Shifting Sands for Current Employees – The Litany of Changes since 2008
In 2011 with the inauguration of Rick Scott and a Republican Legislature, the Florida Retirement System started to change. These changes were predicated on the aftermath of 2008 on the state’s finances. The market decline during 2008 and 2009 dramatically reduced the value of the FRS Pension Plan assets from about $135 billion to under $100 billion. As a result, politicians embarked on a cost cutting spree that effectively reduced your retirement benefits. The effect of these changes on employees depended on whether they were in the Pension Plan, DROP or the Investment Plan. These changes still remain in place despite the improvement in state finances and the value of Pension Plan assets returning to over $160 billion as of June 30, 2018.
The single biggest change was the requirement for all state employees to contribute 3% of their salary to the Florida Retirement System. For those in the Investment Plan, these monies go into their own account. For those in the Pension Plan, those monies go into the general fund of the Pension Plan. This required contribution did not apply to those employees who were currently on DROP. This required contribution continues to effectively act as a 3% reduction in one’s salary. For most employees that was particularly tough to take over the past few years given the absence of any salary increases.
Meanwhile, the biggest change for those under the Pension Plan was the effective elimination of the Cost of Living (COLA) of 3% per year that is part of the calculation of one’s Pension Plan benefit.
While the original legislation stipulated that this was a five year suspension ending in 2016, by requiring legislative action to bring the COLA back, it effectively served as an elimination of this benefit. To date, there has been no real movement by the Florida Legislative to reinstate the COLA for state employees. Given that the value of the Pension Plan assets have returned to a value greater than what they were before the 2008-2009 financial crisis, the COLA benefit should arguably return.
The effect of this change is to prorate an employee’s COLA benefit across their total number of service years. For example, if you have 25 years of service as of July 1, 2011 and worked another 5 years, your COLA benefit under the FRS Pension Plan would decrease to about 2.5% per year from the current 3%. Similarly, if you plan to retire in 2020 with 25 years of service, you would have 9 years at a COLA of 0% (the years since 2011) and 14 years at a COLA of 3%. This would average out to produce a COLA of 1.7% on your pension in retirement.
Employees who choose to go on DROP are also affected by these legislative changes as well. Prior to 2011, DROP monies earned a guaranteed rate of return of 6.5%. After 2011, this rate dropped dramatically to just 1.3%. Over the five year DROP period, this 5.2% annual differential has a dramatic effect on reducing DROP values. In fact, employees should compare the impact of the additional years of service time on their pension with this more limited benefit of DROP. In some cases, the additional years increase one’s pension benefit more significantly than the potential income from the lump sum DROP amount. Remember, years spent on DROP don’t count towards calculating your pension benefit.
Investment Plan members were able to escape the effect of the 2011 legislative changes but in 2012 politicians caught up with them. In 2012, House Bill 5005 reduced the contribution paid by employers into the Investment Plan by a huge margin. Prior to July 1, 2012, the total contributions to one’s Investment Plan account was 22% for special risk employees and 9% for regular class employees. After July 1, 2012 those contribution rates declined to 13% and 6.3% respectively. Since then, these contribution rates have increased only slightly to 15% for special rate employees. Unfortunately, for regular class employees the contribution rate has further declined to 6%. These rates include the mandatory 3% employee contribution.
While billed as a necessary change to level the benefits between the Pension Plan and the Investment Plan, it served to disproportionately undermine the benefits of the Investment Plan. In addition, these changes in contribution rates were buried in legislation that was passed at the 11th hour and largely occurred without much discussion with the affected employees.
Of course, the deal is also different for new State employees as well. For those entering FRS employment on or after July 1, 2011, the vesting under the FRS Pension Plan increased to 8 years from 6 years. Vesting under the FRS Investment Plan remains at one year. In addition, average final compensation under the FRS Pension Plan increased to the 8 highest years of service from the 5 highest years.
The age eligibility for retirement increased from age 62 to age 65 for regular class and from age 55 to age 60 for special risk. The retirement eligibility based on years of creditable service increased from 30 years to 33 years for regular class and from 25 years to 30 years for special risk. New FRS employees will need to work longer in order to receive comparable benefits available to current FRS employees.
In addition, new employees must make an election between the Pension Plan and the Investment Plan within eight months after their hire – otherwise the state will choose for them! Effective January 1, 2018 if new employees do not make an election by the end of the election period of eight months, there will be a default membership. Employees in classes other than the Special Risk Class will default to the Investment Plan and members in the Special Risk Class will default to the Pension Plan. All members will continue to have a second election but employees should make their first election immediately after their hire. Otherwise you may wind up using your second election to reverse a default decision that you didn’t intend to make.
The bottom line on all these changes is that it affects your decision and timing on making any changes to your retirement. In the past, when employer contribution rates to the Investment Plan were 30% higher, the timing of any switch to the Investment Plan was somewhat immaterial. Now, the timing of the switch really matters. Over the years we have reviewed countless individual comparisons and while each situation is unique, based on these reviews, it seems that any move to the Investment Plan needs to be either at the inception of your career or at the end. This also preserves your second election to switch among the FRS options for future use as well.
At the beginning of your FRS career you have time to generate a sufficient balance in your Investment Plan and can take advantage of its shorter vesting requirements. In fact, we have seen some scenarios of late where employees who had initially started with the Investment Plan had the opportunity after 10-15 years to buy back into the Pension Plan and retain a significant portion of their Investment Plan balance.
In contrast, those that wait to switch at their 25th year of service (30 years if not special risk) experience the largest run up in their projected lump sum balance in the last five years of service. After hitting these full retirement service years, the projected balance rises at a rate similar to inflation. In those cases, it may make sense to make a move in that 25th (or 30th) year of service if an employee wants to go into the Investment Plan. The hardest scenarios are those with 15 years or so of service. For them, it probably makes sense to just wait things out before considering any move among the FRS options.
In addition, those retiring under the FRS Investment Plan need to be aware of the timing restraints that exist to access your money. Retirees must wait one full calendar month after the month in which they retire before they have an early access opportunity to draw funds from the FRS Investment Plan. In order to shorten this window, one should retire at the end of the month rather than the beginning of the month. For example, if you work a few days at the beginning of a month, you would have to wait the rest of the month plus all of the next month before getting any access to your FRS Investment Plan. This early access is also limited to just 10% of the balance and is available only to retirees who meet the normal age and years of service retirement parameters. In order to gain full access to their Investment Plan balance, retirees then have to wait another full two months after the early access period. Consequently, it often amounts to over three months before retirees can set up normal retirement income from their accounts. This is a significant issue with retiring under the FRS Investment Plan and retirees need to consider their timing restraints and plan their finances accordingly in order to have enough resources to bridge those first three months of retirement.