Benefits

The contral organizing element of the public pension community is the defined benefit plan, also known as a pension. A DB plan provides a retirement benefit based on a formula that includes the employee's length of service, salary, and a retirement factor or multiplier. In most cases, the value of a pension benefit is not affected by the return on investments of the assets that are invested to fund the benefit, although some public retirement systems provide cost-of-living adjustments based wholly or partly on investment performance.

In addition to pension benefits, most public retirement systems also administer death and disability benefits; some system also administer retiree health care benefits or supplemental defined contribution plans.

Some retirement systems administer Hybrid Plans, which contain features of both defined benefit and defined contribution retirement plans.

Public Pension Plan Design

The design of a public pension plan pertains to the overall benefits structure of the pension plan. Approximately 90 percent of full-time employees of state and local government participate in a defined benefit plan, or traditional pension. The main distinguishing elements of public pension plan design includes:

• Mandatory participation by employees
• Cost-sharing betweeen employees and employers
• A retirement benefit that reflects the participant's years of service and salary
• Assets that are pooled and professionally invested
• Mandatory annuitization

Distribution of Defined Benefit, Defined Contribution and Other Retirement Plans by State

(includes the District of Columbia and Puerto Rico)

Plan Characteristics	State Employees' Plan	State Teachers' Plan
DB plan only	36	43
DC plan only	4	2
Hybrid plan only	4	5
DB plan plus optional DC plan	6	1
DB plan plus optional hybrid	1	0
DC plan plus optional hybrid	1	1
DB plan plus optional DC and hybrid	1	1

Source: NCSL [1]

How Pension Benefits are Calculated

Most public pension plans base pension benefits on a formula that includes the participant's final average salary, years of service credit, and a retirement multiplier. For example, an employee retiring with a final average salary of $60,000 with 20 years of service, participating in a plan with a retirement multiplier of 2.0 (two percent) would be eligible for an annual pension benefit of $24,000: $60,000 x 20 x .02 = $24,000.

Retirement Multiplier

The retirement multiplier is a factor which determines the amount of a retired employee's annuity. The multiplier is usually determined as a percentage of final average salary (FAS) times years of service.

Service Credit

Service credit refers to the period of employment that are either earned, claimed, or purchased by an employee. Service credit is used both to determine an employee's eligibility for retirement and to determine the amount of his or her annual benefit as calculated in the retirement formula.

Some plans allow members to purchase service credit, usually with a corresponding rate of interest.

Final Average Salary

Final average salary (FAS) refers to the method used by defined benefit pension plans to determine an employee’s salary for purposes of calculating a retirement benefit. FAS is sometimes referred to as final average compensation (FAC).

Plans vary in terms of what compensation is allowed to be included in the FAS. The period over which the FAS is determined also varies, although most public retirement plans use three- or five-year periods.

Some plans permit overtime pay; other plans specifically prohibit overtime from being included in the FAS. Likewise, plans vary in whether or not longevity pay, uniform allowance, unused sick and vacation pay, may vary.

Most plans calculate FAS on the basis of either a three- or five-year period, although a small number of public plans determine FAS based on the employee’s final year of pay. Some plans have specific rules to prevent the artificial inflation of an employee's final average salary for the purpose of calculating their pension. This practice is known as pension spiking.

It is not unusual for a plan to determine FAS using months (e.g., 36 or 60) rather than years. Also, some plans specify use of the employee’s highest earning years or months. Although salaries tend to rise and the final years and months usually are the highest, this is not always the case.

Generally (but not always), the shorter the FAS period, the higher the pension benefit will be, and the longer the period, the lower the benefit. As the Wisconsin study notes, and as evidenced in legislative pension enactments compiled by NCSL, the movement in recent years has been toward longer FAS periods.

Benefit Protections

Pension benefits for employees of state and local government generally are protected by either constitutional or statutory provisions or case law. Levels and types of protections vary by state and are considered by some to be unclear or uncertain in some cases. The Legal page discusses these protections in greater detail.

Exceptions to the Prevailing Public Pension Plan Design Model

Defined benefit plans are the predominant retirement benefit among employees of state and local government. Exceptions exist, including two states--Alaska and Michigan--where broad groups of workers have access only to a defined contribution plan; and states that provide a hybrid or defined contribution plan on an optional basis. A NASRA primer, [2] Hybrd and Defined Contribution Plans as the Primary or Optional Retirement Benefit] discusses exceptions to the DB-only model.

Cost of Living Adjustment

A cost-of-living adjustment, or COLA, is a benefit provision intended to offset the effects of inflation on annuitants. According to the Public Fund Survey, approximately three-fourths of pension plans sponsored by states and local governments provide some form of an automatic COLA, i.e., one that does not require specific approval of or action by the plan sponsor (the legislature or city council). The Cost of Living Adjustment page provides details and additional information.

Forfeiture of Retirement Benefits

Forfeiture refers to the relinquishing of benefits by an employee found to have engaged in criminal activity or other acts of malfeasance or misfeasance as identified by the state and plan governing body. Many states have policies governing termination or garnishment of public pensions.

Benefits for University Faculty and Staff

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Final Average Salary
Hybrid Plans
Retiree Health Care
Social Security

See Also

Glossary of Actuarial Terms and Concepts, National Education Association

State-by-state legal protections of public pension benefits
Public Pension Plan Reform: The Legal Framework
Comparison of 457(b) Plans, 401(k) Plans, 403(b) Plans, and Deemed IRAs (provides a synopsis of plans that can provide for voluntary pretax employee contributions)

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