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Was it constitutional for Proposition 124 to replace PSPRS' permanent benefit increases with a capped 2% COLA?

In this blog I and multiple commenters have broached the subject of the suspect constitutionality of PSPRS' replacement of the old perma...

Monday, August 29, 2016

The waiting is the hardest part for PSPRS members: The only update the the Hall case is that there is no update

I know that the number one question that everyone has (myself included) is when will the Hall v. EORP decision come out.  This is repeatedly asked in the comments and on the Facebook page.  If you are a Tier 1 member (20 years of service before January 1, 2012) or a Tier 2a member (hired before January 1, 2012 but with less than 20 years as of that date), there are major financial implications for you.  A decision favorable to the plaintiffs would mean refunds in the thousands of dollars to Tier 1 and Tier 2a PSPRS members and a 4% decrease in contribution rates going forward.  The flip side is that PSPRS will go further into deficit and affect the budgets of all public safety employers.  A decision in favor of the defendants will maintain the status quo but will also set a precedent that contribution rates are not fixed at the time of hire.  This could mean theoretically that the Arizona Legislature could constitutionally raise employee contribution rates as high as they want.  Remember that the recently enacted pension reforms require Tier 3 members (those hired July 1, 2017 or after) to split contributions 50/50 with employers, as is done in the Arizona State Retirement System.  This 50/50 split could not realistically be imposed on Tier 1 and Tier 2a/2b members as it would leave employees with little or no net pay, but it could certainly be possible for the employee contribution rate to creep up a few percentage points.  The Hall decision may affect some retirees, especially if you were an active PSPRS member after SB 1609 was enacted and did not DROP, but I would expect that this would be a very small number of individuals.  (Note: The Parker v. PSPRS case is contesting the same issue as Hall, and the decision in Hall will decide Parker as well.)

I wish I had some insight into when the decision was coming.  If anyone, other than the four judges and the one Arizona Supreme Court justice who heard the case in February 2016, knows when or what the decision will be, I don't know who that would be.  My understanding of the process is that once the decision is finalized and ready to be made public a 24-hour notice is given to the parties to the case.  That is it.  I do not know if there will be also be a 24-hour advance press release or any other public announcement, though such a big decision will be headline news the day of the decision.

For some perspective, we can look at the timeline of the Fields case.  The Arizona Supreme Court heard arguments in Fields on June 4, 2013 and didn't announce a decision until February 20, 2014, which is over 8 months. The arguments before the panel in Hall were on February 18, 2016, a little over 6 months ago, so if they take as long as in Fields, we could be waiting until October 2016 for a decision. Furthermore, Hall is dealing with the issue of increased contribution rates (the COLA issue in the Hall case is now moot with the passage of Proposition 124 in May 2016), an issue that is not as clearly protected by the Arizona Constitution, so if they take longer than in Fields and announce a decision sometime in 2017, I would not be surprised, especially in light of the aforementioned consequences to all parties.

I have added a link to the Arizona Supreme Court in the sidebar.  If you go to active civil cases, you will see Hall v. EORP at the very top of the list.  It shows the last update to the case was in April 2016 with nothing else since that date.  I have heard that PSPRS is preparing for a plaintiff victory, though I do not know if this is just wise preparation or if they have some other insight into what will happen.  Ideally, a plaintiff victory will come soon enough before the end of 2016 that refunds would come in the 2016 calendar year.  I say "ideally" because my guess would be that the large refunds of excess contributions will likely be subject to  an IRS withholding rate of 25%.  (I do not know how the state of Arizona will treat the refund; hopefully more leniently since it was the state's doing in the first place.)  These refunded contributions are wages and subject to state and federal income tax, and the lump sum nature of the payment is similar to a bonus.  A payment in 2016 will allow members to get back any overpayment in taxes, if they have a lower taxable rate than 25%, early in 2017 via their 2016 tax refund.  A payment in early 2017 would mean members would not see a refund of any tax overpayment until a year later after they file their 2017 taxes.  It is way too early to speculate about the refund, but I would guess that it would come back through the employer if the PSPRS member is still employed by a public safety agency.  Also, the refund could also be broken up into smaller chunks or paid out over two or more years to lower the immediate tax burden.  Once again, we are probably getting a little ahead of ourselves here.

A decision could come tomorrow or six months from now.  I wish I had more information, but we will all just have to wait.

16 comments:

  1. Why a 25% tax rate? This is not a bonus, it is money we earned that was forcibly taken from us.

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    1. I will have to correct the post. I should have wrote made it clearer that it is a 25% withholding. The final tax you pay would be based on your individual tax rate. I am not a tax expert, but bonuses are usually withheld at 25%. While this refund would be for excess contributions, it is refunded wages and subject to income tax just like any other wages. Since it will likely be significantly larger than a normal paycheck, I believe it will be treated as a bonus and subject to a 25% withholding. It will be interesting to see how they do the refund. I am guessing that it will come through your employer, if you are not retired, and taxed accordingly. Maybe they will allow an option to pay it out over two (or more)years to reduce the tax burden if the refund was large enough to change someone's tax bracket? I don't know. We will have to see.

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    2. or allow us to dump it all into a 457

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  2. Do you happen to know what will happen to our funding level if Hall is successful? I saw a presentation to one of the committees when they were working through the pension legislation that said the funding level would only drop one percent. I've since been unable to locate any info on that. Any idea?

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    1. I have not heard anything like what you have mentioned. The original dumb proposal by the PFFA wanted to maintain the 4% increase and use it for COLA's, but that was only a preliminary proposal that did not make into the law. As far as I know, the contribution rate would drop back to 7.65% for Tier 1 and Tier 2a members. The crux of the Hall and Parker cases is that it was unconstitutional to raise the contribution rate after an employee is hired. This seems to overly expand the meaning of the Pension Protection Clause of the Arizona Constitution by considering the contribution rate as a form of a pension benefit, but the stronger case is under the Yeazell precedent which states that you are vested under the pension rules that existed when you were hired. Under either justification, I don't see any way that the employee contribution rate does not decrease 4% back to 7.65%, if it is deemed unconstitutional by the judges, and any increases could only be accomplished through a constitutional amendment.

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  3. So it sounds as though they are anticipating a ruling for the plaintiffs. I have heard that there has been discussion within the PSPRS to allow the refund to stay in the system and credit you the time to whatever the amount equates to. Anyone hear of that and would that even be possible to do in the system itself?

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    1. I have not heard anything about this, though the new service purchase policy PSPRS is implementing will be essentially run as for-profit enterprise, so it would not surprise me if PSPRS did this. Discounting service purchases at a lower rate than they discount PSPRS' own liabilities would allow PSPRS to profit on the spread between the two rates. This certainly sounds like something PSPRS would do as it benefits them at the expense of the member.

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  4. I wasn't very clear in my original question. I believe at the time that the presentation to the senate (i think) committee was given, PSPRS was at 51% funded. The report was that a successful suit by Hall would drop the funded level to only 50%. I believe this was because when they calculate the funding level, the actuaries take into account future refunds that will be due to those who leave prior to a 20 year retirement. Since the refunds will be smaller due to the smaller amount the employees have contributed, the funding level will remain relatively static. I'd be lying if I said I fully understood what I just wrote, but was hoping you'd be able to shed some light on it. Thank you for your insightful updates, I appreciate you keeping us all up to date.

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    1. I apologize. Your question was clearly about the funded ratio, not contribution rates. I did a quick check back on documents I had from PSPRS, and I could not find written materials related to the effect Hall would have on the funded ratio, though I went to a presentation in 2015 where they said that a plaintiff victory would drop the aggregate funded ratio 4% and raise the aggregate employer contribution rate 6%. Things should have changed favorably for PSPRS since the COLA issue with Hall is no longer relevant due to Proposition 124.

      I cannot tell you how favorably this affects PSPRS, and I am not sure how the refunds of those who leave early would affect the funded ratio. It would seem to me that leaving early would be a wash as you eliminate both the asset and the liability at the same time with no net overall effect, but like you, actuarial information is foreign to me.

      It is important to remember that the increased contribution amount, currently 4%, was additional money added to PSPRS. It was not used to lower the employer contribution amount. The normal costs were calculated and the employer paid the normal cost minus the 7.65% employee share. The additional amount was extra and used to help PSPRS. If the plaintiffs win, all this extra money will be refunded and be able to compound over and no more extra money will be coming in. My gut feeling is that the effect on the funded ratio will be more than 1%, but that is just a gut feeling.

      I apologize. Your question was clearly about the funded ratio, not contribution rates. I did a quick check back on documents I had from PSPRS, and I could not find written materials related to the effect Hall would have on the funded ratio, though I went to a presentation in 2015 where they said that a plaintiff victory would drop the aggregate funded ratio 4% and raise the aggregate employer contribution rate 6%. Things should have changed favorably for PSPRS since the COLA issue is no longer relevant due to the passage of Proposition 124.

      I cannot tell you how favorably it affects PSPRS, and I am not sure how the refunds of those who leave early would affect the funded ratio. It would seem to me that leaving early would be a wash as you eliminate both the asset and the liability at the same time with no net overall effect, but like you, actuarial information is foreign to me. The refunds of excess contributions will not change PSPRS' liabilities, only reduce its assets.

      It is important to remember that the increased contribution amount, currently 4%, was additional money added to PSPRS. It was not used to lower the employer contribution amount. The normal costs were calculated and the employer paid the normal cost minus the 7.65% employee share. The additional amount was extra and used to help PSPRS. If the plaintiffs win, all this extra money will be refunded and not be able to compound over time and no more extra money will be coming in. My gut feeling is that the effect on the funded ratio will be more than 1%, but that is just a gut feeling.

      Again, sorry for not answering the question you asked the first time.

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  5. I retired at the end of 2008 after 17 years. Will any of the courts decisions affect me?

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    1. No, SB 1609 did not go into effect until 2011. The completed Fields case would have affected you, but that decision has been made moot by Proposition 124.

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  6. You would have thought something would have come out by now on this. Seemso strange.

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  7. Here is what PSPRS put out recently in their 1st quarter newsletter:

    After hearing arguments in Hall v. EORP in February, the Arizona Supreme Court has yet to release its opinion on whether employee contribution rate increases and limits on pension increases passed into law in 2011 will remain in effect. The lawsuit against Senate Bill 1609, which was implemented to improve the financial health and sustainability of PSPRS-managed plans, was filed by two judges, Phillip Hall and Jon Thompson, who contended the bill violated state and federal constitutional clauses.

    At issue is whether the increases to EORP (Elected Officials' Retirement Plan) employee contribution rates are legal because the rate isn't defined as a "benefit" under the state constitutional pension clause. Also at question is whether existing law defining that a member's "right to benefits" vests, or becomes active, upon retirement applies to Tier 1 members who retired on or after Aug. 1, 2011, or remain active.

    In ruling on Hall, the court could uphold or strike the contribution increases and PBI adjustments or apply impacts of its own. It is not known by PSPRS when a ruling can be expected. Typically, the court gives litigants 24 hour notice before an opinion is released.

    A handful of members of PSPRS-managed plans have reached out to PSPRS with questions about the scope and timing of the pending opinion. Others have inquired about how previous contributions would be refunded in the event of a victory by the Hall plaintiffs and how refunds would impact the overall funding level of PSPRS, which is currently about 50 percent.

    Unfortunately, we are still in the dark until those judges make up their minds. The wheels of justice really do turn slow, don't they.

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    1. Is there any guidelines they have to follow for releasing the decision or could they wait till the summer of 2017 ?

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    2. I looked at both the Arizona Constitution and state Supreme Court's own rules. I can find nothing in either that enforces a time limit on decisions, nor does there seem to be a set annual term like the US Supreme Court has. From what I read (and as always, I am not an attorney nor any type of expert on this) they can take as long as they need to reach a decision.

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