This month marks passage of the first Illinois state budget in over two years. The biggest changes resulting from this budget are to the Illinois tax code. Effective July 6th of this year (and retroactive to July 1st), the individual income tax rate has been increased to 4.95% along with other modifications to corporate tax and lesser used tax credits. Details of this bill are still coming, but we do know that this bill also requires changes to the State University Retirement System (SURS) Plan.
Under SB 0042 – Fiscal Year 2018 Budget Implementation Act, SURS is directed to create a new Tier III plan. All new employees hired who first become participants of SURS after the effective date of this new plan will have the choice of this new Tier III plan, the current Tier II plans (Traditional or Portable), or the Self-Managed Plan (SMP). SURS needs to work out many of the details for this new Tier III plan and formally adopt the changes before implementation. Therefore, we do not know the effective date at this point.
Further, existing employees in Tier II will also have the option to opt into Tier III, but the choice would be irrevocable. If you are uncertain which Tier plan you are in, Tier I generally applies to participants enrolled in a SURS Portable or Traditional pension plan before January 1, 2011. Everyone employed after this date is generally Tier II. The new Tier III pension plan would not affect those in Tier I plans or those who chose the Self-Managed Plan (SMP).
The overall goal of this Tier III program is the creation of a hybrid plan – a cross between a defined benefit and defined contribution pension system. In other words, it acts like a mix between the features of the Traditional/Portable Plans and the SMP Plan. Under Tier I and Tier II, the Traditional & Portable Plans are considered Defined Benefit pension plans. In these plans, the employer assumes all of the investment risk. The retirement income that you will receive is determined by a formula that takes into consideration your earnings and length of service. The SMP Plan is a Defined Contribution plan. The employer contributes a pre-determined percentage of your earnings to the SMP plan on your behalf. Those funds are deposited into your account to be invested at your direction (self-directed). This means you are responsible for selecting and managing the investments now and into the future. Your future retirement income depends on the balance of your SMP account at retirement.
Under this newest hybrid Tier III plan, you would get a combination of the two plan features above, albeit with a lower benefit from each. As laid out in the budget bill, the main features of the two components of the Tier III plan are:
Tier III Defined-Benefit Portion would include a pension based on:
- Final Average Salary (FAS) x Years of Credit x 1.25%. This is less than the 2.2% of FAS used in Tier I and Tier II calculations. The reduced pension benefit is designed to be supplemented by the additional savings in the required defined benefit contributions account described below.
- (FAS) equals the average monthly (or annual) salary during the period of service in which earnings were the highest during the last 120 months (or 10 years) of service. In contrast, Tier I uses the highest four consecutive years for FAS and Tier II uses the highest 8 consecutive years in the past 10 years of service (or equivalent highest consecutive earnings months).
- Earnings are only considered and included up to the federal Social Security Wage Base ($127,000 in 2017). This is actually higher than the Tier II plan earnings inclusion which is capped at $111,571.63 (in 2016, adjusted annually). Tier I pensions have no cap on salary earnings included in the FAS final average salary calculation.
- Retirement age under Tier III will be based upon normal Social Security retirement age. This means that retirement age of 67 (with 10 years of service credit) will apply to most participants. It is still unclear if there will be provisions for early retirement options for those who have attained more years of service.
- Employee contributions are equal to the lower of 6.2% of salary or the normal cost of pension benefits. This seems to imply that if the actuarial cost of a Tier III pension benefit is lower than 6.2% of salary, employee contributions may be less than 6.2%. More details are needed to evaluate this.
Tier III Defined-Contribution Portion would have the following provisions:
- Employee contributions of at least 4% of salary to this plan. Combined with the Defined Benefit Contribution, total employee contributions could be as high as 10.2%. This is higher than the 8% contribution rate currently required under Tier I and Tier II. However:
- Whatever the employee contributes, the Employer will match. The language states this employer match may be no higher than 6% of salary and no lower than 2% of salary. This will give each university flexibility to set up a higher match in an effort to attract talent and compete against other public and private employers; albeit coming from the respective university’s (or department’s) budget.
- The employer contributions do not start until after one year of employment, but at that point are 100% vested for the participant.
- Employer and employee contributions would be invested in a separate account maintained by SURS. Likely it would be the same or similar investment choices we currently see under SURS SMP.
Another big change in the budget bill shifts responsibility for funding the SURS employer contributions from the State of Illinois to each university. While increasing university budget expenses, this change will have a smaller impact directly on employees in the SURS system than the new Tier III hybrid plan.
While Tier I participants are not affected by the SURS changes, there are more proposed bills in the pipeline that may affect all SURS pension plan participants. One bill currently under consideration aims to slash the SURS pension Cost-of-Living Adjustment (COLA). To avoid the diminishment of benefits rule, it would offer defined benefit pension plan members a choice to keep their current COLA, but lose all rights to future increase in pension benefits as their salary increases; OR take a reduced COLA in exchange for continued accrual of future pension benefits and lower employee contributions. In other words, you could keep the COLA but lose future accrual of a higher initial pension or take a reduced COLA for continued benefit accrual. Additionally, the proposed legislation appears to offer lump sum buyouts to entice current members out of the SURS defined benefit plans. However, this bill has not passed yet and it is too uncertain to make predictions.
In all cases, there are still many details left before decisions can be made. We know changes are coming for new employees. Existing employees under Tier II Traditional or Portable plans will likely face an irrevocable choice to stay in Tier II or move to the new Tier III hybrid plan. However, SURS needs to make final plans before any analysis can be done. We will continue to monitor and keep our clients informed when changes will affect them.
For more information on the legislation discussed in this post click here.
To view our previous blog post on SURS plan selection click here.