This hybrid plan was created to try to reduce the cost of converting from the current KPERS defined benefit plan to a defined contribution plan. If the state closed the current defined benefit plan, and implemented only a defined contribution plan, the KPERS investment mix would have to change. A defined benefit plan chooses investments based on the fact that the plan will always continue; since the plan does not have a known end date, the investments can generally be riskier and receive a higher rate of return. The plan is currently invested to receive an 8% rate of return. If the plan has a set “end” date where all participants will be drawing benefits, the investment mix must become more conservative to insure that benefits will be available as of that end date. This would change the expected rate of return from 8% to around 5-6%.
Senator King was looking for a way to avoid changing the investment mix and the rate of return. The cash balance portion of the new plan is a defined benefit plan, so its funds may be mixed with the current KPERS defined benefit funds (no defined contribution funds may be mixed with defined benefit funds). Mixing the cash balance funds with the current KPERS funds will allow the plan to continue having new participants, will avoid the plan having a set end date and will allow funds to remain invested to receive a higher rate of return. Senator King believes this, and the scaled employer contribution described below, offsets the increased cost of starting a defined contribution plan.
No changes for current retired KPERS members.
All KPERS members vested by July 1, 2013 will remain in the current KPERS Defined Benefit system, as modified by HB 2194. There will be no change in employee contribution amount, no change of 85 point rule, multiplier, or final salary calculation formula. The option to move into new plan may be available to all current vested members but will not be mandatory.
NON-VESTED AND NEW PARTICIPANTS
Beginning July 1, 2013 all non-vested and new employees will participate in the Service-Based Plan. Non-vested employees will be bought out from the current KPERS system. At the employee’s direction, the funds then may be invested entirely in the defined contribution plan, entirely in the cash balance plan, or split between the two. If the employee chooses to split funds between the defined contribution plan and the cash balance plan, the employee specifies what percent of funds goes into each plan.
The plan requires the employee to contribute 6% of pay each pay period. The employer contribution amount starts at 1% in the first year of employment and then increases by 0.5% per year until the employer contribution reaches the maximum amount of 5%.
So, from Day 1 of employment, employees will contribute 6%, while the state will build its contribution over an eight-year period and will cap the employer contribution at 5%. After eight years of employment, this will result in a total 11% contribution to the employee’s retirement account which will then continue for the duraiton of employment.
All employee contributions will go into the defined contribution plan. The defined contribution plan is a traditional defined contribution plan and contains no guarantee of what will be available for payment at retirement (this type of plan is completely subject to market ups and downs). Investments are self-directed. The plan will provide a number of funds in which participants can invest, and each individual participant shall determine how his/her contributions will be split amongst those optoins. As is common with these types of plans, employees will have access to education materials that will inform them about the various investment options. Each employee’s individual account is subject to daily market valuation, and the money in the account will accrue market gains and losses based on the employee’s investment choices. Money in the defined contribution plan is portable, and may be rolled over to another defined contribution plan if the employee leaves state employment.
All employer contributions will go into the cash balance plan. A cash balance plan is a form of defined benefit plan. In a cash balance plan, the employee is always guaranteed to receive at least the amount of contributions which went into the plan on the employee’s behalf plus a specified guaranteed rate of return. For example, if the guaranteed rate of return is set at 4%, the employee would always be entitled to receive the dollar value of contributions which went into the account plus a guaranteed 4% return. With a cash balance plan, any earnings over the guaranteed rate of return may, at the discretion of the plan sponsor/administrator, be awarded to the participants as a dividend or retained by the plan. The cash balance plan in Senator King’s proposal contains a 0% guaranteed rate of return, meaning the participants are not automatically entitled to receive any earnings. Whether earnings are awarded will be a completely discretionary. The plan as presented does not indicate whether the KPERS board or the legislature will control whether dividends are awarded. Money in the cash balance plan is not portable and must remain in the cash balance plan until the employee reaches retirement age.
Upon retirement, the employee will receive benefits in two parts: one benefit from the defined contribution plan, and one benefit from the cash balance plan. Senator King’s plan does not identify the benefit payout options for the defined contirbution plan, but funds from such plans are usually either paid as a lump sum or coverted to an annuity. The benefit avaialble for pay out will depend on the investment returns.
Funds from the cash balance plan must be taken as an annuity. The amount that will be annuitized will be the amount of contributions made on the employee’s behalf, plus any dividends awarded on that amount. As stated above, the employee is not automatically entitled to any investment returns from the cash balance plan. Benefits from the cash balance plan may not be taken as a lump sum.
All current and future legislators will move to the new plan. Legislators currently vested in KPERS will have their interest calculated and bought out and the legislator can then invest the amount in the Defined Contribution 401(k), Cash Balance, or divide it between the two. Retired legislators will remain in the current KPERS system.
UNFUNDED ACTUARIAL LIABILITY
The new plan does not specifically address the current KPERS estimated $8.3 billion UAL. The Commission will recommend to the legislature to use tax free bonds to pay a portion or all of the UAL.