GRS Updates Research Memo on Maximum Deferral and Threshold Limits for 2017 and 2018

On November 29, 2017, Gabriel, Roeder, Smith & Company (GRS) updated its research memorandum, Maximum Deferral and Threshold Limits for 2017 and 2018. This memorandum summarizes the Internal Revenue Service’s (IRS) new maximum deferral and threshold limits effective for limitation years beginning on or after January 1, 2018.  The Internal Revenue Code (IRC) establishes a number of limits on retirement plan benefits and contributions.  The limits are located in various sections of the Code and often apply in different ways to private and public-sector plans.  Generally, plans must comply with the limits to maintain their tax-qualified status.

NOTE: After the GRS Research Memorandum was originally published on November 7, 2017, the Social Security Administration (SSA) updated the 2018 Taxable Maximum Earnings. On November 27, 2017, SSA issued a press release stating, “Based on the wage data Social Security had at the time of the October 13, 2017, announcement, the maximum amount of earnings subject to the Social Security tax (taxable maximum) was to increase to $128,700 in 2018, from $127,200 in 2017. The new amount for 2018, based on updated wage data reported to Social Security, is $128,400. This lower taxable maximum amount is due to corrected W2s provided to Social Security in late October 2017 by a national payroll service provider.”

The updated GRS Research Memorandum is available here.

The SSA press release is available here.

NIRS Finds DB Pension Plans are an Effective Tool for Recruiting and Retaining Teachers

On October 26, 2017, the National Institute on Retirement Security (NIRS) released its report, Win-Win: Pensions Efficiently Serve American Schools and Teachers. Authored by Dr. Christian Weller, Professor of Public Policy at the University of Massachusetts Boston, the report indicates that defined benefit (DB) pension plans for teachers are beneficial for both teachers and schools. According to NIRS, DB pension plans provide a financial incentive for teachers to continue working which results in more experienced teachers helping to benefit students, schools and education.

Key findings include:

  • DB pension plans help employers recruit and retain committed teachers so that schools benefit from teachers’ increasing effectiveness;
  • DB pension plans better address obstacles to retirement income security by covering a majority of employees, with adequate savings and managing risk associated with retirement;
  • DB pension plans provide lifetime income benefits more efficiently than defined contribution (DC) retirement accounts. Each dollar saved in a DB plan delivers about twice the amount of retirement income than money invested in an individual savings plan due to lower costs and risk sharing; and
  • The public strongly supports DB pension plans for teachers and recognizes their retention benefits.

The report concludes that schools should remain committed to DB pension plans while managing “the long-term challenge to maintain these crucial benefits on a sustainable basis, for instance by, improving states’ pension funding through continued increases in employer contributions.”

The report is available here.

NASRA Releases Public Fund Survey Findings for FY 2016

In November 2017, the National Association of State Retirement Administrators (NASRA) released its Public Fund Survey Summary of Findings for FY 2016.  The survey presents key data from 98 public defined benefit (DB) retirement systems with 121 plans, covering 12.8 million active members, 9.1 million retirees and other annuitants, and holding $3.16 trillion in assets.

Overall, the retirement systems surveyed represent approximately 85% of state and local DB plan membership and assets as of fiscal year (FY) 2016.  The Summary of Findings presents information regarding plan funding, membership, benefits, contribution rates, cash flows, and actuarial assumptions.

According to the report:

  • The average actuarial funded ratio for the surveyed plans was 72.1% in FY 2016, slightly lower than the prior year.  Between FY 2015 and FY 2016, the aggregate actuarial value of assets increased 3.3% and the actuarial value of liabilities increased 5.7%.  Many state and local plans smooth investment gains and losses into the actuarial value of assets over time (typically five years and sometimes longer). Moreover, most plans have completed recognizing their 2008-2009 investment losses, which have been partially offset by investment gains since 2008.
  • Growth in pension liabilities remains at a median rate at or below 5.0% over the last seven consecutive years, as a result of low salary growth, declining or stagnant employment levels among states and local governments and benefit reductions due to pension reforms.
  • The combined allocation of plan assets to public equities and fixed income securities declined from 71.8% in FY 2015 to 70.8% in FY 2016.  At the same time, allocations to real estate remains about 6% and allocations to alternative investments (such as private equity and hedge funds) remains about 18%.  In FY 2016, the allocation to fixed income securities remains about 23%.
  • The median annual investment return was 0.5% for plans with fiscal years ending 6/30/2016 (approximately 75% of the plans in the survey) and 7.5% for plans with fiscal years ending 12/31/2016.   Investment returns for longer periods are mostly strong.  For longer periods (i.e., 25 years and more), the median actual investment returns remain above the long-term assumed returns used by most plans.
  • For most of the Public Fund Survey’s measurement period, the median investment return assumption used by public pension plans was 8.0%.  However, in FY 2016, the median actuarial assumption for investment return was 7.5%.  Notably, since 2009, many plans have reduced their investment return assumptions.
  • The number of plans receiving at least 90% of their Annual Required Contribution (ARC) has been increasing since FY 2011, reaching over 75% of plans in FY 2014.  However, effective in FY 2014, public pension plans are no longer required by the Governmental Accounting Standards Board (GASB) to calculate and report an ARC.  Instead, under GASB Statement No. 67, public plans (except for agent plans) are required to report their “Actuarially Determined Contribution” (ADC) which should be included in the retirement system’s financial reports.  In FY 2016, the average ARC/ADC was about 96% and more than 76% of plans received over 90% of their ARC/ADC, representing a continued restoration of funding discipline beginning in FY 2012.

The survey data are available for each individual retirement system and plan in Appendices A and B.  The data include: plan membership, plan assets and liabilities, and actuarial funding levels.

The summary is available here.

NASRA Updates Issue Brief on Cost-of-Living Adjustments

In November 2017, the National Association of State Retirement Administrators (NASRA) released its issue brief, Cost-of-Living Adjustments, which updates an earlier version published in October 2016.  The brief discusses: 1) the purpose of cost-of-living adjustments (COLAs); 2) types of COLAs; 3) costs of COLAs; and 4) recent state COLA legislative changes.

According to the brief, most state and local government pension plans provide some form of COLAs to offset or reduce the effects of inflation on retirement income.  In addition, COLAs are important for state and local government employees who do not participate in Social Security in order to supplement their income during disability or normal retirement.  Typically, governments prefund the cost of a COLA over an employee’s working career.

The report also provides a summary of COLA provisions by state-level plans, including any recent legislative changes.  According to the report, of the 100 selected state-level plans that provide COLAs, 72 provide them on an automatic basis and 28 provide them on an ad hoc basis.  In addition, since 2009, 17 states have changed their COLAs for current retirees, 7 states have changed COLAs for current employees’ future benefits, and 7 have changed COLAs for future employees only.  Since 2016, only 2 states have enacted COLA reductions that affect one or more major employee groups.  However, in several states, the legality of these changes has been challenged.  In addition, some states are including provisions that would allow COLAs to increase if the plan’s funding status or fiscal conditions improve or if inflation rises.

The report also includes an appendix with a listing of COLA provisions for many state retirement plans and identifies the applicable changes from 2009-2017.

The brief is available here.

NCPERS Finds Public Pension Plans Consistently Meet Obligations

On November 16, 2017, the National Conference on Public Employee Retirement Systems (NCPERS) released its report, Don’t Dismantle Public Pensions Because They Aren’t 100 Percent Funded.  The latest report in the NCPERS Research Series addresses critics’ arguments about the funding of public pension plans and explains that funding status has little correlation with the ability of state and local pension plans to pay promised benefits.

According to the report, public pension plans are able to tolerate stock market volatility while meeting their current benefit and other payment obligations.  In addition, it indicates that although funding ratios are an important actuarial tool, the current funding level is unrelated to a pension plan’s ability to pay annual benefits. NCPERS’s analysis suggests that a pension fund’s ability to pay benefits depends on: 1) contributions and investment income that is greater than benefit obligations in a given year; and 2) there are adequate assets to withstand an economic recession.  Overall, in 2016, the 299 state plans had total assets of $3.05 trillion with pension obligations of $4.2 trillion, which resulted in a funding level of 72.6%.

NCPERS recommended that state and local policymakers consider the following policy options:

  • Stop dismantling plans on grounds that they are not fully funded;
  • Improve funding by determining the appropriate levels of required employer contributions;
  • Establish a pension stabilization fund that can set aside money from a certain revenue stream to be used in special circumstances such as a recession; and
  • Implement a mechanism to ensure that full employer contributions are made on a timely basis, perhaps by making employer contributions a nondiscretionary part of the budget.

The report concludes that, “dismantling public pensions increases economic inequality and volatility and drags the economy down. If we continue to dismantle public pensions, our national economy will suffer $3 trillion in damage by 2025.”

The report is available here.

NASBO Releases State Expenditure Report for Fiscal Years 2015-2017

On November 16, 2017, the National Association of State Budget Officers (NASBO) released its State Expenditure Report: Examining Fiscal 2015-2017 State Spending.  This annual report examines spending in the various areas of state budgets including: elementary, secondary and higher education; public assistance; Medicaid; corrections; transportation; and other areas.  It also includes data on the State Children’s Health Insurance Program (CHIP) and revenue sources in state general funds.

The key findings include:

  • In fiscal year (FY) 2017, the estimated total state spending growth rate (including general funds, other state funds, bonds and federal funds) increased 5.2%, following an increase of 2.2% in FY 2016.
  • In both FY 2016 and FY 2017, transportation experienced strong spending growth from state funds while Medicaid experienced the largest gains from all funds.
  • Education spending for K-12 remained the largest category from state funds.  States allocated about 25% of their general fund spending to elementary and secondary education and nearly 14% for higher education.
  • Medicaid was the largest category for state general fund spending increasing to 29.0% in FY 2017, up from 20.5% in FY 2008.  Medicaid also continued to increase as a share of total state spending and grew 6.1%.
  • Revenue growth continued to grow slowly, increasing 2.2% in estimated FY 2017. In the last three out of four years, revenues have grown slowly or declined. In FY 2017, the median growth rate for corporate income taxes declined 5.8%, sales taxes increased 2.5% and personal income taxes increased 2.9%.

The report concluded, “State spending growth in the near future will likely remain modest as states contend with sluggish revenue collections and modest growth in the national economy. States are expected to target spending increases to certain priority areas, while also focusing on addressing long-term obligations, building up reserves, and promoting structural balance. Additionally, states are facing federal uncertainty in a number of areas including the possibility of federal tax reform, the consideration of healthcare changes, and discussions regarding various infrastructure proposals, which has the potential to impact future spending plans.”

The report is available here.

CBO Reports on Retirement Income Adequacy

On October 20, 2017, the Congressional Budget Office (CBO) issued its report, Measuring the Adequacy of Retirement Income: A Primer. The CBO report discusses the different measures and approaches for quantifying the adequacy of retirement income.

The report explains that researchers have developed diverse approaches for quantifying the adequacy of retirement income, focusing on different groups of retirees and employing different definitions of income and adequacy. The researchers defined the adequacy of retirement income by: 1) whether it satisfies basic needs; and 2) whether it enables retirees to maintain the standard of living they experienced before retirement.

According to the CBO, the standard of living definition (known as the target replacement rate) is the most common measure of retirement income adequacy. Typically, that rate is defined as the amount of income in retirement, expressed as a percentage of income before retirement, which would allow retirees to maintain the standard of living from their working years.  Generally, replacing at least 70% of gross preretirement income would avoid a significant decline in retirees’ standard of living.  However, the CBO cautions that the 70% target may not be appropriate for all individuals.  Based on the diversity of individual’s circumstances, researchers have developed a range of target rates that differ with individual characteristics, such as lifetime income, homeownership and marital status.

The report concludes that ongoing research will help to improve the understanding of the nature and extent of underreporting income and to clarify how underreporting could affect conclusions about retirement adequacy.

The report is available here.

Survey Finds Retirees Face Higher than Expected Retiree Health Care Expenses

​On October 16, 2017, the LIMRA Secure Retirement Institute released a new study, Expectations vs. Reality – More than a Quarter of U.S. Retirees Underestimated Basic Living Expenses in Retirement. Based on a 2017 survey, the report indicates that a significant amount of retirees underestimate their basic living expenses in retirement, mainly health care and long-term care costs.  On average, about 67% of retirees’ expenditures are spent on basic living expenses, health care and long-term care costs.

According to LIMRA, 26% of retirees said their basic living expenses in retirement were higher than they expected prior to retiring. Furthermore, another 4 in 10 retirees underestimated health care and long-term care costs based on all demographics, income and asset levels.  In addition, 15% of retirees who had higher than expected basic living expenses found that health care costs primarily accounted for the higher than expected expenses.  On average, about 13% of a retiree’s income is spent on health and long-term care expenses.

Other key findings include:

  • Women are 43% more likely to experience higher than expected health and long-term care-related expenses than men (39%);
  • Women are 50% more likely than men to respond that their basic living expenses are somewhat or significantly higher than they expected before they retired;
  • Lower-income retirees are substantially more likely than higher-income retirees to respond that their basic living expenses are higher than anticipated; and
  • Retirees with household incomes of $35,000 to $49,999 spend about 60% of their income on basic living expenses.

According to Matthew Drinkwater, PhD, Assistant Vice President of the LIMRA Secure Retirement Institute, “Mismatches between spending expectations and experiences are strongly associated with retirees’ confidence levels.” He added, “Our study found retirees whose basic living expenses or health and long-term care expenses are higher than anticipated generally express lower confidence in their ability to live the retirement lifestyle they want.”

LIMRA Secure Retirement Institute conducted the survey of over 2,000 U.S. consumers ages 50–79 that retired at least one year earlier with annual household incomes of at least $35,000 and were involved in the household’s financial decisions.  The results were weighted to demographic characteristics to ensure the results represented the U.S. population.

Further information is available here.