Retirement insights from a Colorado PERA perspective

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The State of Colorado <a href="https://peraontheissues.com/wp-content/uploads/2020/09/Furlough_2020_Release.pdf" target="_blank" rel="noreferrer noopener">announced</a> last week that all state employees who make more than $50,000 annually will face furlough days on a graduated scale—the higher the salary, the more furlough days they must take. 



“Colorado is facing one of the most challenging economic crises in our history, and public agencies are facing difficult budget constraints,&#8221; Governor Jared Polis said in a press release. &#8220;Just as the private sector is tightening its belt, so too must the government.



That announcement, which affects more than 30,000 employees, only applies to state employees. But thousands of other public employees also face furlough days—school workers, local employees, and more.



Some PERA members have asked, &#8220;will furlough days affect my PERA benefit?&#8221; 



Furlough days can affect a PERA member&#8217;s highest average salary and service credit. But for many members, this won&#8217;t be the case. Read on to learn more. 



The Furlough Effect on PERA Highest Average Salary



PERA members build a retirement benefit based on their <a href="https://content.copera.org/how-furloughs-impact-pera-benefits/" target="_blank" rel="noreferrer noopener">highest average salary</a> (HAS). For most members, this amount is the average of their top three years of earnings. (Some members use a <a href="https://www.copera.org/contributions-to-colorado-pensions-lower-than-average" target="_blank" rel="noreferrer noopener" class="broken_link">five-year HAS</a> and others have a one-year HAS.)



A furlough day reduces an employee’s salary for that pay period. Because PERA contributions are a percentage of pay, a member on furlough would send a smaller sum to their PERA account that during pay period. 



As a result, a member who checks their PERA account online in the month in which they were furloughed will see a lower salary recorded than they had in previous months.



Should PERA Members be Concerned?



Despite a lower salary in the month of the furlough day(s), most members won&#8217;t see an effect on their retirement benefit. Why? The HAS uses a member’s highest one, three, or five years of earnings. All other years of earnings do not come into play.



Members who expect to continue working for a number of years beyond 2020 still have those highest-earning years ahead of them. Any furlough-related salary reductions this year won’t end up as part of their final HAS.



Members who are in their highest years of earning, however, would see an impact. The size of the impact depends on the number of furlough days they face. 



Furloughs and Service Credit



Although furloughs result in fewer work hours in a month, PERA service credit is not based on hours worked. Instead, it is a measure of contributions.



If a member makes PERA contributions on at least $580 of earnings in one month, they receive one month of service credit, regardless of how many days or hours they spent working. So, if a PERA member is on furlough for any number of days in one month but still earns and makes PERA contributions on at least $580, then he or she will still receive a full month of PERA service credit.



It&#8217;s possible that some PERA members who work part time earn just above $580 each month. In these cases, a furlough day could drop their paycheck below $580. They will still receive service credit—it will just be prorated. For example, if they earned $500 in a month, they would receive 0.862 months of service credit (500 divided by 580).



In other words furloughs won&#8217;t affect service credit, even for those in their final years of employment, unless monthly earnings are less than $580.

How Furloughs Impact PERA Benefits

The pension equation is relatively simple: Contributions and investment income must equal benefits and expenses, or C + I = B + E. As with all equations, the task is getting the two sides to balance. When one side of the equation exceeds the other, challenges arise. In the case of PERA, there was an imbalance caused by contributions and investment income being insufficient to fund current and future benefit payments. The difference between those two sides is the unfunded liability.



Let’s look at that equation in greater detail as a way to better understand the need for changes to PERA, many of which were included in SB 18-200, passed in the Colorado Legislature and signed into law earlier this year.



Contributions Contributions from members ($910 million in 2017) and their employers ($1.6 billion in 2017) are invested and used to pre-fund retirement benefits. These amounts represent a steady stream of capital that is invested every day the financial markets are open. Currently, most members contribute 8 percent of their pay. <a href="https://www.copera.org/employers/employer-contribution-rates" target="_blank" rel="noreferrer noopener">Employers also contribute a percentage of salary</a>. Research by the National Association of State Retirement Administrators (NASRA) has shown that the <a href="https://www.nasra.org/files/Issue%20Briefs/NASRAContribBrief.pdf" target="_blank" rel="noreferrer noopener">member contribution rate for most public non-Social Security retirement plans has increased</a> since 2009. At PERA, the member contribution rate will begin to increase gradually on July 1, 2019, to equal an additional 2 percent of pay (for most members) by July 1, 2021. The employer contribution rate will also increase on July 1, 2019, for PERA employers (except in the Local Government Division).



Investment Income PERA is a long-term investor, with a diversified portfolio of investments currently totaling more than $48 billion. With billions of dollars to invest, the investment team at PERA is able to attain low fees. Most members will work 20 or more years, so investments from contributions have time to compound and grow before they will be used to pay benefits. Investment income in 2017 was $7.7 billion.



Benefits In 2017, PERA paid $4.8 billion in benefits to more than 118,000 benefit recipients. This amount also includes refunds and rollovers made to those members who withdrew their accounts after leaving PERA-covered employment. Changes included in Senate Bill 18-200 combined with investment returns resulted in a significant improvement of PERA’s funded status for all five divisions, with each reaching full funding within 30 years. These significant changes made to the benefits side of the equation reduced PERA’s liabilities by $3.4 billion, bringing the equation further into balance.



Expenses Some have questioned whether or not PERA’s expenses could be reduced. PERA invests $48 billion in member assets and pays more than $4 billion in benefits annually – all with the foremost attention to cost. The overall cost to invest assets and pay benefits has averaged about 50 basis points (0.50%) over time – an extremely cost effective and competitive sum that allows PERA to have more assets to invest.



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The changes in benefits included in SB 200 were necessary to rebalance the equation, ensuring that C + I = B + E.

Calculating the need for changes to PERA

The Colorado PERA Board of Trustees has endorsed a comprehensive reform package to reduce the overall risk profile of the plan and improve PERA’s funded status. This endorsement follows extensive analysis by the PERA Board and a statewide outreach effort with a range of stakeholders conducted earlier this year. Learn more about the next phase of outreach at <a href="https://www.copera.org/colorado-pera-board-endorses-package-reforms" class="broken_link">PERAtour.org</a>.



After taking into account assumption changes made in 2016, each of PERA’s five divisions are in the <a href="https://www.copera.org/colorado-pera-board-endorses-package-reforms" target="_blank" rel="noreferrer noopener" class="broken_link">“orange” category, where reporting standards applicable to PERA called for the Board to develop a plan to reduce the amount of time it will take PERA to be fully funded</a>.



The Board’s package, which must be approved by the General Assembly, includes recommendations that will significantly change the benefit provisions and contribution structure of the plan. If passed by the Legislature, the Board’s proposal would fortify the fund by making major changes:



Modify the benefits of current retirees, members, and future members.



<ul>
<li>Increase the number of years used to calculate Highest Average Salary from three years to five for most divisions. The exception is the Judicial Division, which currently uses a one-year HAS and will now use a three-year calculation. For new hires starting in 2020 and for members with less than five years of service credit as of January 1, 2020, more years of salary will be considered to calculate an average salary used to determine the total retirement benefit.</li>



<li>Change the age of eligibility for full service retirement benefits to 65 for new hires starting in 2020. For State Troopers, the minimum age for full service retirement eligibility will be raised to age 55. This change aligns PERA with national trends, including Social Security and peer defined benefit plans across the country.</li>



<li>Reduce the Annual Increase (commonly called the Cost of Living Adjustment or COLA) provided to current and future retirees. Most current retirees receive a 2 percent Annual Increase and that will be lowered to 1.5 percent. Those who became members after 2006 currently do or will receive an Annual Increase based on the CPI with a limit up to 2 percent. This Annual Increase would also be capped at 1.5 percent. This change will go into effect on the date legislation is passed.</li>



<li>Suspend the Annual Increase for two years for current benefit recipients. Under existing law, current benefit recipients have experienced a one-year waiting period upon retirement to receive an increase. Future retirees would have a three-year waiting period before their Annual Increase begins. This change will go into effect on the date legislation is passed.</li>
</ul>



Increase contributions into the fund.



<ul>
<li>Increase employee contributions for current members hired before 1/1/2020 by an additional 3 percent above current contribution rates. This increase would impact all active PERA members and retirees working after retirement.</li>



<li>Increase employee contributions for future members hired on or after 1/1/2020 by an additional 2 percent.</li>



<li>Increase employer contributions by an additional 2 percent.</li>
</ul>



Ensure the equitable alignment of “input” or contributions and service credit, with “output” of benefits paid out.



<ul>
<li>Change the definition of PERA-includable salary to require PERA to collect contributions on salary that includes Internal Revenue Code Section 125 and 132 deductions. In other words, PERA contributions would be made on gross pay rather than net pay. These changes would impact current and future members.</li>



<li>Change the definition of full-time service accrual. Under the Board’s proposal, PERA future members will earn service credit for part-time work based on the percentage of full-time employment they are actually working.</li>
</ul>



The Board also came forward with an innovative solution that will respond to future economic and demographic changes by instituting an automatic mechanism by which employer and employee contributions as well as Annual Increase amounts will adjust based on the financial condition of the fund. <a href="https://www.copera.org/2018-pera-on-the-issues-legislative-preview" target="_blank" rel="noreferrer noopener" class="broken_link">More details</a> on the Board’s proposal may be found on the PERA website.



By State law, the Colorado General Assembly sets contribution rates and benefit levels and the PERA Board of Trustees has oversight of investments and benefit administration. More information on the Board of Trustees may be found on the PERA <a href="https://www.copera.org/recap-of-pera-boards-june-2021-meeting" target="_blank" rel="noreferrer noopener" class="broken_link">website</a>.

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How Furloughs Impact PERA Benefits

Calculating the need for changes to PERA

Colorado PERA Board Endorses Package of Reforms

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