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Police pension switch to cost $19,000 per year, if all goes well

(April 26, 2013) After a number of conflicting accounts last week as to whom – and to what extent – the city had disclosed its financial data regarding the recent police pension switch, a report submitted to this publication indicates that the city will be paying, on average, an extra $19,297 per year to support the plan change for the 22 officers in question.

In two weeks, the City Council will be taking a final vote on an ordinance to move those 22 Ocean City Police Department officers – the entirety of the workforce hired in the last two years – from the defined-contribution retirement plan back into the defined-benefit pension system.

The change comes as an agreement in the Fraternal Order of Police’s negotiated contract, which specifies that officers hired since the inception of the 401(a) retirement account system two years ago will have their monies rolled over into the group pension trust, which the 401(a) plan was originally designed to phase out.

Following a series of heated debates by the City Council from late 2010 through the spring of 2011, the pension fund was closed to new hires. While employees currently enrolled in the defined-benefit system will stay in the plan, all new hires after April of 2011 currently have a system of individualized 401(a) accounts.

Under a defined benefit system – the traditional pension – employees contribute a certain amount of their paycheck each week to a group retirement investment fund. Police and fire employees, who have a separate fund from the general employee body, contribute eight percent of their pay, and the city matches this amount with its own contribution.

Upon retirement, public safety employees continue to receive 60 percent of their salary once they have reached a threshold of 25 years of service. The 22 officers slated to return to the plan, however, will have the additional requirement of being 55 years of age, as well as having 25 years of service.

The city’s 401(a) system – identical to a 401(k), but is for municipal employees under IRS code – involves employees contributing between 5 and 7 percent of their pay, matched by the city, to a personal account that becomes their own Individualized Retirement Account (IRA) at any time they may wish to leave the city’s employ.

The key difference between the two setups, besides the retention incentive, is that the city assumes any financial risk in the defined-benefit system.

Under that plan, the city is required to annually contribute the amount of post-retirement benefit liability an employee incurs in any given year, known as the “normal cost.” For public safety workers, this is roughly 1/25th of the total expected value of their pension benefit, although the value will increase as they advance in pay and in the vesting schedule.

“The town’s liability increases after you hit year 15 [of employment], because then you’re fully vested,” said city Finance Administrator Martha Bennett. “You only own one-third of the benefit after year five, and two-thirds after year ten.”

However, the city must also contribute money each year to make up for additional liability incurred by any inconsistencies in the fund’s performance. This may change abruptly, as the city has to assume the risk not only for investment losses – or gains, in good economic times – but also the possibility that the trust may be underfunded due to employees’ early departure or termination.

If the 22 employees being added into the plan conform exactly to predictions as far as their work and lifespan, they will not affect this liability, according to the most recent report by Cavanaugh MacDonald, the city’s financial advising firm.

Although the 8 percent city contribution under the DB plan is designed, in theory, to cover the entirely of the annual normal cost, Cavanaugh MacDonald found that the city’s average normal contribution is 10.61 percent of its payroll.

With the age 55 requirement for new plan members, as well as their benefit being based on an average of their last five years of salary, as opposed to three, this contribution is expected to be reduced to 7.5 percent.

But it is still higher than the average contribution that the town was making for the 22 officers under the 401(a) system, at 5.7 percent, given that the DC plan had no liability other than the city’s match of employee contribution

However, the city will likely not have to contribute anything this year, or for the next three years, as value of the officers’ 401(a) plans currently exceed the normal cost of the first five years, before vesting is reached.

“What the city put in for the DC plan exceeded the liability or the DB plan, at least for the first three years,” Bennett said.

Over time, however, the wage difference between the 5.7 and 7.5 percent normal costs for the defined contribution and defined benefit plan, respectively, will average out to $19,297 per year.

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