The California Legislature has approved a pension reform bill endorsed by Governor Jerry Brown.  The bill will impact retirement systems across the State, including the California Public Employees’ Retirement System (CalPERS), pension systems operating under the County Retirement Law of 1937 (“’37 Act”), and independent local agency systems.  The only retirement systems that appear to have escaped pension reform are those that were created by an agency’s charter (e.g., the San Francisco Employees’ Retirement System). 

We summarize highlights of the bill, known as the California Public Employees’ Pension Reform Act of 2013, below.

New, Lower Retirement Formulas

Employees first hired by a public agency on or after January 1, 2013, will be subject to new, lower retirement formulas.  Under these new formulas, the minimum retirement age for miscellaneous employees increased from age 50 to 52.  New miscellaneous employees will earn benefits under a 2%-at-age-62 formula, with a maximum benefit factor of 2.5% if they retire at age 67.

The minimum retirement age for safety employees remains at age 50.  There are three new formula options for safety employees hired on or after January 1, 2013.  The Basic Safety Plan is the lowest option and provides for benefits under a 2%-at-age-57 formula.  The Safety Option Plan One provides for a 2.357%-at-age-55 formula, with a maximum benefit factor of 2.5% for safety members who retire at age 57.  The Safety Option Plan Two provides for benefits under a 2.5%-at-age-55 formula, with a maximum benefit factor of 2.7% at 57. 

The safety formula that applies to new employees of a public agency will be the formula that is closest to and provides a lower benefit at age 55 than the formula currently offered by that agency.  For those agencies that already adopted a second benefit tier (e.g., 3% at 55), this will likely be Safety Option Plan Two. 

There is an exception to application of these new lower formulas to new employees.  If a retirement system’s reciprocity rules apply to a new employee, then the new employee can earn pension benefits from a subsequent employer under the terms of any retirement plan that was in effect on or before December 31, 2012.  Reciprocity generally applies when an employee changes retirement systems (e.g., from a ’37 Act system to CalPERS).  The reciprocity exception is not likely to apply to employees who go from employment with one CalPERS contracting agency to another.

New Definitions of Compensation

The new law limits the amount of compensation that can be included by a retirement system in calculating pension benefits.  This limit is tied to the employee’s participation in Social Security.  If an employee participates in the Social Security system, then the maximum amount of salary that can be considered in calculating pension benefits is 100% of the Social Security contribution limit (currently $110,100 per year).  If an employee does not participate in the Social Security system, then the maximum amount of salary that can be considered in calculating pension benefits is 120% of the Social Security contribution limit (currently $132,000).  These salary caps will be adjusted annually, based on the Consumer Price Index for all Urban Consumers. 

The new law also limits the type of compensation that can be included by a retirement system in calculating pension benefits.  The term “pensionable compensation” is defined as “the normal monthly rate of pay or base pay of the member paid in cash to similarly situated members of the same group or class of employment for services rendered on a full-time basis during normal working hours pursuant to publicly available pay schedules.”  The new definition of “pensionable compensation” includes deferred compensation, but excludes severance pay and most overtime compensation.  In a significant change from the existing definition of compensation, the new law expressly excludes uniform pay when calculating pensionable compensation for new hires.  In addition, the new law significantly narrows the definition of compensation for ’37 Act systems to exclude most payments for unused leaves.  

New Final Period for Calculating Benefits

For employees hired on or after January 1, 2013, pension benefits may no longer be calculated based on an employee’s highest salary during a single one-year period.  Instead, benefits will be calculated based on the employee’s average salary during a 36-month consecutive period.  This 36-month period does not have to be the 36-months immediately preceding retirement.  Employees have the option to designate any 36-month consecutive period.

Changes to Employee Contributions

Under the new law, all employees must begin making contributions towards pension benefits.  New employees must pay 50% of the normal costs of pension benefits.  Employers no longer may pay all or a portion of the member contribution for current employees and must cease such payments when renegotiating successor collective bargaining agreements. 

For CalPERS agencies, the employee contribution is capped at 8% of salary for local miscellaneous members and 12% of salary for local police officers, local firefighters and county police officers.  The employee contribution for local safety members other than police officers, firefighters and county peace officers is capped at 11% of salary.  For ’37 Act systems, the employer contribution caps vary based on application of a specific formula and the terms of the system.

Sharing the Employer Contribution

The new law expands the portion of employer contribution that can be paid by employees.  Previously, employers and employees could only agree to share the cost of optional benefits.  Employers and employees will be able to share any aspect of the employer contribution, including both normal costs and the optional benefit costs.  A written agreement to share employer costs continues to be required and sharing of the employer contribution cannot be imposed.  However, employers with more than one bargaining unit now have greater flexibility in negotiating those agreements, as the amount shared by employees no longer needs to be uniform across a retirement membership class (e.g., all miscellaneous employees) in order to adopt a CalPERS contract amendment.

Disability Retirement Benefits

The new law contains temporary changes to industrial disability retirement benefits for public safety employees.  Public safety members who retire on or after January 1, 2013, because of an industrial disability will receive a pension benefit equal to the greater of:

  1. 50 % of his or her final compensation plus an annuity purchased with any accumulated contributions;
  2. A service retirement allowance if he or she is of age to receive a service retirement benefit (50 or older); or
  3. An actuarially reduced factor, based on age and years of service, if he or she is not eligible for a service retirement.

In no event will a CalPERS member receive less under this temporary program than he or she would have received prior to January 1, 2013.  These changes to industrial disability retirement benefits will remain in effect until January 1, 2018, unless extended by the Legislature. 

Employing Retirees

The new law reaffirms the limits on employing retirees.  These limits prohibit a retiree from serving without reinstatement to the retirement system unless employment of the retiree is necessary “either during an emergency to prevent the stoppage of public business or because the retired person has skills needed to perform work of limited duration.”  The retiree continues to be limited to 960 hours of work per year (either calendar or fiscal, depending on the retirement system).  There are also limits on the amount of compensation that can be paid to the retiree by the public employer.  

CalPERS agencies will find that many of the terms for employing retirees are unchanged.  However, there is one new change that applies to all retirees, regardless of retirement system.  The new law contains a 180-day waiting period that must pass before a retiree may be employed by an employer in the same retirement system from which the retiree is receiving pension benefits.  There are exceptions to this 180-day waiting period, including one for the employment of a public safety officer or firefighter, and another where the governing body of the employer declares that immediate appointment is necessary.  The exceptions are not available to retirees who accepted a retirement incentive. 

Other Changes

Finally, in addition to the major changes discussed above, the new law prohibits the purchase of additional service credit (“airtime”) and bars pension holidays, unless a plan is funded at 120%. It also requires the forfeiture of pension benefits if a member is convicted of certain crimes.

Apply Provisions with Caution

Agencies interpreting and applying the new law should consult with legal counsel.  There are limits on the ability of agencies to implement some of the terms if collective bargaining does not result in an agreement, as by adopting either the Basic Safety Plan or Safety Option Plan One.  Additionally, agencies are encouraged to review their procedures for hiring retirees to ensure that all new requirements are met.  They also should review their reporting procedures to ensure correct compensation reporting.