By now, almost everyone in the state of Kentucky has likely heard that changes are in store for the state’s struggling pension system. One of the pensions heavily affected by these changes is the Kentucky Teachers’ Retirement System (KTRS). When Governor Matt Bevin revealed proposed changes to the state’s pension system last Wednesday many expressed frustrations with the plan which, admittedly, lacked substantial specific details on precisely how they will fully remedy the financial crisis being faced.
However, the Governor’s office did release bullet points of the key changes being proposed and it’s important to break a few of these down in detail. Furthermore, consider whether these changes, as they’ve been communicated so far, are positive (+), negative (-), or neutral (=) for teachers’ retirement.
1. No change to the retirement age
This is welcome news for many teachers who are working their way towards retirement as the state is not “moving the goalpost” mid-game. Current employees should be able to continue towards their retirement knowing what that date is and planning on similar benefits to what they were expecting up to this point.
Impact: Neutral (=)
2. No Social Security
The question of teachers’ social security participation wasn’t really a question at all. As teachers aren’t currently paying into the social security system, shifting employees into the system would result in their pay being cut by the mandatory 6.2% social security tax as well as the state’s expense being increased by the same for the employer portion. This would be in addition to the >12% teachers currently pay into the pension. Doing so would give teachers access to spousal and survivor benefits but could come at a great cost now to both employees and the state.
Impact: Neutral (=)
3. Current benefits accrue until 27 years of service (or age 60)
For teachers already employed and working their way towards retirement, there’s no significant change in the accrual of benefits. However, there is a key change in how benefits will accrue for teachers who reach 27 years of service after July 1, 2018. For these teachers, who effectively have less than 26 years of service currently, the pension accrual will stop at 27 years of service and they’ll be able to utilize the 401k-style plan for years worked beyond 27 years of service. The impact of this is difficult to calculate because the portion saved in the 401k-style plan will be dependent on market changes. However, it will take away the bump-up in guaranteed income many teachers looked forward to by working a few extra years.
Impact: Neutral (=) to Negative (-)
4. 3% employee contribution to retiree health care
With the rising cost of health care, especially in the ages covered by the Kentucky Employees’ Health Plan (KEHP), the fact that the state is increasing funding for the plan is hardly a surprise. What is unfortunate is they’re sticking part of the increased cost to the employee. This will result in teachers taking an immediate 3% cut in their take-home pay to help fund the health benefits of current retirees, as well as their own future healthcare (should they retire before 65).
Impact: Negative (-)
5. No cost-of-living (COLA) clawbacks
Any adjustment to current retirees would have been a massive political hot-button and legal landmine. The fact that current retirees can rest-assured that their previous cost-of-living adjustments will stand is a good thing. However, what’s not clear is if this promise is set in stone or simply a talking point for the current plan changes.
Impact: Neutral (=)
6. Cost-of-living (COLA) increases suspended five years
For current retirees, the suspension will start if/when the plan is enacted and last for five years, for future retirees it is in effect the first five years of their benefits.
COLA increases are an essential part of any pension plan as it allows retirees to maintain a similar retirement lifestyle as they had on the day of their retirement, assuming they follow their financial plan and keep their expenses in-line. While inflation, which is what affects cost-of-living over time, has been fairly low lately no one can say for certain what the future holds. To say definitively that retirees’ benefits won’t be adjusted regardless of what happens to inflation is a bit disheartening. Since this rule affects current retirees and the first five years of retirement for all future retirees it would be much more responsible if legislators added an equation that tied this to the inflation rate to account for any future large-scale swings in cost-of-living.
Impact: Negative (-)
7. Retirees taking public jobs must suspend their pension
The spirit of this rule makes some sense, either be retired or be employed. However, those teachers who were thinking of retiring from their current position to take another public job in an effort to supplement their pension income will have to think again. While the number of people this directly effects may be limited, for those it does affect it will sting. The bright side here is the rule does not preclude a retiree from finding work outside of public service and receiving their pension at the same time.
Impact: Negative (-) for teachers wanting to retire and work. Neutral (=) for all others.
8. New teachers to be given a 401k style plan
In a sweeping admittance that the pension system is going extinct, all new employees will be required to utilize a 401k style plan. This plan requires the employee to contribute 9% of their pay with an option for up to 3% more, this would bring the total to slightly less than the 12.8% teachers currently pay into the pension. In addition, they will get a 6% match (4% from the state, 2% from the school district).
This type of program would put new teachers on a similar footing to many other non-public employees who have a 401k, with the important distinction being lack of social security benefits. Unfortunately for new teachers, this style of program shifts all the risks on to the employee’s shoulders. If markets perform poorly, if you live longer than expected, or if you choose to underfund your account, you’ll end up losing out in retirement. However, if the investment options in these accounts are low-cost sensible mutual funds, and the market performs well over time, you may be able to accumulate a sizable nest egg. Either way, the state no longer wants to be responsible for the risk of these variables.
A few questions we still have on these plans.
Will employees be able to withdraw without penalties at 27 years of service or need to wait until 59½ as they would with traditional 401k?
Will the state commit to sensible low-cost investment options?
Impact: Unknown (?)
Regardless of whether some or all of these bullet points get incorporated into the final plan, there are some big changes on the horizon for teachers’ pensions in Kentucky, especially for those just starting out in their career. No longer will teachers be able to look forward to a guaranteed monthly check in retirement. However, with a little planning and saving from the start these new teachers may be able to set themselves for a reasonable retirement. albeit at a later age than current teachers are able to retire. Put simply, the math doesn’t quite work on a 401k style plan at a teacher’s salary to save for 27 years and be retired for 35+ years.
One big question legislators still have yet to answer is how they’re going to pay for current and future retirees. Since the income from new teachers goes towards their 401k instead of the pension one can imagine hitting a funding gap in the future. It’s not until we get more clarity on that that we’ll be able to assess how beneficial this new plan is for the taxpayer side of the equation in both the short and long-run.
Whether or not you’re a teacher, if you’re looking down the road at retirement and haven’t run your numbers it may be time to do so. We work with clients of all ages to determine the required rate of return they need on their investments to not outlive their money then implement that plan with their investments. You can find out more about this LIFE Plan process and get started HERE.