State and local pension benefits are computed as the product of (a) the average of the employee’s highest three years of compensation (for example $60,000) and (b) a percentage factor determined by their age (for a 65 year old administrative employee, 2.5%) and (c) number of years of service (but not more than 32). So the example employee would have a pension of $60,000 x 2.5% x 32 = $48,000.
Sounds simple enough, but the system has a number of obscure rules allowing some employees to “buy back” service and inflate their pension by claiming additional years of service. In some instances, it makes sense to permit buy backs — as for example, when someone leaves state service, withdraws their pension funds, then later returns.
The real problem comes in how the buyback cost is computed. The pension system is built around the idea that as funds are salted away to cover future benefits, they will earn investment returns at the rate of 8.25%. When people buyback benefits, they only have to pay half that rate in Massachusetts. In longer delayed buybacks, much of the cost of the buyback comes in the interest, so buying benefits at half the assumed investment return amounts to getting them at 50 cents on the dollar.
According to a new survey by the National Association of State Retirement Administrators, most other states require buyback interest to be paid at the full assumed investment return rate.
The low-interest give-away compounds the arbitrariness of the special purpose buyback rules in the statute:
- Teachers can buy back three years of Peace Corps service. Why can’t other helping professionals do the same? And why not buyback other kinds of honorable volunteer service?
- Teachers can buy back non-public school service before 1973 or service in educational collaboratives before 1983 or service in any non-public school partially funded by the commonwealth. Why can’t state doctors and nurses who served in private hospitals buy back some service?
- Vocational education teachers can buy back three years of work in the trades. Why can’t math teachers buy back service as analysts?
- Teachers and educational administrators can buy back up to 10 years of time in other states. Why can’t other professionals do the same?
There are answers to all of these questions, but they aren’t good ones — these are exceptions that have been grafted on to the system over the years because one group made an especially good appeal while other groups weren’t paying attention. This kind of exceptionalism breeds disrepect for the pension system.
Let’s at least charge people fairly for their special service credits. The fix is simple: Set the buyback interest rate equal to the assumed investment return.
The Governor’s recent pension reform proposal gives this issue some attention — requiring the higher rate in cases of out of state service or when people don’t promptly buyback service after reinstatement — but it’s hard to see a reason why not to go for a clean sweep on the issue and fully eliminate cut-rate buybacks.