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Pennsylvania Pension Reform Bill Passes

State legislators successfully passed a comprehensive pension reform in Pennsylvania in early June. The new law aims to shift risk away from the taxpayers when it comes to state-funded pensions.

Pennsylvania Governor Tom Wolf signed the state pension reform bill, known as Senate Bill 1, into law. The reform restructures retirement benefits for all new school employees and most state employees in Pennsylvania. The measure was intended to improve the security and sustainability of the state’s retirement system for its public employees.

Certain workers, such as state police or corrections officers, who are not considered to be in high-risk positions, will be moved into a hybrid retirement system.

The changes will apply to employees who are hired after January 1, 2019. The reform will affect two Harrisburg-based retirement systems: those of the Pennsylvania public school system employees and Pennsylvania state employees. The retirement systems hold assets of $51.3 billion and $26 billion, respectively.

The pension reform would have the Pennsylvania retirement system receive one-half of the benefits from a 401(a) defined contribution plan and the other one-half from the taxpayer-funded plan that is already currently in place. Under the new law current employees have 90 days to choose to opt into the hybrid plan in 2019. Those employees hired after January 1, 2019 have the choice to elect to participate solely in the 401(a) plan, according to currently available reports.

The defined contribution plan will be similar to the 401(k) retirement plans commonly used in the private sector, which grant the individual employee greater control over his or her retirement savings. Moreover, Pennsylvania taxpayers will no longer have to make up the difference between what the state promises its retirees and what the employee sets aside for him or herself. Taxpayers are still liable, however, for the existing underfunded liabilities.

Pennsylvania’s pension issues can be traced back as far as 2001. At the time, the state had a $20 billion surplus. This excess funding prompted the state’s legislature to increase benefits for workers without increasing contributions to the retirement systems.

In 2003, the state redirected public workers’ retirement funds to other parts of the state budget. Subsequently, the retirement system experienced underfunding by the state government and school districts. Weak investment returns made the situation worse, especially after the 2008 financial crash.

The massive pension reform is expected to save between $5 billion and $20 billion over 30 years depending on market performance, according to an independent analysis of the plan.

Pennsylvania’s pension shortfall is estimated at a combined $62 billion in debt for the state’s two largest funds: one for state workers and the other for public school teachers. As of 2015, a study by the National Association of State Retirement Administrators reported that Pennsylvania had the second highest underfunded pension plan in the country.

About 401(a) Defined Benefit Plans

Under Internal Revenue Code Section 414(d), a governmental plan is an IRC Section 401(a) retirement plan established and maintained for the employees of:

the United States or its agency or instrumentality; a state or political subdivision, or its agency or instrumentality; or an Indian tribal government or its subdivision.

Rising U.S. Pension Costs

A 2015 report issued by Pew found that state-run retirement systems across the United States are operating at a collective shortfall of as much as $968 billion. Pennsylvania is one of many states that are struggling to deal with rising pension costs and unfunded liabilities. Other states include Connecticut, Illinois and New Jersey.

The Pew Charitable Trust, a nonpartisan and independent nonprofit research organization, notes that the Pennsylvania law represents one of the most comprehensive state-level reforms in the nation.

Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.For specific technical or legal advice on the information provided and related topics, please contact the author.

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