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In the wake of a super-sized salary scandal in the city of Bell, CalPERS is looking at its plan that allows pensions to pay more than the federal limit of $195,000 a year at ages 62 to 65.
The federal limit aimed at preventing public pensions from being used as tax shelters drops for early retirements ($117,672 for non-safety retirements at age 55) and increases for later retirements.
CalPERS gets around the limit imposed by Internal Revenue code section 415(b) with a “Replacement Benefit Plan” that provides a different way of paying the part of the pension that exceeds the federal limit.
It’s a kind of paper shuffle that the California Public Employees Retirement System says works like this:
CalPERS sends a bill for the amount over the federal limit to the government employer. The nation’s largest public pension fund covers about 3,000 local governments and school districts in addition to state workers.
The employer sends CalPERS a payment for the excess amount, which CalPERS gives to the retiree in quarterly payments. The employer gets a “credit” or reduction of a similar amount in its regular contribution to CalPERS.
In general, CalPERS says the plan is designed to be “cost neutral” for the employer. But there is a little slippage because the amount over the federal limit is taxed like regular wages.
In addition to the income tax paid on pensions, the amount over the federal limit is taxed under FICA (Federal Insurance Contributions Act) for Social Security and Medicare.
CalPERS says the FICA payment on the amount over the federal limit is due only in the first year of retirement. Actuaries calculate the “present value” of the replacement benefit over the expected life of the retiree.
“The replacement benefit is paid as a wage subject to an upfront balloon payment of Social Security and Medicare on the present value of the lifetime stream,” said a CalPERS response to a question.
The Social Security tax rate is 6.2 percent on earnings up to a maximum, which is $106,000 this year. The Medicare tax rate is 1.45 percent with no maximum earnings amount.
CalPERS said its plan is a “Qualified Governmental Excess Benefit Arrangement (GGEBA) as introduced by the Small Business Job Protection Act of 1996.” Many California public pensions also have a way to exceed the federal limit.
An information sheet from the San Diego City Employees Retirement System says in boldface type: “Retirement benefits that exceed Section 415 dollar limits are not ‘illegal.'”
It’s apparently assurance from a deeply troubled pension system, hit by charges against former board members and ballooning costs cutting deep into the city budget, that retirees do not need to worry about another scandal triggering a big tax bill later on.
CalPERS is looking at its excess benefit plan as part of a broad policy reappraisal after the Los Angeles Times revealed that the city manager of Bell, a small city with a large immigrant population, had an annual salary of nearly $800,000.
CalPERS discovered in 2006 that the city manager, Robert Rizzo, received a 47 percent salary increase to $442,000, the Times said. But pension fund staff, following the rules, did not sound an alarm because other Bell officials also received large pay raises.
Anne Stausboll, the CalPERS chief executive, told the board last month that peer review and manager approval have been added to audit procedures since 2006. She said CalPERS is “changing the guidelines and culture” to avoid repeating the Bell response.
In addition, Stausboll said, CalPERS has formed a task force with local government, labor and the Legislature to look at several issues: pay disclosure, capping pay that determines pensions, and spreading pension costs among employers.
CalPERS is reviewing the salaries of members who earn $400,000 or more a year. When that is completed, CalPERS will review the salaries of members who earn $245,000 a year or more.
Under a second federal limit, 401(a)(17), the maximum amount of salary that can be used to determine a pension amount this year is $245,000. It only applies to those who became CalPERS members after July 1, 1996, when the limit was imposed.
Similarly, the limit on pension payments, 415(b), exempts persons who became CalPERS members before Jan. 1, 1990, if the employer has not increased benefits since October 1987.
About 70 percent of CalPERS members are subject to both federal limits. The number of members with pensions that exceed the 415(b) limit and receive payments through the Replacement Benefit Plan was not available.
Two other issues being looked at after the Bell scandal are “risk pools” and “reciprocity.” In 2005 CalPERS put small plans with less than 100 members into large pools of 100 or more government agencies to spread the risk of death and disability.
Bell is in three risk pools. Contrary to reports, CalPERS said in a news release last month, the big pensions resulting from high Bell salaries are likely to have “negligible” impact on other cities and agencies in the pools.
Some calculate, for example, that Rizzo could be eligible for a pension of about $600,000 a year, giving him a total of $30 million during his life expectancy. Several other Bell officials also could be eligible for big pensions.
Not only would the cost of the big pensions be spread across the large pool, said CalPERS, but Bell’s contributions to the pension fund have been based on the high salaries.
A potential problem, however, is the standard pension “reciprocity” agreements with government agencies not in CalPERS.
If a worker moves from one government job covered by CalPERS to a job with another government employer covered by CalPERS, the pension fund continues to bill the former employer for its share as the worker adds years of service and a higher salary.
But if the worker moves to a government job not covered by CalPERS but with a “reciprocity” agreement, CalPERS loses track of the worker and cannot put the bill into an annual payment, seeking a lump sum on retirement instead.
“So when that individual finally retires there is a shock to the former employer, and that can be totally unexpected and difficult for the employer to bear,” the chief actuary, Alan Milligan, told the CalPERS board last month.
As for the Replacement Benefit Plan, he said, the cost can be included in the annual CalPERS contribution rate for large employers not in a risk pool, offsetting credits given for payments above the federal limit.
“It works well for a stand-alone employer,” said Milligan. “It does not work as well for a pooled employer. So this is something we again are going to be discussing with the task force.”
The two federal limits and risk pools and reciprocity are among a half dozen issues the CalPERS staff is looking at as a result of the Bell salaries, the CalPERS employer services chief, Lori McGartland, told the board.
Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at http://calpensions.com