ERO: How Benefit Enhancements Drive Up Pension Costs.

In my last article (see here), I documented how more than 130 benefit increases for the TRS (Teachers Retirement System) have been passed by the legislature since the “Pension Guarantee” amendment to the constitution was passed in 1970.  The overwhelming majority of these benefits have been paid for by the taxpayer, not the employees.  The Early Retirement Option (ERO) is just one of the more egregious examples of how benefit enhancements affect the overall cost of providing long-term pension benefits to public employees.

ERO – Early Retirement Option (2004).
The normal full- retirement age for TRS is 60 or you must have 35 years’ “service credit” (not actual years worked).  If you are a teacher and want to retire before age 60, you must pay a penalty of 6%/yr off of your pension for every year less than 60 or every year short of 35 years’ “service credit.”

The ERO was devised to allow retiring teachers to avoid the early retirement penalty.  Like virtually every benefit enhancement since 1970, the cost burden of this benefit is predominately passed on to the taxpayer.

ERO Example:
     Teacher retires at age 55 with 30 years of creditable service.
     Teacher’s average pensionable salary is $100,000.
     Teacher’s highest salary is $120,000.

Full pension = $66,000/yr (33 years times 2.2% per year).
Discounted pension (because she does not have 35 years and is not age 60) = $46,000.

So under rules in place prior to passing the ERO legislation in2004, this teacher could either wait until she is 60 to collect $66,000 or she could start taking $46,000 at age 50.  With ERO, she can receive the full $66,000 at age 55.  That means she will receive $330,000 between ages 55 and 60 with ERO that she would not have received otherwise.  But over her expected lifetime at age 55, she will receive $700,000 more in pension payments under ERO than under the previous plan.

What does she pay for this?  A measly .4% of salary (only since 2004) or about $400/yr (why bother?) plus 11.5% of her highest salary for each year under age 60 or $69,000.  However, at most suburban schools the $69,000 is picked up by the school district so the teacher pays virtually nothing for a $700,000 pension benefit.

In addition to the employees’ portion, the local school district i.e. the taxpayers, must also contribute to ERO in the amount of 23.5% and these amounts can be substantial.  As of Nov. 2011, about 988 retirees have had the local district pay out $100,000 to $361,000 to allow them to retire early without the discount normally applied to early retirees.

Below is a list of those retirees who received more than $200,000 in ERO payments by their employer, the local school districts:

SOURCE: Teachers Retirement System.

Notice how few years have actually been worked.  The average of the group is 25 years.  That’s because “service credit” years are used for pension calculation, not actual on-the-ground years, and those include non-work items such as sick-leave and Optional Service credits.  Yes, you can become an Illinois pension millionaire without working too long in Illinois.

Fortunately (maybe) for beleaguered Illinois taxpayers, the ERO law terminates at the end of 2012 and will disappear unless renewed by the state legislature.  Let’s hope they have more sense now than they did when they first passed this law in 2004.