What's all this about proposed changes to the teacher retirement system? Here's a Q&A.
Some lawmakers are hoping to pass a bill in this lame-duck session of the Legislature that would force new teachers into a 401(k)-style retirement system, and move the state away from supporting a traditional pension system.
To get a sense for what's going on with the debate, I decided to call up the Citizens Research Council.
The CRC has been researching and providing in-depth analysis on the big issues facing state and local government organization and finance for 100 years in Michigan.
I spoke with Eric Lupher, the CRC's president.
Mark Brush: What's the history here? Teachers in Michigan had a pure pension system, and now they have what’s called a “hybrid” pension system?
Eric Lupher: They had a pure pension what we would call a defined benefit plan, where the school districts paid into a system and then when you retire you can start pulling down from that retirement system.
The system is run by a quasi-governmental entity -- the Michigan Public School Employee Retirement System.
MPSERS pension administrators told each school district, "this is how much you have to pay to keep it current." Over time it became underfunded, and it became apparent that this was not sustainable.
Several years ago, they tried to do something about that by creating incentives for school employees, teachers and administrators to stop being so much in this defined benefit plan and to either move into an IRA or a 401(k)-type of plan -- or to balance it -- to have some reliance on the defined benefit plan and some reliance on the 401(k)-type plan, and then you can benefit from both in retirement.
What they saw, though, when they set that up is that teachers continued to enroll into the defined benefit plan – the pension type of plan.
And, by the way, that pension plan didn't make the return on investment and suffered through losses in the Great Recession that made trying to get back to fully funded very difficult.
So a few years ago the state said, “Well, we're going to cap how much individual school districts have to pay into that plan, and the state is just going to make a direct payment above and beyond what the school districts are doing.”
And so the state had to live up to the promise that's been made, but it is becoming a bigger and bigger burden on the state budget. And so you can look forward and see what the ramifications of this are. So those who are proposing these changes and advocating for reform they want to close down that defined benefit plan and provide the IRA or a 401(k)-type of plan as the only option going forward.
So if you're a teacher or school administrator who already has a pension, you won't lose that. But new employees, new school teachers, and new people coming into the system won't have a choice to do one or the other.
If this is enacted, they would only be able to go into that IRA-type plan.
MB: And so what is the risk of changing that system -- of going to this 401(k) plan?
EL: So there's risk for both the teachers and for the state as a whole.
The risk for the teachers is when you have a pension, they make a promise to you that regardless of what happens you will have a stream of income going forward based on your years of service and how much you made. And you'd know that you'll be able to live comfortably in retirement.
When you go to an IRA-type plan, they don't make that promise anymore. They say, "we're going to give you money every month and you invest it," and then based on that return -- how much money you put in, and how aggressive you are -- that's what you'll have to live on going forward. But if something happens to the market -- if you underperform -- then the risk is on you.”
And if you run out of money that's your problem it's not the employer's, so there is risk for employees anytime you make this sort of change.
And for the state, because they continue to live up to the promise that they've made on the pensions -- they can't take pensions away from anybody who has already earned it -- they can only say we're not going to pay into that anymore -- they have to now both give money to the current employees for their IRA plans and pay to the pension, so you're kind of paying twice.
And because it becomes a “closed system” it becomes a fixed cost. When you close the system, you have to pay on a flat rate until the whole thing is done. And so it becomes a greater cost in the current year and in the near future, than it would have been had you kept doing what you were doing.
So there's some risk on both sides.
For the employer, the state who administers this plan and pays into it, it's sort of a known risk that you're going to have to pay more.
For the schoolteachers, it's crystal ball gazing. Can you put enough money into the pot and have it work for you and foresee bad economic times to put your money into safe havens?
A lot to think about.
MB: And so what is the risk of continuing on with just the hybrid system?
EL: The risk is a couple of things. One, right now, anytime you have a trust fund that is set up for a pension you know that you have to pay in a certain amount, and that you're relying on the stock market or investments to take the money that's in that pot and compound it with earnings with gains on the stock market.
So you make assumptions as an administrator of that plan. For the last eight or so years, the return on investments have not been living up to the assumptions.
So every time that happens it costs more and more to try to play catch up.
One risk is that you'll continue to underperform against assumptions and it will cost more and more for the state to try to catch up.
Another risk is that we might go through another substantial stock downturn like we saw in 2008 when the market took a big hit. A lot of people lost investment earnings. And should that happen, that's going to create an even bigger burden for the pension, the pot of money already invested. If you lose what's invested and then you've got to try to pay more and more into it. It means every tax dollar coming in, a greater and greater portion of it is not being spent to educate a kid. It's being paid to for the teachers that educated kids 10 and 20 years ago.
MB: And so what about those teachers close to retirement. How might this affect them if they do go to a 401(k) plan?
EL: If you are close to retirement, you've probably been benefiting from the school district investing money on your behalf into a pension. They're not going to take that pension away. They can't under the Constitution take any of that away. So this will affect those people very close to retirement very little. It is new people coming into the system who are going to feel this the most, but not until they get close to retirement.
MB: And if it passed, this would line up with what happens in the private sector now?
EL: Yeah it very much. There are very few private sector companies that offer a regular pension. The accounting is different for private companies versus public governments. And so most of the companies have said, "No more pension, but we're going to give you money for a 401(k) or an IRA or things like that." So it is the government trying to catch up with what's already going on in the private sector.
MB: Critics are saying that this is going to end up costing the government a lot of money if they if they stop new people from coming in paying into this pension system with the hybridized version and that's going to cost the state a lot of money. Do you agree with that? Is that correct?
EL: Yes. Once you close your pension plan, the rules say that you have to fund that at an equal amount from year to year. You can't pay less now and more over time. It's the same amount from here going forward. And so it will be, in the near term, much more than what they were paying. It's it's kind of a upward slope line. If you keep doing what you're doing, but a flat line at a higher level if you close the system, so it will certainly cost the state more to fund the pension plan if they were to close it, and just go with the 401(k).
MB: So it will cost more money?
MB: But in the long term, would it switch them away from paying into a pension system and the state taking all the risk?
EL: This is something new and exciting for our term-limited Legislature to think long term about the fiscal sustainability of something.
They will long since be termed out when this really begins to benefit the state.
But it is certainly what is best for the long term sustainability of the system from the state point of view.
If you go back to the Engler administration, which is now three governors ago, they did this with state employees. They closed down the state pension plan and put all state employees from that point going forward into an IRA-type plan. And so all current employees, this is what they've done.
Many other states -- if you look at Illinois, and Kentucky, and some other states -- are really struggling to deal with their pension system. Michigan's not in that boat because they made the changes back in the 1990s and they're reaping the benefits from it now.
MB: So in other states, are their school employees still paying into a pension system, or have many switch to a 401(k) system?
EL: There are a few that have made the change, but most still have a pension system.
MB: Workers have lost pensions in the past when a company goes bankrupt. Is there any risk to teachers close to retirement losing their pension this way?
EL: If the state goes bottom up, we have a whole lot bigger problems than the pensions of teachers. It's a whole different way of thinking about it because governments for the most part are sort of perpetual beings. The state was here in 1835, and it will be here years and years and years after we're gone. So this is thinking about funding something over a stretch of time without sort of thinking about the risk of the government stopping to exist.
MB: Is this a smart move by the state to try to switch over the teachers to strictly to a 401(k) plan?
EL: This is the type of issue that where you stand depends on where you sit.
From the long term sustainability of the system, it's a move that makes a great deal of sense for our current economic times. The state is not flush with money. It doesn't have a drawer full of money that it can open up and say, "I see we're going to have greater costs now, we can just start using this money to pay the extra pension cost."
For it to do something like that is going to mean that it has to cut elsewhere in the budget, or think about increasing taxes to make up those costs. And if you're a teacher getting into the system, you think about whether this is in your long term best interest.
Now again, if you're a young teacher and you look at, “Well, maybe I want to go into working in business somewhere or doing something else.” This is very comparable to what you might get in the private sector -- so it’s a new way of thinking about retirement and investing going forward. So there are some benefits to it, but there's also some cost. The risk is shifted from the state to the employee because of it.
MB: Why should citizens care about this particular issue at this point in time?
EL: Citizens, to the extent you think long term, you want to know that the costs are being controlled by the government that you're paying taxes to. And so dealing with an issue now that potentially could have huge costs later is in your best interest.
But in doing so, it's clear that the state's going to have to find money somewhere to pay that extra cost of closing the pension. And that might mean going without a service that you expect from the state. Or it might mean increasing taxes in some way to come up with more money to pay that cost.
MB: Given our current Legislature, I don't see them raising taxes, do you?
EL: Well hopefully that is part of the equation they're considering as they think through this system. I don't foresee them increasing taxes “just because,” but if you're going to making major policy change like this, you have to think about how you're going to pay for it. And let's hope that's part of what they're thinking about.
MB: For teachers, I imagine they would expect to see more cuts coming to make this happen.
EL: I mean that's certainly a possibility. Right.