Overhaul the State retirement system

The State of Hawaii has a complex and unfunded Employee Retirement System (ERS).

Right now, there are three different retirement plans (contributory, noncontributory, and hybrid) for four different types of employee (general, police/fire/public safety workers, judges, and elected/legislative officers), with three different retirement levels (regular, early, and vested).

The ERS’ unfunded liability is $5.1 billion, and the funding ratio is 67.5%, according to the 2007 Comprehensive Annual Financial Report (the latest year available).

How can we fix our State pension system? Here’s what I suggest:

1. Require that the retirement system is at least 90% fully funded. Pension systems with a funding ratio below 80% are generally believed to be at risk of failing.

2. Limit employee pensions to the amount that they paid into the system. Retirees would only receive the amount they contributed to the system, plus interest. This would probably need to go into effect in 10-15 years, so that employees have time to plan for retirement.

3. Consolidate and phase-out retirement plans. We need one plan (contributory, with the option to opt-out), for two different types of employees (general and “at risk” police/fire/public safety workers). Pensions would be based on contributions, not service years. Eliminate the special consideration for elected and legislative officers.

4. Consolidate the retirement plan options. There are 5 options a confusing number of option combinations. We need three plan options (monthly pension over 20 years to the employee or surviving spouse; deferred pension that continues to earn interest; and one-time distribution). Eliminate the lifetime pension to a non-spouse beneficiary (otherwise, we could pay lifetime benefits to a 20 year old!).

5. Change the interest rate to prime plus 1%. This would replace the 4.5% interest rate, which is unaffordable when interest rates are low (like now), and unfair when interest rates are high.

6. Allow retirees to choose a one-time tax-free pension distribution. Retirees could roll it into an individual retirement account (IRA) and take responsibility for their money. This would allow the State to save on management and administration costs.

I think the some of these fixes to the State retirement system could also work for Social Security too. After all, the unfunded liability for Social Security is $17.5 trillion (yes, trillion!), according to the 2009 Social Security and Medicare Trustees Reports.

You may be thinking, those State workers earned their pensions!

Here are two examples of the how the State retirement system works. Remember, the average life expectancy in Hawaii is 80 years, according to the US Census.

Example #1: According to the ERS brochure, a general noncontributory employee who retires at age 55 with 30 years of service and a monthly average final compensation of $2,500 is eligible to receive $937.50 per month for life.

That’s 37% of their average salary—more than twice as much as the 15% that the State government contributed to the retirement system, supposedly on their behalf.

Example #2: According to the ERS brochure, a general contributory employee who retires at age 55 with 25 years of service and a monthly average final compensation of $2,500 is eligible to receive 50% of their salary or $1,250 per month for life.

Assuming the employee contributed the required 7.8% of their monthly $2,500 salary, they will have contributed an average of $2,340 per year, earning 4.5% interest compounded annually, or around $108,976 over 25 years. By age 63, they will have received all of the money they paid into the retirement system.

How can we afford our current State retirement system? And do legislators have the courage to fix it before the State goes bankrupt?

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