A Discussion on the Pension Proposal and How it Will Affect Kentucky Teachers

Oct 27, 2017

Credit Sergey Kuzmin, 123rf stock photo

Governor Matt Bevin and state GOP leaders recently unveiled a proposal to overhaul the state's beleaguered pension systems. But what does it mean for teachers and other state workers? How will this plan affect people who aren't in the pension systems? Many agree something needs to be done about the state's pension crisis. So, if not this plan, then what could work as an alternative? Matt Markgraf sits down with Calloway County Retired Teachers Association President Marshall Ward and Treasurer Larry Guin, who is a Murray State Professor Emeritus of Finance, to unpack the proposal. 

Note: This interview was recorded on Wednesday, October 25. This is the full conversation. A shorter version aired in two-parts on Sounds Good on Monday, October 30.

Governor Bevin has been touring the state pitching the plan to business leaders and Rotary groups. The plan can be seen in outlines on the governor's "Saving Kentucky's Pensions" page. Bevin has also addressed pension reform questions in an interview on a Kentucky Chamber website. The Chamber has announced support for the plan.  

The Kentucky Education Association opposes the plan as does the Kentucky Association of State Employees, among other groups that represent state workers. Financial Advisor Ryan Stith of Pivot Point Wealth has written a detailed analysis of how the plan would affect workers.

Bevin's office has released a draft of the pension bill. Read the bill here

The governor's office has also released a side-by-side comparison and summary highlights of each section.

Overall Impressions

Marshall Ward said the rhetoric put out by leadership in Frankfort is "both bombastic and somewhat confusing." He says teachers are becoming nervous about their prospects given the potential changes. Ward argues teachers know they are going to take a fairly low pay upfront in order to garner a pension at the end, one they contribute to along the way (matched by state funding). He feels young people will be disincentivized to become teachers in Kentucky and thus, the Commonwealth will suffer from a teacher shortage.

Larry Guin says he's concerned by the finger-pointing in the conversation. He said there were mistakes along the way, that the issue has been kicked down the road for many years and has finally 'come home to roost.' He credited Bevin for taking on the issue, which he said is not something previous governor's have done. "I may differ with a few issues in this particular plan, but I very much appreciate the fact that they are looking at it now."

Changes Needed?

Governor Matt Bevin has said it's simply not possible for the system to continue without any changes. Guin agreed with this assessment, adding that it would eventually 'take down the entire Commonwealth' with bankruptcy an inevitable result.

"The unfunded liabilities right now for all of the systems are estimated to be about $33 million dollars. But there's a new set of accounting rules that have been implemented at the national level regarding pensions. And if you take those into account, really, rather than for KTRS - or TRS - rather than about 54% funded, under the new guidelines would about 45% funded. And to get that up to a reasonable level and the rest of the state on the other pension fund systems would probably take in the neighborhood of about $45 billion dollars under the new accounting rules. The state budget last year was approximately $10 billion dollars," Guin said.

How this Affects Teachers

Unpacking what this means for teachers, depends on ones stage in their career, with different implications for future, current and retired teachers. The largest change would be a requirement for new individuals becoming teachers joining a 401(k)-style plan. Guin said he said he disagrees with the Governor on the plan being "generous."

"In my opinion it is not generous at all in fact it's on the other end of the scale because the state right now is putting in about 9.1% of an employee's salary for their match in the current system. That would drop under the proposal to about 4% by the state. The local school districts are putting another 2%. The employee would be required to put in 9% could at their option increase that to a total of 12%. So if you go to 12%, about two-thirds of all of the contributions into the plan are coming from employee savings. If the employee can save that much. So the state putting in 4% as opposed to 9.1% now does not strike me as generous," Guin said.

Current teachers can stay under their current defined benefit plan (pension). 27 years is the maximum amount of time that current teachers can stay on their plans. If they want to teach beyond 27 years, they would have to switch to a defined contribution plan (a 401(k)-style plan).

There is a phase-in period of three years. So, for example, a teacher with 27 years in the system who wants to teach for another 10 years would have three more on the pension before the switch. The uncertainty that comes with a 401(k) is due to outside factors like the status of the stock market. Guin noted a teacher with a 401(k) getting ready to retire in 2008 (during the recession) would not have been able to do so.

Social Security?

Governor Bevin has said teacher groups don't want to pay into social security. Teachers in Kentucky (not including university faculty and staff) don't collect social security per state law. Ward said he didn't know why teachers wouldn't want this as an option. Guin said he thinks the state is trying to save money by keeping social security off the table. "The employer match for social security is 6.2% of the employee's salary. And I think the governor shied away from this very quickly when he realized that we're going to have to come up with another 6.2% of the salaries for covering social security," Guin said.

Other Matches

Guin said the additional 3% workers will have to pay into the state health care system caught him off guard. He suspects the money will go into a general pool and may not end up in health care. Ward said the 3% contribution is effectively a pay cut for teachers. He also said he feels the 2% additional payments from school districts means it will be difficult to enact pay raises in the future.

Is a Pension Plan Sustainable?

Governor Matt Bevin has suggested that Millennials don't want pension plans because it locks them in for 27 years, when young people are working in an era where mobility is desired. This brings about a question as to whether pensions are still sustainable in the modern era.

Guin said there's been a lot of talk about changing the structure, by going shifting from direct benefit plans to 401(k)s. He argues there's nothing wrong with a pension plan and that the structure is actuarially sound with proper financial discipline. That's where the system broke down, he said.

"The employer has to put their money on time and the amount that they promised. Employees have to contribute their own time as they promised to do also. And if you get a reasonable rate of return on investments they're 100% funded and they do very well," he said.

When asked about an example of a pension plan that works, Ward said Missouri offers a hybrid plan where the amount contributed by the employer and the employee changes as the economy changes. "That might be something that would be a good compromise here in Kentucky to allow some flexibility for the employer and employee."

If Not This Proposal, Then What?

Governor Matt Bevin has said people opposed to the plan haven't offered any alternative suggestions as to how to resolve the state's pension crisis.

Guin said there are too many constraints on the solution since the Republican leadership opposes tax increases. He said that road can be avoided by taking a look at tax loopholes in the current code. He said the state budget is about $10 billion and there are about $13 billion in loopholes (citing a recent report in Lexington). He said there are credits given to wealthy individuals who own boats and end up paying fewer taxes than fishing boards. He said the movie industry receives tax credits and there's no evidence to support a payoff in terms of increased economic activity.

(Bevin has also suggested closing these loopholes by aligning tax expenditures with federal tax code.)

Guin noted that there are other 'tax credits' that many may consider tax increases: for instance: there is no sales tax for people consulting accountants, attorneys or doctors. He said there is no sales tax on services. There are no taxes on medicine or groceries. "Now that's a tax increase. Maybe that's not a tax loophole. But there are certainly loopholes out there that help to build golf courses and pet projects of legislators and things like that. The racehorse industry, for example, for horse race horses are horses that are less than two years old, there are tremendous credits for that." He said he hopes factors like these will be considered int he next session as lawmakers consider tax reform.

Ward added that the state could also consider new revenue streams like a push for growing hemp statewide, legalizing medical marijuana and investing in alternative energy.

As to whether closing loopholes that benefits one industry to help shore up funding for another industry is simply moving money around that could still cost jobs or affect the economy, Guin said, "Yes, if you pull that money away from them that reduces their profits that's going to reduce a little bit of economic activity. So it's a matter basically of what is working and what is not. Most tax loopholes were either put in for political reasons or incentives and I'm a big fan of incentives. But if you're going to give tremendous tax breaks for an industry to move into a locality you need to make sure that your eventual payoff from that is greater than the benefits that you're granting them to come in for it. And I'm not sure that's being done really well right now at the state level."

What is Level Dollar Funding?

This term effectively mandates that the pension system is paid for 100% in the budget. Guin added this is popular nationwide.

Guin detailed some of the history of the pension system: detailed that an assumption is made- in this case that the number of teachers will increase over the years and that they will receive raises over that time. The state would take a certain percentage of that payroll and set it aside in the form of contributions to the pension plan. He said the problem, however, is that has not occurred and that the number of teachers has not increased near the level it was assumed to have reached. Consequently, the state ended up putting less in the fund than they had planned on putting in initially, which led to about one-fourth of the underfunding in the current pension system.

Guin said level dollar funding is the best part of the governor's plan as it would mean the state would contribute in the same way a homeowner would for a mortgage, to contribute the same each month, each year, on a level basis for 30 years. At the end of that 30 year period, the underfunding would be paid off and the state would be back to 100 percent funding again.

What About Those Not in the System?

Ward predicts a ripple-effect into local economies since teachers will have less disposable income due to the additional 3% contributions and a temporary, five-year freeze on COLAs (cost-of-living adjustments) for those retired. They estimate that the freeze amounts to about 1.5 years of pension (over a typical 20 year retirement) and that money would have otherwise been a part of a recipients earnings that would have, to some degree, gone into the local economy.

In Conclusion

Guin said he feels for the governor and the lawmakers for having to deal with this problem, particularly the newer legislators who weren't part of the problem stemming back over a period of 17 or 18 years. He said he feels they are making a good effort to come up with solutions, but wants them to consider alternatives like closing tax loopholes rather than placing the burden back on those who were promised benefits and will not receive them now.

Ward said he agrees that legislators are 'stuck between a rock and a hard place' on this issue and credited state lawmakers for meeting with local constituent groups. "My fear is that 10 years down the road we're going to have a very dilapidated school district in terms of employees and people who want to do this profession, which will irreparably harm the state for decades to come. So we've got to fix this and get it right or we're going to suffer the consequences," he said, citing issues in Kansas, where this experiment was tried a few years ago. He said he wants to move away from things that haven't worked and find compromise through debate and discussion.

This story has been updated.