This week the South Carolina Senate Finance Committee’s Standing Subcommittee on State Retirement Systems heard legislation introduced by Senator Sean Bennett to modernize the retirement options offered to newly hired state employees and tackle a backlog of unfunded liabilities at the same time.
If enacted Senate Bill 176 will close the current South Carolina Retirement System (SCRS) defined benefit plan to new entrants after June 30, 2021, and provide new hires a choice between a new “Shared-Risk Defined Benefit” pension plan and an improved version of South Carolina’s Optional Retirement Plan (ORP). The ORP, the defined contribution plan currently offered in the state, would be redesigned and renamed the “Wealth Builder – Primary Retirement Savings Plan” (WPRS) and would be the default retirement plan if an employee does not choose to opt-out of the plan within 60 days.
Since WPRS would become the new default retirement plan, it is important to assess its adequacy and ability to meet the needs of retirees and employers. Upon review, the Pension Integrity Project finds that the proposal reflects a high-quality retirement plan design that incorporates best practices from national experience.
While decades of experience with public sector defined contribution (DC) plans have demonstrated that they can be an effective means to providing adequate retirement income for public workers, not all DC plans meet the definition of an effective retirement plan. There are a number of straightforward plan design principles that when carefully incorporated into DC plans serve to create a sound retirement plan that meets the needs of employees and employers.
The proposed WPRS retirement plan conforms to most of the best practices of public sector defined contribution plans, and other elements could be addressed to ensure the plan is as effective as possible.
Senate Bill 176 importantly avoids a shortcoming of many retirement plans by providing a formal statement of legislative intent and plan objective for the WPRS that is consistent with retirement best practices:
“The intent of the General Assembly is for the State of South Carolina WealthBuilder-Primary Retirement Savings Plan (WPRS) to be the primary retirement plan for participants of the state’s retirement system. The objective of the WPRS is to provide participants with a path towards having a secure retirement through a focus on lifetime retirement income in order to maintain a participant’s standard of living, following a full career of employment.”
This formal declaration of plan intent and objective is a critical guideline for the administrative and investment fiduciary for the WPRS and provides clear direction to the Public Employees Benefits Association (PEBA) as the plan administrator for the WPRS and the South Carolina Retirement System Investment Commission (RSIC) under PEBA, which is responsible for the investment structure.
The WPRS also satisfies the critical best practice of automatically enrolling eligible employees into the plan as well as providing adequate contributions. Retirement experts agree that a total contribution rate of between 10 percent and 15 percent is necessary over a career to adequately fund retirement (when combined with Social Security and personal savings). The WPRS contribution design of 16 percent (9 percent employee; 7 percent employer) for most employees would meet these best practice contribution standards.
The bill also allows an auto-escalation feature that would increase employee contributions by up to 1 percent per year up to a maximum employee contribution of 15 percent. The employer will also make matching contributions up to 2 percent for employee contributions made above 5 percent. If an employee maintains their default contribution, this would automatically trigger the full 7 percent employer contribution. However, employees are allowed elect a minimum employee contribution of 5 percent, and if they chose to do so, the resulting 10 percent aggregate contribution rate that would still fall within the lower bound of benefit adequacy. That said, a higher floor for employee contributions, such as 7 percent, might be warranted to secure the ability to fund lifetime financial security in combination with Social Security and reasonable personal savings.
The investment structure for the WPRS has not yet been established. However, SB 176 does provide substantial guidelines by authorizing the use of a wide variety of investments under the plan including annuities, mutual funds and other similar investment products and professionally managed portfolio options. If these guidelines are followed there is a strong likelihood the retirement plan will provide a variety of investment options and allow participants the ability to create a portfolio that best meets their retirement needs.
One potential area of divergence from best practice is the multiple vendor configuration of the state’s current ORP, which would be retained under the WPRS. Vendors are the wealth management and financial firms that states contract to administer and manage defined contribution assets and benefits. The large number of plan provider options currently offered in the ORP may be confusing for employees, and the current level of complexity is not necessary nor considered a best practice. If the multiple vendor configuration is continued for the WPRS it is important to consider additional educational steps to ensure employees know what retirement income services each vendor provides. For example, not all the vendors currently offer lifetime annuity solutions.
Under the proposed legislation, accumulations attributable to employer contributions into the WPRS are vested in the employee 20% per year with full vesting after 5 years of service. This is a substantial change from the current 100% immediate vesting of the ORP. While 5-year graded vesting is longer than desired, it is still shorter and provides better portability than the DB plan’s 8-year cliff vesting. Nonetheless, full and immediate vesting is best practice and would be preferred.
The distribution methods offered under the WPRS will depend on the vendor but will generally include annuities, full or partial lump-sum withdrawals and periodic payments. SB 176 also requires at least one vendor provide lifetime fixed and variable annuity products but does not include a provision allowing PEBA or an employer to require annuitization of some or all assets. This creates more flexible retirement income choices for employees, which is valuable, this approach also increases the chance that some employees may outlive their retirement assets from the plan. PEBA and RSIC can address this shortcoming by emphasizing the income-focused and annuity options being provided and considering lifetime income investment options as the default.
Disability coverage in the WPRS is the same as in the DB pension plan. This is an improvement over the current ORP structure, which provides no disability benefit for ORP members. Employers are required to make separate contributions to help fund the benefit. While the consistency between plans is good, the DB disability benefit is not available until an employee has eight years of creditable service, which seems excessive and not in line with best-practice standards.
Overall, the new default WPRS has an excellent foundation upon which to build a sound and effective modern retirement plan for public employees in South Carolina.
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