On December 23rd, Pennsylvania Governor Tom Corbett signed legislation reigning in the costly practice of pension spiking, potentially saving taxpayers $1.1 billion, or $22 million annually, over the next fifty years. Pension spiking, also known as pension padding, is the practice of inflating one's pension benefits by manipulating the factors used in pension calculations. Typically, it results in more pension benefits than the contributions made over an employee's career are designed to cover, thereby contributing to the pension plan's system-wide unfunded liability.
In Allegheny County, the source of the spiking problem has been overtime spiking, that is, employees working exceptional periods of overtime in their final years of employment in order to maximize pensionable compension. Local media recently reported one example of pension spiking: "an employee working at the jail making $56,000 jacks up his overtime the last two years he’s there to nearly $140,000 salary. That employee retires with a nearly $92,000 a year pension, costing you the taxpayer more than $1.6 million dollars."
That is, $1.6 million in additional costs that would not have been the case had the employee not engaged in overtime spiking, or was subject to caps on the amount of overtime included in pension calculations.
In order to prevent further instances like this, Pennsylvania has reformed how it conducts pension calculations for employees hired on and after January 1, 2014. On the one hand, this means that pension spiking is likely to be limited (at least $1.1 billion worth), but it also means that pension spiking will continue to occur for employees hired before January 1, 2014.
Under the old system, monthly pension benefits were based on the average of the highest-earning 24-month period in an employee's final four years of employment. Under the recently enacted reforms, monthly pension benefits will be based on the average of the highest-earning 48-month period in an employee's final eight years of employment. This is likely to prevent cases of employees working an excessive amount of overtime in the final two years before retirement.
Pennsylvania's method of broadening the time periods considered for pension benefits is one of many potential strategies to combat pension spiking. Texas, for example, uses the average salary of an employee's final five years of employment for consideration in pension calculations, thereby mitigating the influence of late-career salary spikes. Other states, such as Nevada and New York place a 10% cap on year-to-year salary increases eligible for consideration in pension calculations. This strategy is designed to limit the cost of sudden increases in salary earning that may significantly stray from the salary assumptions used to calculate pension contributions over an employee's career.
Fortunately for taxpayers, future employees will not able to engage in overtime spiking to the extent it is currently permitted. Unfortunately, taxpayers will likely continue to be on the hook for unreasonable pension benefits attained in part by gaming the system.