions, a number of state pensions are currently underfunded by $4.7 trillion. There are several reasons why pension plans are underfunded. It is estimated that the average annual pension promised to a CalSTRS teacher who worked from age 23 to 65 is over $110,000 per year. Pensions also use extremely optimistic estimates for how much their investments will earn. According to the National Association of State Retirement Administrators (NASRA), U.S. public pensions are expected to earn 8 percent per year on average. This is extremely unlikely, with the average public pension actually earning just 3.4 percent. In fact, CalPERS reported that in July it earned 2.4 percent in its last fiscal year.
California Public Employees’ Pension Reform Act (PEPRA)
Because both CalPERS and CalSTRS retirement plans were extremely underfunded, an effort was made by law makers to fix the issue. The result was the California Public Employees’ Pension Reform Act (PEPRA) which was approved in 2012 and took effect January 1, 2013. PEPRA makes a few important changes to the system, including:
- Increasing the retirement age for new employees depending on their job
- Places a cap on the annual payout at $132,120
- Eliminates numerous abuses of the system
- Requires workers who are not contributing half of their retirement costs to pay more
The bill fails to include a hybrid system like a 401(k)-style plan, meaning that public employees will bear some of the same investment risks private-sector workers do. The bill also failed to reduce health care costs upon retirement. Despite these issues, CalPERS estimates that the bill will save between $42 billion and $55 billion over 30 years while CalSTRS has estimated a savings of $22.7 billion over 30 years.
Though this new law has been put into effect, there are still issues that will need to be addressed. Currently, new employees starting on or after Jan. 1, 2013 will automatically have to contribute 50 percent of their pension costs. However, local government labor unions will have five years to negotiate a change in this through collective bargaining. If they fail to change this by Jan, 1, 2018, a city or school district could force its employees to pay half of their pension costs. This equates to up to 8 percent of pay for civil workers and 11 percent or 12 percent for public safety workers.
Classic vs. New Members
PEPRA has placed new compensation limits on members. The greatest impact is felt by “new” members. PEPRA defines a new member as:
- Membership was established prior to January 1, 2013, but was rehired by a different eligible employer after a break in service of more than six months.
- A new hire who gains membership for the first time on or after January 1, 2013, and who has no prior membership in any California public retirement system.
- A new hire who establishes membership for the first time on or after January 1, 2013, and who is not eligible for reciprocity with another California public retirement system.
All members that do not fall into the above definitions are considered “classic” members. A classic member will retain the existing benefit levels for future service with the same employer.
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