To this end, data on Social Security coverage were gathered using two independent surveys of plan administrators, one conducted by the authors and the other by the National Association of State Retirement Administrators (NASRA). The surveys targeted the 56 largest state-administered retirement systems in 13 states that account for 80 percent of U.S. noncovered state and local payroll (Government Accountability Office [GAO] 2010). We also collected plan membership counts by occupation using the Census Bureau's Annual Survey of Public Employment & Payroll and obtained detailed descriptions of benefit provisions for state and local workers without Social Security coverage from the plans' actuarial valuation reports. The final study sample consists of 38 retirement plans offering 81 benefit formulas for significant numbers of noncovered workers in 12 of those 13 states.7
all accounting formulas pdf 218
Table 2 also shows the variation in the number of retirement systems and the types of benefit formulas offered, by state. Because benefit designs may vary by occupation, the number of formulas exceeds the number of systems in most states. Most of the formulas for noncovered workers are structured as traditional defined benefit pensions, although seven of the 38 systems offer voluntary defined contribution plans and three offer hybrid plans (either mandatory or voluntary) that pair a less-generous defined benefit formula with a defined contribution account. Five systems have a cash-balance structure for at least some members; in this type of defined benefit plan, the employer contributes a set percentage of the participant's salary each year and the account earns interest at a notional rate.
For defined benefit pensions, the Safe Harbor regulations set a maximum NRA and a formula for calculating annual benefits: FAS times years of state/local tenure times a benefit factor (multiplier). FAS is calculated using the worker's earnings in the final years of employment (that is, the highest earning years); the number of years used in the calculation varies from one benefit formula to another.9 Table 3 summarizes the NRAs and the benefit factors for our sample of defined benefit formulas for noncovered workers, and compares the results with the Safe Harbor requirements. Although the NRAs set by a couple of formulas are older than the Safe Harbor NRA of 65, no formula's NRA exceeds the Social Security FRA of 67 (for workers born after 1959), and many allow for normal retirement at substantially younger ages: The median NRA is 62. Similarly, the parameters that determine the level of annual benefits are typically more generous than those required by law. For example, among formulas that calculate FAS using the final 3 years, the median benefit factor is 3 percent, whereas the Safe Harbor formula requires a minimum factor of only 1.5 percent. Among defined contribution plans, the median total contribution rate (employer plus employee) is 18 percent of salary and the sample minimum is 10 percent, well above the Safe Harbor minimum requirement of 7.5 percent. In short, the benefits earned by noncovered state and local new hires appear to satisfy the Safe Harbor requirements.
For analytical tractability, and to maintain the spirit of the Employment Tax Regulations, this article considers only individual benefits and ignores spousal and survivor benefits. Because the hypothetical worker will retire many years in the future (in 2058, at age 65), the Social Security benefit calculation requires projections of several annually adjusted program parameters, including the average wage index (AWI), the COLA, the taxable maximum, and the benefit formula's bend points. We assume that the AWI and COLA will increase by the long-run intermediate assumptions in the 2018 Trustees Report; the taxable maximum and bend points are projected using legislated formulas that refer to the AWI.12
We evaluate state and local defined benefit formulas using the same hypothetical worker with whom we assessed Safe Harbor compliance.23 We posit a baseline scenario in which this worker enters the labor market with a private-sector job at age 25. At age 35, the worker takes a noncovered government position with a $50,000 salary. He or she receives 3.8 percent nominal wage increases annually for 12 years, after which he or she returns to private-sector employment until retirement at age 65. Public pension benefits are calculated as in Charts 2 and 3, with the provisions of each state and local formula for noncovered workers substituting for the Safe Harbor parameters. We assume that the hypothetical worker claims his or her public pension benefit at the plan's NRA, after which benefits increase according to the plan's COLA provision.24 We also assume that the 15 percent of state and local plans that grant only unscheduled COLAs will not grant any future adjustments. For consistency across plans with different NRAs, benefits are discounted to age 25.25
A related analysis considers how the worker's vesting status affects benefit sufficiency. Chart 8 shows that a nonvested worker is at risk of falling short only if he or she accrues more than 5 years in noncovered employment. In practice, around half of the formulas sampled have vesting periods longer than 5 years and, as expected, none of those formulas satisfy the counterfactual wealth test for a worker who separates right before vesting.26 However, even if those formulas were to shorten their vesting periods, they still might not pass the counterfactual wealth test; very few formulas require more than 10 years to vest, yet Chart 8 shows that many fall short for a worker with 12 years of tenure.
Finally, the distribution of counterfactual wealth ratios does not appear to be sensitive to realistic variation in earnings levels. We define a hypothetical high earner as having a $60,000 starting salary in noncovered employment with 4.3 percent annual wage increases and a hypothetical low earner as starting at $40,000 and having annual wage increases of 3.3 percent.27 For each earner, about 45 percent of formulas generate a counterfactual wealth ratio of less than 1 (Chart 10). However, the story changes for very high earners (not shown). If a worker is assumed to earn the taxable maximum amount each year, then 95 percent of formulas generate counterfactual wealth ratios greater than 1, and most provide benefits considerably greater than the counterfactual Social Security level.
In summary, although the benefit formulas for noncovered state and local government employees meet the federal Safe Harbor requirements, those requirements do not account for vesting-period, COLA, and retirement-age differences between the public plans and Social Security. As such, some formulas may still fall short of Social Security equivalence for a significant minority of members.
Section 218 of the Social Security Act allows state and local governments to extend Social Security coverage to their employees, and the Omnibus Budget Reconciliation Act of 1990 mandates Social Security coverage for state and local workers unless they participate in a sufficiently generous employer-sponsored retirement system. The requirements for generosity are elaborated in the IRS Employment Tax Regulations, pursuant to IRC Section 3121. Public plans must provide their members, on reaching their Social Security FRA, with a monthly benefit that matches the PIA that the member would have received had he or she been covered by Social Security. Alternatively, a public plan's benefit formula can simply match one of the Safe Harbor formulas established by the IRS's Revenue Procedure 91-40.
19 The present-value calculations employ a 50-50 male-female split of the cohort mortality tables developed for the 2017 Trustees Report. The cohort tables were obtained on request from the SSA's Office of the Chief Actuary. Appendix B describes the present-value formulas.
22 The distribution of vesting periods is bimodal, with peaks at 5 years and 10 years. Consequently, small changes in the sample of benefit formulas can produce large shifts in the median vesting period. Although plans do not frequently change their vesting periods, the three plans covering teachers and university faculty in Illinois extended their vesting periods from 5 years to 10 years following the 2008 financial crisis. 2ff7e9595c
Comments