The problem
Illinois has the worst-funded pension systems in the nation. The structure of Illinois’ current defined benefit system coupled with the political unwillingness to reform has left the state’s pension systems in danger of running completely dry. Even the head of the Illinois Teachers’ Retirement System, or TRS, Dick Ingram, said the fund may run dry by 2029.

Unfortunately for students and schools in Illinois, the state’s pension crisis is crowding out money for the classroom. Gov. Pat Quinn’s proposed 2014 budget cuts $400 million from the classroom to make room for a $900 million increase in pension costs.

A significant driver of Illinois’ $97 billion pension crisis is the fact that the state makes pension contributions to TRS on behalf of school districts, even though teachers aren’t employees of the state.

Under the current system, local school districts set salaries for teachers. These salaries determine a teacher’s eventual pension benefit. In order to fund these pensions, the employee (the teacher) and the employer (the school district) contribute specific amounts to the teacher retirement funds each year. But presently, the school district – the employer of these teachers – does not pay the full employer contribution to TRS. Instead, the state pays on behalf of these districts.

The state pays more than $632 million a year in retirement costs for local suburban and downstate school districts. By paying the employer contribution of teachers’ pensions on behalf of school districts, the state is essentially paying for spending decisions over which it has little control. This means that one unit of government hands out benefits while another pays for them, leading to abuse and the destruction of spending accountability.

The current arrangement allows school districts to offer teachers overly generous benefits, including end-of-career salary spikes, sick day accumulations and other pension sweeteners, with little incentive to curb retirement costs because the state picks up the pension payments. In fact, this arrangement provides an incentive for school districts to continually increase teacher benefits. As more school districts balloon benefit packages to attract talent, other districts compete by doing the same – which ultimately perpetuates the cycle of unaffordable and unsustainable retirement benefits.

Currently, the wealthiest school districts benefit the most from the state’s role in funding pensions because they offer the highest compensation packages. That means that all taxpayers, including those from downstate, are on the hook for North Shore pension benefits.

A look at state pension contributions per pupil shows the dramatic disparities between districts. For example, the state contributes $1,100 per pupil to cover the annual cost of teacher pensions in Rondout District 72 in Lake County. Meanwhile, the state only contributes $249 per pupil to cover the annual cost of teacher pensions in Dalzell District 98 in Bureau County.

Sending scarce state tax dollars to the wealthiest districts is regressive and directly contradicts the state’s goal of sending education money to districts based on need.

Many school districts have claimed that the cost of making the employer contribution would be difficult to bear and could, for example, result in property tax increases. This is simply untrue. The average cost increase is modest and can be reconciled with additional spending reforms.

Our solution
The Illinois Policy Institute’s comprehensive pension solution freezes the current defined benefit plan and protects already earned benefits for current workers and retirees.

Going forward the Institute’s plan moves government workers to a 401(k)-style retirement system. Rather than the state making contributions to TRS, the Institute’s plan requires school districts to pay the employer share of their employees’ retirement savings plans. This reform is necessary in order to increase accountability and prevent the current pension system from crowding out state dollars meant for the classroom.

The Institute’s plan is based on the self-managed 401(a) plan currently operating in the State Universities’ Retirement System, or SURS. The SURS self-managed plan had more than 17,500 participants in 2012.

Under the Institute’s plan, a teacher pays 8 percent of her salary into her own 401(k)-style plan, and the school district contributes 7 percent of that teacher’s salary to her retirement plan.

The 7 percent match under the defined contribution system is a contractual agreement between the school and the teacher. The school district’s match would be visible in every paycheck and the contribution would be automatic.

And the cost to school districts is a simple calculation – 7 percent of the district’s TRS payroll. This gives school districts more stability and predictability in budgeting teacher retirement costs. The 7 percent employer contribution will cost school districts, on average, an amount equal to 2.9 percent of their total education expenditures. The costs are, therefore, not of the magnitude that opponents to this reform have portrayed. The appendix of this report includes the specific cost increase for each downstate and suburban school district.

In exchange for paying the retirement costs of their employees, school districts should be given more freedom and flexibility.

They should be given the ability to manage the increased costs by renegotiating the prevailing wage requirement, project labor agreements and other unfunded mandates. School districts
can also manage costs by opening up teacher contracts, negotiating benefits and ending the practice of picking up the pension contributions for their employees.

Local school districts should also have the freedom to exit the state’s retirement systems in the future. School districts should be free to stay in the new defined contribution plan going forward or design their own retirement plans from the ground up.

Why it works
Requiring school districts to pay the employer share of their employees’ 401(k)-style retirement savings plans creates an incentive to be more prudent with the compensation packages they award, thereby increasing the overall security of the retirement system. This plan also ends state subsidies to wealthy school districts and enhances spending accountability, because costs are paid where they are incurred.

Requiring school districts to be directly accountable for their employees reduces the state’s cost by more than $632 million. The state could save an additional $440 million by implementing similar reforms for public universities.10 Combined, these reforms would ultimately reduce the overall cost of state government by approximately $1 billion.

Accountability for retirement costs, coupled with the rest of the Illinois Policy Institute’s pension reform plan, ultimately restores fiscal order to the state by eliminating unsustainable pensions and unfunded liabilities. This paves the way for the economy to flourish, fostering an environment where businesses can thrive and create the jobs Illinoisans need.

Appendix
This appendix includes data for 862 school districts in Illinois.11 The data are for fiscal year 2010 and the list is organized by county.

The following definitions describe each variable:

• Total district expenditures: This column of information includes the total expenditures for each school district. Total expenditures include instruction, general administration, support services and other expenditures.

• Teachers’ creditable earnings: The Illinois Teachers’ Retirement System, or TRS, defines creditable earnings as, “In general, ‘creditable earnings’ are forms of compensation that are recognized by TRS as salary for reporting and retirement purposes. TRS accepts many, but not all, types of compensation … Creditable earnings are the basis upon which member contributions, employer contributions, and benefits are calculated.”

• Cost of 7 percent employer contribution: Under the Illinois Policy Institute’s plan, a teacher pays 8 percent of her earnings into her own 401(k)-style plan and the school district contributes 7 percent of that teacher’s earnings to her retirement plan. The 7 percent contribution equals 7 percent of teachers’ creditable earnings for each district.

• Contribution as a percent of total expenditures: This is a simple calculation: Contribution as a percent of total expenditures = 7 percent contribution / total district expenditures.