As a former financial planner in Colorado, I get a lot of questions about Colorado’s PERA program. For those of you who are not from Colorado, PERA stands for Public Employment Retirement Association. It is a public pension plan for employees of the State of Colorado and public school teachers, similar to CalPERS, the public pension plan for California. Recently, PERA has taken some lumps in the media. Often times, these criticisms are valid, and sometimes they are not. What is true, is that PERA is not just another ordinary pension plan, and to really understand it, requires delving into those details.
PERA and Social Security
The most important thing to understand about PERA is that it replaces Social Security. You know how people are always saying that Social Security would be better off if it invested worker’s contributions in the stock market? That is exactly what PERA does.
When Social Security was first started, state government employees were not covered by the program. If you remember your Constitutional history, you’ll recall that the federal government cannot tax the state governments. The original thought was that the taxes required to make Social Security work could not be taken from state employees without violating this separation of powers. Prior to 1983, state and local governments could opt-out of Social Security and run their own programs instead. In 1983, Congress saw that only a fool would willingly stay in the Social Security program, and was alarmed that it might lose out on the contributions of workers if they flocked to better state run pension plans. The law was changed, however, any states that had already opted out were allowed to continue their own programs.
The choice then is for the State of Colorado to run a PERA-type retirement plan, or enroll its employees in Social Security. There is no third option.
This is important because the State contributes a percentage of an employee’s salary to PERA on behalf of the employee. This amount varies, but is currently 16 percent. Three percent of this amount comes from the budget for employee salaries. In other words, the pool available for salary increases for employees is 3 percent smaller for increased contributions. Employer contributions to Social Security are 6.2 percent. When comparing the cost to the State for PERA, it is important to remember that the entire 16 percent could not be saved by eliminating PERA because then the employer would have to contribute the normal 6.2 percent to Social Security instead.
It is also important to note that unlike most other large employers, the State of Colorado offers its employees no match at all on 401k contributions as part of the more generous retirement contributions.
PERA Better Than Social Security
For employees, there is no doubt that PERA is better than Social Security. PERA allows for employees to retire with a full benefit after reaching the age of 60 and meeting the “Rule of 90.” The Rule of 90 requires that the employee’s age plus their total years of service add up to at least 90. Thus, the earliest someone could retire with a full benefit would be at age 60, with 30 years of service. In contrast, Social Security is raising its minimum retirement age to receive full benefits to 67 for anyone born after 1960. Furthermore, the payout from PERA is much higher than the benefits paid from Social Security, with PERA participants eligible for a benefit of 2.5 percent of their salary times the number of years worked. In other words, someone retiring with 30 years of service would get a benefit of 75 percent of their salary, much higher than most Social Security benefits, especially for higher income employees.
PERA also administers a 401k plan for employees, although like private 401k plans, it costs the state nothing. All expenses are deducted from employee accounts in the form of investment expenses and fees. Maximum 401k contributions for employees are the same as for all other taxpayers. There is currently no matching contribution for State of Colorado employees. Employees can also use a 457 plan offered by PERA.
Problems With PERA
Unfortunately, in the late 1990s, the people running PERA got caught up in the same euphoria as the rest of the country. With account balances high, and the plan seemingly “over-funded,” PERA began to offer higher benefits and schemes that allowed workers to “buy years” at below cost. The result was a draining of the PERA pension fund right before the internet bubble popped and investment returns fell. By the time, people got their senses back, it was too late, and the PERA pension fund was on thin ice.
Critics contend that these measures are proof that PERA cannot survive and that the State should get out of the pension business. The reality is that if PERA hadn’t bowed to political pressure to grant greater benefits during the irrational exuberance of the internet bubble, the fund would be intact. Assuming that lesson has been learned for another generation, PERA should end up just fine, and leave its members in much better shape than if they were part of the quickly bankrupting Social Security system.Then came the financial crisis of 2008, and PERA found itself woefully underfunded. Legislation was passed raising contributions to today’s higher levels. Employee contributions were raised as well as a way to replenish the trust fund. The higher contributions have made a difference, and if PERA can continue to receive market level returns, the ship will right itself. However, another Great Recession (or worse) could still spell doom for the plan.