Public Policy Statements - Public Employee Pension and Benefits Administration Policies
Public Policy Statements
Tax Regulations on Employer-Provided Vehicles
The Government Finance Officers Association (GFOA) believes that state and local governments should not be subject to the Internal Revenue Service regulations that require that the value of an employer-provided vehicle be included in the compensation of their employees. These regulations create onerous and costly administrative recordkeeping requirements, as well as mandate increased employment taxes and pension and benefit costs for state and local governments without regard to the unique nature of governmental responsibilities. The regulations ignore the following:
- In many jurisdictions it is necessary for government officials, safety officers, and public service employees to be on-call twenty-four hours a day. A take-home vehicle allows these individuals to respond immediately to emergency situations. Additionally, police officers are required or encouraged to use marked vehicles on off-duty hours as a crime prevention technique.
- Most state and local government salaries are set by statute or union-negotiated contract. Charging an employee with the personal use of an employer-provided automobile has the effect of raising compensation without considering legal restrictions or contractual agreements.
- A major difference in employment taxes between the private and public sectors is that these taxes are a deductible expense for businesses, but not for state or local government. Therefore, the 85 percent of state and local government that participate in social security must pay the total cost of the increase in employment taxes unlike the private sector that can reduce their liability through tax deductions. Moreover, pension, life insurance premiums and other employment benefits that are calculated as a percentage of salary will be increased.
- Many jurisdictions require employees to commute in government vehicles for the convenience of the employer and limit the use of such vehicles to official purposes. This arrangement eliminates the cost of providing a secured parking area and allows for efficient dispatch of field representatives to site locations.
- State and local government decisions on the purchase and use of employer-provided automobiles are not "tax-motivated" as they are in the private sector. Therefore, there is no opportunity for abuse and no need for corrective action.
The GFOA, therefore, concludes that state and local governments must be exempted from these overly restrictive regulations.
Adopted: May 28, 1985
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Maintaining Incentives for Retirement Savings
The Government Finance Officers Association (GFOA) supports the federal government's efforts to encourage private citizens to plan and save for retirement. State and local governments have also been responsible partners in providing for adequate retirement income for their employees. Presently, the vast majority of state and local workers participate in public employee retirement systems that provide sound, secure benefits in post-work years. As the Congress deliberates the issues of tax reform and deficit reduction, the social goal of maintaining a stable national policy regarding the tax treatment of employee pension benefits should be an overriding consideration.
Retain the Three-Year Recovery Rule
The proposed taxation of contributory pensions is in conflict with a strong national pension policy. Currently, local, state, and federal government employees are not taxed on their annuities until the retiree recovers his or her contributions made to the plan, if that recovery is no longer than three years.
Most public plan employees, unlike their private-sector counterparts, make pension contributions with after-tax dollars. Historically, the Congress has deemed it fair to allow individuals who had paid taxes "up front" on their pension plan contributions to recover them tax free within three years of retirement. On average, this recovery is accomplished within 18 months. The pension begins to be included in taxable income once it exceeds the individual's own contributions.
Since an employee's income is at its highest level when taxes are paid on these contributions, the ability to recover this cost immediately at the time of retirement on a dollar-for-dollar basis is a matter of basic equity.
Employees approaching retirement have utilized the three-year rule as a major element of their pre-retirement financial planning. Deferred compensation programs have been established in most states to encourage employees to accumulate personal savings for retirement. Since withdrawals from these programs are automatically taxed as ordinary income, elimination of the three-year rule will, in the future, create a major disincentive for employees to utilize these programs. Total repeal of the three-year rule at one point in time is particularly inequitable to employees who have participated in these programs and are within a few years of retirement.
Recognizing the devastating financial impact of this change on senior employees, it must be assumed that many individuals now eligible will elect to retire who would have otherwise remained in active service. This will create additional pension payments as well as productivity losses and training expenses at the very time when local, state, and federal governments can least afford them.
Preserve Current Distribution Rule
Additionally, the requirement that retirement benefits begin at age 70 1/2 presents a special problem for PERS. Unlike many private-sector plans, public plans allow additional benefit accruals beyond age 70. Implementation of this provision would result in a situation where an employee is being paid a retirement benefit and a full salary and at the same time earning additional retirement credits. This would obviously result in additional costs to state and local governments and would discourage the employment of older workers.
Retain 401(k)s for Public Employees
Another incentive to save for retirement should remain available to state and local government. The 401(k) is a valuable tool for encouraging retirement savings and for recruiting quality employees. The exclusion of public employers from maintaining 401(k) plans is unnecessary since the pending tax reform proposal would reduce deferrals by any amount contributed to an eligible deferred compensation plan commonly known as 457s. Therefore, the federal tax revenue foregone is kept at a fixed level, making no difference which deferred compensation plan is adopted.
For the reasons stated above, the GFOA opposes these changes contained in the pending tax reform bill that would adversely affect the distribution, taxation, and availability of retirement benefits for public employees.
Adopted: June 3, 1986
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Taxation of Deferred Compensation
The Government Finance Officers Association (GFOA) opposes the taxation of deferred benefits at the time accrued rather than when the benefit is taken. The Department of the Treasury's interpretation of Section 457 of the Internal Revenue Code set out in Internal Revenue Notice 87-13 would require employers to tax at the time of accrual vacation, sick, severance, compensatory leave, death and disability benefits and other similar benefits. Previously these benefits were taxed when their economic value was received. Moving taxation to the time of accrual will result in several undesirable effects on state and local government workers and employers.
- It will require workers to pay taxes on a current basis on benefits they have not and may never receive.
- It will encourage workers to use leave time inefficiently as they will be taxed on benefits whether or not they are used. This is the opposite result that employers have been trying to achieve through wellness programs.
- It will saddle state and local governments with costly and complex recordkeeping to track, compute and report the value of these benefits and to avoid double taxation of benefits.
IRS Notice 87-l3 overreaches and interferes with state and local governments' authority to set benefit levels for employees. The U.S. Department of Treasury is concerned that deferred compensation benefits will be offered by state and local governments in lieu of salaries thereby avoiding current taxation of earnings and reducing federal tax revenues. This is an inappropriate conclusion because state and local governments set maximum accrual limitations for employees under the scrutiny of the public and therefore are constrained from offering excessive benefits.
The GFOA supports legislation to clarify that bona fide deferred compensation be taxed on a cash rather than an accrual basis and not be subject to Section 457 provided that the benefits are established pursuant to state or local law, rule, regulation, procedure, or benefits provided under a collective bargaining agreement.
Adopted: May 3, 1988
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Age-Based Distinctions in Benefit Plans
Legislation is pending before the U.S. Congress that would overturn the U.S. Supreme Court's decision in Public Employees Retirement System of Ohio v. Betts.
In Betts the Court held that fringe benefits, such as pension plans, severance pay, and health and life insurance, are not subject to the Age Discrimination in Employment Act of 1967 (ADEA) so long as they are not "a subterfuge" for discrimination in other non-benefit aspects of the employment relationship. The Court's 7-2 decision invalidated certain regulations of the Equal Employment Opportunity Commission (EEOC) requiring that age-based distinctions, set by the employer, must be justified on the basis of costs.
In an attempt to overturn the Court's opinion, legislation has been introduced in Congress to codify the substance of the EEOC regulations. These proposals would amend ADEA to state that all employee benefits would fall under the Act and that the employer would have to prove that any age-based distinctions were cost-justified.
Age is an element used in calculating the appropriate amount of employee contributions or employer contributions necessary to provide adequate benefit levels. The Government Finance Officers Association calls upon Congress to delay action until there is thorough study of the issues related to:
- permitting legitimate age-based benefit distinctions,
- establishing a reasonable period of time to make necessary revisions to existing plans, and
- implementing required changes to benefit programs.
Adopted: May 1, 1990
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Federal Tax Policy Relating to State and Local Government Retirement Plans
The Government Finance Officers Association is concerned over the effect federal tax policy and regulatory requirements are having on public employee retirement systems. Continual tax code revisions and the inclusion of public pension plans under rules intended for the private sector have caused great concern for state and local governments and their employees.
Two specific areas of the Internal Revenue Code (IRC) that place state and local governments in conflict with federal tax code requirements are the nondiscrimination rules of Section 401(a) and the maximum annual benefit and contribution limits found in Section 415. Failure to resolve these conflicts can mean the disqualification of plans, an extremely harsh penalty, resulting in the loss of tax-favored treatment for the employees' benefit accruals, contributions and the investment earnings of the trust.
Nondiscrimination Rules-IRC Section 401(a). The existing rules applicable to state and local governments are based on mathematical calculations that are designed to identify private sector benefit structures that disproportionally benefit high-income employees. When applied to public plans the type of benefit differentials that are identified are not between different categories of employees. State and local governments employ a wide variety of workers and sponsor multiple systems tailored to meet the needs of each group.
Maximum Annual Contribution and Benefit Limits (IRC Section 415). The Section 415 limits were enacted to cap the federal revenue loss associated with the employers' tax-deductible contributions to the employees' pension funds. Under these rules the allowable employee pension benefit can be dramatically lower than under the benefit formula of the state or local government pension plan. Basically, this is due to the restricted definition of compensation that is used in the federal tax code as opposed to what is included under state or local government statute. Furthermore, if state and local governments are forced to comply with the federal law, that is to reduce benefits, many will be in violation of their own laws that protect workers from reductions in benefits once they are in the employ of a jurisdiction.
Clearly state and local governments are caught in a dilemma. Failure to meet these federal laws that were designed to identify discriminatory practices in the private sector can result in the loss of tax-qualified status. If such an event was to take place, Congress' policy of encouraging retirement savings by workers and the providing of pension benefits by employers would be weakened.
A rational approach to applying the federal tax code to state and local government pension plans must be devised. GFOA recommends that all parties concerned--Congress, IRS, and the state and local government pension community--work cooperatively to make necessary revisions and modifications to and exemptions from the Internal Revenue Code.
Adopted: May 1, 1990
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Federal Taxation of State and Local Government Retirement Plan Investment Earnings
The Government Finance Officers Association (GFOA) opposes any form of taxation that would reduce the earnings of pension plans. The primary responsibility of a pension plan and its fiduciaries is to provide promised benefits to its members. Part of the funds used to pay for these benefits are derived from investment earnings. Taxation of investment gains or investment transactions would reduce the income of pension plans.
The overwhelming majority of public employers sponsor defined benefit plans, which promise a specified benefit at retirement, and many are legally prohibited from reducing pension benefits. Therefore, if investment earnings are diverted to pay taxes the plan sponsor will be required to increase contributions to meet benefit obligations.
State and local government pension plans support and practice long-term investment policies. They do so, however, with the knowledge that short-term investment strategies are appropriate under certain market conditions. Government investment practices and policies reflect the on-going nature of public entities. The overriding responsibility of meeting benefit obligations through the prudent practices of diversification of investments, and investing funds at a reasonable level of risk and rate of return can only be met through a long-term investment approach.
GFOA encourages federal policymakers to reject proposals to tax public pension plans for the purposes of raising federal revenues or encouraging certain investment behavior because this would:
- skew investment decisions by discouraging public investment officials from actively managing their portfolios in order to avoid taxation,
- reduce market liquidity, and
- reduce investment earnings of public employee retirement systems requiring state and local governments, their employees and taxpayers to make up any revenue shortfall.
Adopted: May 1, 1990
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Federal Regulation of Public Employee Retirement Systems
The Government Finance Officers Association (GFOA), has long encouraged and supported strong fiduciary, reporting and disclosure standards for public employee retirement systems (PERS). Recognizing the special information needs in this area of public finance and administration, the GFOA has developed a series of publications to provide guidance to public officials on best practice in the areas of operations, investment policy, accounting procedures, fiduciary standards, and reporting and disclosure of financial information.
Since passage of the Employee Retirement Income Security Act, in 1974, which regulates private sector pension plans, Congress has deliberated over federal involvement in the setting of conforming standards for state and local government retirement systems. In 1978, the Pension Task Force Report, issued by the House Committee on Education and Labor, recommended federal regulation of PERS. Legislative proposals have been introduced in each successive Congress to establish federal rules for state and local government retirement systems. However, during this period PERS have made great strides in funding future pension obligations, following prudent investment policies, disseminating information and implementing administrative and operational discipline. These advances have been made without the intervention of the federal government.
The GFOA believes that adoption and enforcement of standards for state and local governments to operate PERS for the exclusive benefit of plan participants is the responsibility of state and local government units. These public pension plans are backed by on-going governmental entities that have the sole responsibility for funding PERS and meeting benefit obligations.
Federal legislation that would mandate certain standardized reports, actuarial and accounting analysis, and disclosures to plan participants in addition to establishing fiduciary standards for plan trustees, managers, and other co-fiduciaries is redundant. State and local government statutes already require adequate controls.
GFOA restates its opposition to federal involvement in the area of state and local government employee retirement systems. Therefore, GFOA suggests that all levels of government consult on each of their concerns to best protect the rights of plan participants, beneficiaries, fiduciaries and general taxpayers.
Adopted: June 23, 1992
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Health Care Reform
State and local governments have a dual role in providing health care. As employers, they offer health care benefits to both current and retired employees. They also provide health care to the uninsured. Health care is now the largest growing portion of state budgets and local governments have cited rising employee health benefit costs as one of the main contributors to budgetary pressure. State and local governments shoulder a large share of the cost of health care provided to Medicaid recipients, the estimated 35 million uninsured and the growing number of under-insured people. This expanded role as health care provider of last resort coupled with increases in employee health care benefits of three to four times the rate of inflation are crowding out governmental spending on other compelling needs such as education, infrastructure and economic development.
A leadership role has been taken by states and localities in devising strategies to expand access to health care and contain the growth of health costs. These mechanisms involve the managing of care, reducing administrative costs of the health care systems, or both. However, the range of programs and reform options may differ depending on the target group or specific problem the state or locality is attempting to remedy.
As federal policy makers design and implement health care reform at the national level, careful consideration must be given to state and local government programs and initiatives. These programs must be integrated into a national reform strategy. Any national strategy for health care reform should expand access to quality health care such as primary and preventive care; include an equitable broad-based financing mechanism; control the growth in health care costs; and amend federal laws to promote state and local government innovations in the area of health care reform.
The Government Finance Officers Association urges direct involvement of all levels of government as partners in designing a workable national health care policy and the reestablishment of an intergovernmental approach to providing health care.
Adopted: May 4, 1993
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National Health Care Reform
Federal policy makers are to be commended for their efforts to control spiraling medical costs and barriers that block access to health care. Health care spending currently represents 14 percent of the gross national product (GNP) and if left unchecked is expected to consume over 19 percent of the GNP by the turn of the century. State and local governments have consistently cited the increased cost of providing health care coverage to the uninsured and their own employees as a fiscal factor which limits spending on other important public needs.
The Administration has proposed and the Congress is deliberating over the reform of the nation's health care delivery system that would provide guaranteed coverage and contain the growth in health care costs. To be viable for state and local governments any federal approach must:
- Eliminate Cost-Shifting. An estimated 39 million U.S. residents are reported to have no health care coverage during any year. The cost of uncompensated and under-compensated health care is shifted to covered individuals in the form of higher medical bills, which eventually translates into premium increases. This practice shifts the costs from employers who do not provide coverage to those who do. The high rate of full-time state and local government employee coverage (93 percent) makes this cost shifting especially onerous for public employers. Universal coverage would temper the effects of cost-shifting.
- Retain Financing Flexibility. Many governments self-insure a portion or all of their employees' health care coverage. The full range of health care financing mechanisms must remain available to public employers. Participation in purchasing cooperatives should be voluntary, and self-insurance should remain an alternative financing mechanism.
- Limit State and Local Government Financial Responsibilities. Reform approaches require that employers pay a fixed percentage of the cost of health care or make group health plans available to both full- and part-time employees. Any payroll percentage caps or other subsidies included in these proposals should apply equally to all employers and employees. Moreover, the considerable transition costs resulting from the phase-out of the existing health care system to the new federal plan must be recognized and federally funded. In addition, health care coverage for undocumented residents should not be left as an unfunded mandate for state or local governments.
- Provide Affordable Benefits to Employees. Public employees already are likely to share in the cost of their health care coverage and be participants in managed care arrangements. Existing benefit quality, options and levels for active employees must be retained. Consideration must also be given to present retirees that are ineligible for Medicare coverage. Federal co-payments for these individuals should be provided with parity to private sector workers.
- Integrate Existing State and Local Government Programs. State and local governments have taken a leadership role in developing and implementing many successful cost containment and coverage initiatives for both employees and the uninsured. These programs can provide valuable models for a federal initiative. Federal reform efforts must integrate these programs in a national health care program.
- Include Representation on Health Boards. State and local governments must, in proportion to their annual contributions, be represented on any federal or state health benefits oversight board.
The Government Finance Officers Association (GFOA) is committed to working with federal policy makers to develop a health care reform program that provides parity for public employers and employees with the private sector, expands access to quality health care, including primary and preventive care; contains an equitable broad-based financing mechanism; controls the growth in health care costs; and amends federal law to promote state and local government innovations.
Adopted: June 7, 1994
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Federal Workplace Initiatives Eroding State and Local Government Authority
(Replaces 1995 statement on "Fair Labor Standards Act: Implications for State and Local Governments")
The federal government -- both Congress and the Administration -- has, on occasion, proposed and/or adopted legislation or regulations that erode the independence of state and local governments. These actions undermine the governing authority granted to state and local governments by the Tenth Amendment to the U.S. Constitution by controlling the relationship between public sector governments (as employers) and their employees. Additionally, these actions affect the ability of state and local governments to manage their employees. Two examples of federal initiatives that directly impact the relationship between state and local government employers and their employees are the Fair Labor Standards Act (FLSA) and the Occupational Safety and Health Act (OSHA).
FLSA. State and local governments were originally assumed to be exempted from FLSA. However, a 1983 Supreme Court case, Garcia v. San Antonio Metropolitan Transit Authority, specifically addressed the application of FLSA to state and local governments and declared that the law did apply to governments. Congress passed amendments in 1985 which delayed application of the overtime provisions of the Act until April 15, 1986. Public sector executives and administrators, who are relatively highly paid individuals, were intended to be exempt from the time-and-a-half overtime pay requirements of FLSA. However, the salary basis and duties tests of FLSA conflict with public accountability statutes and administrative duties, causing many public sector executives and administrators to claim rights to overtime pay.
Since the initial application of FLSA regulations to the public sector, court cases have awarded these high-level employees large settlements or retroactive overtime pay and the number of lawsuits from these administrators is increasing. The existing liability for many states and localities is in the millions of dollars and the potential liability from additional court cases will strain governments' budgets, possibly threatening the financial viability of some jurisdictions.
In accordance with the Unfunded Mandates Reform Act of 1995, the U.S. Advisory Commission on Intergovernmental Relations (ACIR) has studied federal mandates and recommends repeal of the provisions of FLSA that extend coverage to state and local governments. ACIR has raised questions over the intrusiveness of the federal law into matters that fall exclusively within the jurisdiction of a state and local government, i.e., employment policies for their own employees. ACIR also contends that the public accountability of elected officials and the collective bargaining powers of employee unions will provide adequate protection for workers.
Federal OSHA. While federal OSHA, as written, does not currently apply to state and local governments, initiatives have surfaced in Congress that would extend the federal OSHA statutes and regulations to public sector employers. Some states and localities have voluntarily adopted the federal OSHA standards by choosing to apply federal OSHA to all employers in their state. Most other states and localities have developed safety programs tailored to address the specific safety needs and hazards of each jurisdiction. Dismantling state OSHA laws, regulations, and enforcement agencies would be very costly for these governments. Furthermore, there has been no analysis demonstrating that federal OSHA would provide a safer environment for public employees than worker safety programs already provided through existing bargaining agreements or state and local laws.
The Government Finance Officers Association (GFOA) supports repeal of FLSA's applicability to the public sector because of the inapplicability of the salary basis test and the duties test to government employers as well as the continued exemption of state and local governments from the purview of OSHA. Application of FLSA and the potential application of OSHA are two examples of the federal government imposing costly regulations without evidence of problems in the public sector. Additionally, GFOA strongly urges the U.S. Congress and the Administration to uphold the governing authority of states and localities. State and local governments should, at a minimum, be able to set the laws and regulations most appropriate for their own employees.
Adopted: May 21, 1996
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Federal Proposals to Unify Compensation Plans
Congress is looking into suggestions to unify various types of deferred compensation plans (Section 457 plans, Section 403(b) plans and Section 401(k) plans into one type of plan. Two approaches are to incorporate all existing plans under Section 401(k) or to establish an entirely new code section that permits transfers between these plans or an individual retirement account (IRA). The advantages cited for making such changes focus on administrative ease for employers, increased portability among plans, and simplicity in the Internal Revenue Code (IRC).
Employer-sponsored deferred compensation plans allow employees to save for retirement by making pre-tax contributions to the plan on a salary reduction basis. In turn, employee contributions are set aside on behalf of the employee or his or her beneficiary and distributed upon separation from service, retirement, or death. In most cases, these savings plans allow participants to choose from among several investment options and to periodically transfer accumulated assets among investment vehicles.
There are important differences between the three types of plans that reflect the needs of those participating in the plans. These include contribution limits, nondiscrimination testing requirements, loan provisions, withdrawal options, distribution options, and reporting requirements. The history of each of these plans provides insight into the basic needs being met by each type of plan:
- Section 457 Plans. Originally, state and local governments relied on private letter rulings to adopt a deferred compensation plan. Many of the provisions of these early plans were codified with the enactment of Section 457 in the Revenue Act of 1978. Section 457 plans are non-qualified, giving employers somewhat more flexibility in plan design, but must meet a separate set of requirements under the IRC to retain the tax deferral feature for participants.
- Section 403(b) Plans. These plans may only be offered to public school teachers and certain other categories of employees in education-related positions. Although employers had been able to purchase annuities for these employees on a tax-deferred basis since 1942, Section 403(b) plans were established in the Technical Amendments Act of 1958. As with Section 457 plans, the subsequent rules placed on Section 403(b) plans, including allowing investments in mutual funds, reflect the needs of this specific group of employers and employees.
- Section 401(k) Plans. The most widely available deferred compensation plans are Section 401(k) plans. These plans were created in the Revenue Act of 1978 and can be offered by any private-sector and not-for-profit employer. State and local governments may not maintain Section 401(k) arrangements unless they were adopted before May 6, 1986.
The Government Finance Officers Association (GFOA) supports federal and state policies that promote increased retirement savings and the preservation of these savings. GFOA recognizes the need for federal tax-law changes that are intended to improve portability among employer-sponsored deferred compensation plans. Such legislation, however, should focus on the preservation of retirement assets and permit state and local employers to continue to provide retirement programs that meet their employees' needs. Changes to these plans should be driven by a national retirement policy that promotes increased retirement savings and provides for adequate transition time and employee education, while not causing undue disruption to the administration and design of current plans.
Adopted: June 3, 1997
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The Administration and Congress are continually reexamining the nation's retirement policy. One area that is beginning to receive increased attention as the workforce becomes more mobile is pension portability. Generally speaking, pension portability refers to the ability of mobile workers to retain undiminished rights to retirement benefits. While there are a variety of avenues for increasing portability, many public employee retirement systems permit extensive portability of service, especially within a state. Portability of service can make a substantial difference in a defined benefit plan where a formula that combines years of service and final pay is used to determine benefit amounts.
Public employee retirement systems frequently provide for portability of service between systems by allowing purchase of service credit for prior periods of employment in other jurisdictions. Some jurisdictions, in efforts to assist employees in preparing for retirement, also allow purchase of service credit in other situations, including previous employment with private sector entities or previous periods of unemployment. Usually, public sector employees purchase service credit through employee contributions sufficient to cover all or part of the long-term cost to the retirement system of providing the increased benefits. These are often costly purchases and public employees frequently lack the financial resources to purchase these service credits until just prior to retirement.
Pension portability is frequently curtailed by certain provisions of federal tax law. Federal laws and regulations place restrictions on the amount that may be paid to a qualified plan during a twelve-month period and, while designed to apply to defined contribution plans, they also affect defined benefit plans. These restrictions may impinge on the efforts of public sector defined benefit plans to comply with state constitutional provisions. Further, as they are based on current compensation, the restrictions fall most heavily on part-time and low-paid workers seeking to obtain a full retirement benefit by purchasing service credit. For millions of state and local government employees who may choose to purchase service credit. For millions of state and local government employees who may choose to purchase service credit, these federal restrictions are often times counterproductive to the goals of achieving pension portability.
The Government Finance Officers Association (GFOA) supports efforts to modify federal restrictions on the amount of contributions that may be paid to a qualified pension plan during a 12-month period. These changes will permit public employee retirement systems to achieve the maximum portability permitted by state laws and plan provisions.
Adopted: June 3, 1997
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Permanent Extension of the Education Assistance Exclusion (Section 127)
The exclusion for employer-provided educational assistance, found in Section 127 of the Internal Revenue Code (IRC), allows workers to exclude from their taxes up to $5,250 annually in reimbursements or direct payments for tuition, fees, and books for certain courses. Section 127 was originally created by the Revenue Act of 1978 and has since expired and been reinstated eight times. Most recently, Section 127 was extended, retroactively, for the period of January 1, 1995 to July 1, 1997, in the Small Business Job Protection Act of 1996 (P.L. 104-188). After July 1, 1996, however, graduate courses can no longer be excluded from taxable income under Section 127.
The repeated expiration and reinstatement of Section 127 has increased the complexity of administering these benefits. Employers are unable to assure employees that the assistance will not be taxed. Furthermore, when the extensions are retroactive, the administrative burdens are multiplied by requiring employers to recalculate which previous benefits are now excludable for the employees. In response to the 1996 retroactive extension of these benefits, employers may need to:
- issue corrected W-2 forms (or W-2c forms) to employees.
- reimburse employees for 1995 Social Security and Medicare taxes.
- reduce their federal tax deposits to Social Security and Medicare for previous overpayments, and
- recalculate the base for contributions to retirement accounts as these benefits would no longer be included in employees' salaries.
Also, the unpredictability of receiving these tax benefits has prevent some workers from participating in the program. Some employees have postponed indefinitely registering for classes because of uncertainty about whether the benefits would be taxable. This issue affects both private and public employers, all of whom benefit from a more skilled and educated work force.
Section 127 does not require employers to offer educational assistance to their employees, nor are employees required to use these benefits. Rather, these benefits are an important way for employers, including state and local governments, to maintain a competitive, well-trained work force.
The Government Finance Officers Association (GFOA) supports making Section 127 a permanent part of the tax code for both undergraduate and graduate courses. Such a change would provide employers and employees with certainty regarding the deductibility of these benefits, reduce the administrative burdens employers experience as a result of the retroactivity of extensions, and remove the possibility of employees having unanticipated tax liabilities.
Adopted: June 3, 1997
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Tax Treatment of Employee Contributions to Retirement Plans
(Replaces 1981 Policy Statement on Tax Exclusions for Employee Contributions to Pension Plans)
The Government Finance Officers Association (GFOA) is aware of a number of bills which have been introduced in the U.S. Congress to allow tax exclusions for contributions to pension plans. Many of these bills have been introduced in order to provide equal treatment for the contributions employees make to various retirement plans including Individual Retirement Accounts (IRAs), Keogh plans, and defined benefit and defined contribution retirement plans. These bills are designed to encourage retirement savings and to give plan participants an added incentive to make contributions.
The GFOA encourages the U.S. Congress to enact tax incentives to stimulate retirement savings through increased contribution limits for retirement systems, deferred compensation arrangements, and other payroll-based savings plans. Such incentives should afford the same rights to members of public retirement plans as to members of private retirement plans.
Adopted: June 30, 1998
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Mandatory Social Security Coverage for State and Local Government Employees
Background. In 1950, 1954, and 1956, amendments were adopted to the Social Security Act allowing states to enter into voluntary agreements with the Social Security Administration in order to elect coverage for their public employees. These amendments also permitted states that had entered into such agreements to elect to withdraw from the program. In 1983, Congress removed the authority for states and localities to withdraw from the program, but retained their ability to voluntarily participate in the program. Additionally, in 1990 Congress mandated Social Security coverage for all state and local employees not covered by a qualified public pension plan.
Discussions are under way between the Congress and the Administration to find solutions to the pending fiscal crisis forecast for the Social Security program in the next 25 years. It has been estimated that by 2032 the Social Security Trust Fund will become insolvent when benefit payments begin to exceed revenues taken in through the payroll tax.
According to the General Accounting Office (GAO), approximately 70 percent of state and local government employees are now covered by Social Security. Those states with the fewest amounts of public employees covered by Social Security include Ohio, Massachusetts, Louisiana, Colorado, Nevada, Alaska, Maine, California, Illinois, and Texas. It is estimated that five million state and local public employees are not currently covered by Social Security. According to GAO, mandating coverage to all newly hired state and local government employees would extend the solvency of the Trust Fund for only an additional two years.
Mandating Social Security coverage for state and local government employees will generate significant fiscal demands. These concerns would primarily focus upon:
- The history of the Social Security system, and its provisions involving state and local employees. Many public retirement systems in non-covered states have designed their plans in reliance on the current exclusion and are structured and funded on that basis.
- State and local governments will incur sharp payroll cost increases that will necessitate an increase in taxes, a reduction in government services, or some combination of the two.
- Some non-covered states provide a constitutional guarantee for public plan retirement benefits. They would be prohibited from adjusting their state plans to maintain a consistent level of benefits upon integration of Social Security coverage.
- Cost increases would particularly affect currently non-covered public safety retirement plans and the bridge payments that are made to their many early retirees.
In 1983, the Congress also adopted the "Windfall Elimination Provision" and the "Government Pension Offset" to protect against inequities resulting from non-covered public employees eligible to receive full Social Security benefits based upon previous work experience in the private sector, or from benefits received based upon an employee's status as a spouse or widower. The Windfall Elimination Provision would reduce the multiplication factor used to calculate the average monthly benefit, while the Government Pension Offset would invoke a two-thirds reduction on benefits received as either a spouse or widower.
GFOA Position. The Government Finance Officers Association (GFOA) supports current law, which permits state and local governments to voluntarily participate in Social Security. This allows states and localities to design, administer and finance retirement plans that best meet the needs of their employees and employment policies.
Mandatory coverage of the estimated five million current non-covered state and local government employees has been proposed as one element of overall Social Security reform. Adoption of such a mandate would require major alterations in current state and local retirement plans in exchange for uncertain benefits. GFOA opposes mandatory Social Security coverage for state and local government employees as a component of Social Security reform.
Approved by the Committee on Retirement and Benefits Administration
February 3, 1999
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Proposed Social Security Reforms
The national discussion of policies and strategies to reform the U.S. Social Security system involves both social policy and financial management issues. The Government Finance Officers Association (GFOA), representing thousands of expert financial managers from all fifty states and their many local governments, is uniquely qualified to offer sound and balanced financial policy recommendations to the nation's policymakers. GFOA urges Congress and the President to assure that the Social Security system is operated on the same sound financial principles that are required of public and private sector retirement plans. GFOA's policy objective is to assure an efficient and equitable intergovernmental system of social insurance and retirement financing that complements public or private retirement plans.
To assure that the primary U.S. social insurance system operates according to prudent financial principles, GFOA recommends that Congress incorporate the following principles and policies in any reform of the Social Security System:
- Independent Budgetary and Accounting Status. Restore the Social Security Trust funds to independent budgetary and accounting status to discourage the co-mingling of restricted revenues and assets. The future solvency of the system that millions will rely on depends on the willingness of federal lawmakers to exhibit the financial discipline necessary to ensure its stability.
- Actuarial-Based Funding Plan. Design a contribution and funding plan in accordance with accepted actuarial practices and the same standards required of public and private pension plans. A review of the assumptions, the plan and its operating and actuarial results should be performed every five years and recommendations made to Congress regarding funding and benefits adjustments.
- Prudent Person Investment Principle. Provide authority to prudently invest an appropriate percentage of the Trust funds in broadly diversified portfolios for the sole and exclusive benefit of the program's beneficiaries.
- Hold Harmless. GFOA opposes mandatory Social Security coverage for state and local government employees as a component of Social Security reform.
Approved by the GFOA Executive Board
February 25, 2000
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Health Care Cost Containment
Rising health care cost inflation is a growing concern confronting state and local governments who provide health care benefits for their retirees and employees. Nearly all governments offer some type of health care coverage to their employees. Allowing public employees and retirees the flexibility and tools necessary to save for retirement and to pay for health care expenditures is essential.
The GFOA supports the Government Accounting Standards Board’s decision to require that state and local governments recognize the cost of other post-employment benefits (OPEB) as those benefits are earned each year by employees, just as they do for pension benefits.
The GFOA supports expanding federal tax incentives to facilitate saving for health care costs prior to retirement and for expenditures that occur during retirement.
The GFOA opposes any efforts by the federal government to impose unfunded mandates such as new health care plan requirements that further escalate the cost of employer-provided health care insurance on state and governments.
The GFOA supports a variety of federal legislative actions that would improve health care and reduce costs, including:
- Allow retired public employees to take a distribution from their deferred compensation plans, such as a 401(a), 401(k), 403(b) or 457 plan, and use these pre-tax dollars to pay for health care costs without incurring a tax penalty.
- Allow for elective conversion of sick leave into a health care account on a pre-tax basis.
- Expand the employer pickup provision under Internal Revenue Code Section 414(h) for health care to allow use of these pre-tax funds for health care costs.
- Allow retirees to pay for health care benefits and long-term care from their pension checks without tax consequences.
- Allow long-term care coverage under a cafeteria plan.
- Close the loopholes in Hatch-Waxman Act of 1984 (Drug Price Competition and Patent Term Restoration Act of 1984) that allow drug manufacturers to extend drug patents beyond their legal time limit and implement federal regulatory policy that makes it easier to obtain and keep generic drugs on the market.
Recommended for approval by the Committee On Retirement and Benefits Administration on January 22, 2004;
Recommended for approval by the Executive Board to the GFOA membership on March 26, 2004;
Approved by the membership June 15, 2004.
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State and local government retirement plans, participants, and beneficiaries have a direct interest in sound corporate governance, since they are major investors in securities markets. State and local retirement plans collectively invest over $2 trillion dollars in the public markets. The quality and integrity of corporate governance directly affects the ability of retirement plans to meet their investment goals, and by extension, the ability to meet their long-term obligations to current and future retirees.
- GFOA supports strengthening financial accountability in the private sector through improved auditor independence and accounting industry oversight.
- GFOA supports corporate governance reforms that enhance transparency and align management and the board of directors with the interests of long-term shareholders. These reforms include, but are not limited to:
- The appointment of a majority of independent board members, as well as audit and compensation committees comprised entirely of independent board members.
- Modification of the proxy process to facilitate good corporate governance.
- Executive compensation that is linked to long-term corporate performance.
Approved by the GFOA Executive Board, March 2005.
Approved by the membership June 28, 2005.
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Health Care Reform Policy
[This Public Policy Statement combines three current Public Policy Statements – Health Care Reform (1993), National Health Care Reform (1994) and Health Care Cost Containment (2004)]
State and local governments have several roles in the health care arena. They are purchasers and providers of health insurance. They must negotiate with health insurance companies to secure adequate health benefits for active and, in many cases, retired employees and their families. At the same time, they must monitor the costs of purchasing and offering these benefits. In addition, state and local governments may also serve as a community safety net or health provider of last resort, providing health care services to the uninsured, the under-insured, and Medicaid recipients.
Health care is now the fastest growing portion of state and local government budgets and governments have cited rising health benefit costs as one of the main contributors to budgetary pressure. These costs limit spending on other important public needs such as education, infrastructure and economic development.
Moreover, the impact of the disclosure provisions required by the Governmental Accounting Standards Board’s (GASB) Statement on Other Post Employment Benefits (OPEB), which mandates that state and local governments disclose their future health care obligations for retired employees and their families, will exacerbate these concerns.
While national health care policy is set at the federal level, health care costs fall heavily on state and local governments. For this reason, federal policy should address state and local governments’ needs and concerns.
The Government Finance Officers Association (GFOA) urges the Administration and Congress to work together with state and local governments on initiatives to reform the nation’s health care delivery system in order to contain the growth of health care costs and expand access to health care for all. GFOA encourages a federal approach that includes:
- Expanded Health Care Coverage. Millions of U.S. residents are reported to have no health care coverage. The cost of uncompensated and under-compensated health care is ultimately shifted to employers who provide health insurance coverage as well as to individual purchasers of health insurance in the form of higher medical bills and premium increases. For public employers in particular, the coverage they provide to their state and local government employees makes this cost shifting especially onerous. In addition, locally funded public health systems must provide costly health care services to an increasing number of the uninsured. Expanded health care coverage would temper the effects of cost shifting. In order to effectively expand health care coverage, the federal government should promote a full range of financing and service delivery options.
- Equal Consideration for All. Federal initiatives that offer health care cost saving mechanisms such as subsidies, reinsurance, purchasing cooperatives, and other options that might arise should be offered to employers, employees and providers in both the public and private sector.
- Adequate Federal Funding. State and local governments shoulder a large share of the cost of the health care provided to Medicaid recipients and the uninsured. The federal government should maintain funding for Medicaid as well as Medicare. It should also permit states and local governments necessary flexibility in program design, including the coordination of benefits. In addition, the federal government should ensure that there is adequate federal funding to address costs associated with the health care provided to undocumented residents by state and local governments.
- Transparency within the Health Care System. The federal government should promote transparency in the health care system so that employers and consumers can be more knowledgeable and proactive. Transparency includes the ability for consumers to compare costs, quality, and suitability of different medical providers, hospitals, procedures, prescription drugs, insurance plans, and premiums.
- Health Care Education. Public education programs have proven successful in modifying behaviors that drive health care costs. All levels of government should work together to continue and expand these efforts.
Health Care Information Technology. The federal government should promote the use of information technology in the health care industry to simplify and standardize health care administration, improve health care coordination, and enhance patient safety, which will increase quality of care while reducing costs.
- Performance Standards. Fewer errors, less duplication, and higher quality are critical components to more effective and less costly medical care. The federal government should promote the adoption and use of physician and hospital performance standards. Medical providers and hospitals should be required to report their performance compared to these standards. Employers and consumers can use these standards to compare the quality and cost of care provided throughout the health care system.
- Affordable Prescription Drugs. The federal government should encourage and support initiatives to reduce the rising costs of prescription drugs. These initiatives may include: allowing the federal government the authority to negotiate directly with pharmaceutical companies to reduce the costs of prescription drugs; permitting the safe importation of prescription drugs; and studying the possibility of reducing the time frame on prescription drug patents.
- Integrate Existing State and Local Government Programs with Federal Programs. State and local governments have taken a leadership role in developing and implementing many successful cost containment and coverage initiatives for both employees and the uninsured. These programs provide valuable models for federal initiatives. State and local government input should be solicited when these federal initiatives are considered.
- Availability of Health Care Professionals. There are significant factors that impact the availability of health care. These factors include the opportunities and affordability of education and on-going training for health care professionals, the dramatic increase in demand for health care with an aging population and the exposure to medical liability. The federal government should address all factors related to the availability of health care professionals.
GFOA is committed to working with federal policy makers to develop and support the health care reform initiatives discussed above in order to expand access to quality care and control the growth of health care costs.
Recommended for GFOA membership approval by the GFOA’s Executive Board, February 24, 2006.
Approved by GFOA membership, May 9, 2006.
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Direction of the Investment of State and Local Government Post-Employment Benefit Trust Funds
(formerly known as Direction of the Investment of State and Local Government Retirement Systems, 1995)
The Government Finance Officers Association (GFOA) believes that the appropriate body to direct the
investment decisions of state and local government post-employment benefit trust funds (i.e., trust funds used to accumulate resources for pension benefits or other post-employment benefits – OPEB) is the plan’s governing body, working within the legislative investment framework established by the sponsoring government. Because pension trusts and OPEB trusts are used to pre-fund liabilities with differing characteristics, the decisions their plan’s governing body make regarding asset allocations and investments may differ; however, the underlying governance structure and investment principles outlined in this policy apply equally to both. 5 The plan’s governing body members are either appointed or elected by the participants, retirees, or sponsoring governments.
The primary obligations of the plan’s governing body in investing assets are to do so for the exclusive benefit of the plan's beneficiaries. Within this exclusive-benefit framework and in accordance with investment policy objectives and constraints established by a plan's fiduciaries, government post-employment benefit trust funds invest their assets.6
The GFOA supports investment strategies for which the paramount goal is the prudent investment of postemployment benefit trust assets and it opposes proposals that attempt, either implicitly or explicitly, to direct or influence state and local government post-employment benefit trust funds to make investments that circumvent the plan’s governing body’s fiduciary responsibility. Investment proposals that are likely to produce below market rates of return would violate fiduciary duties, compromise the plans' risk-return standards and produce less than competitive rates of return.
Recommended for approval by the GFOA’s Executive Board, February 22, 2008.
Approved by GFOA’s membership, June 17, 2008.
5 As OPEB trusts are relatively new, some are currently governed, at least for the time being, by a sole trustee (e.g., finance officer, treasurer) rather than by a board. Ultimately, however, the governance structure of an OPEB trust should evolve to resemble that of a pension trust. return
6 While this policy is intended for defined benefit plans, it is important to note that many aspects can apply to defined contribution plans, specifically GFOA’s opposition to any proposals that would restrict state and local governments from offering their plan participants a diversified selection of investment options. return
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Governing Statutes for Post-Employment Benefit Trust Investments (formerly known as Governing Statutes for Public Pension Plan Investments, 1997)
Millions of state and local government workers and retirees participate in post-employment benefit trusts (i.e., trust funds used to accumulate resources for pension benefits or other post-employment benefits – OPEB) administered by state and local governments. Because pension trusts and OPEB trusts are used to pre-fund liabilities with differing characteristics, the decisions their trustees make regarding asset allocations and investments may differ; however, the underlying governance structure and investment principles outlined in this policy apply equally to both. 2 Trustees and plan administrators are responsible for oversight of the asset
management of these plans.
Subject to applicable federal, state, and local laws, and judicial decisions, governance of investment programs is provided through the investment policy’s objectives and constraints established by the plan's fiduciaries. 3 For most public-sector post-employment benefit trusts, the investment policy decisions are made by the board of trustees. Trustees are either appointed or elected by the participants, retirees, or sponsoring governments.
The actions of the fiduciaries are governed by statute or plan standards. For many plans, the fiduciary standards follow the prudent person of the common law, which requires each board member to perform his or her duties as a prudent person would when acting in a like capacity and in a similar situation. 4
The Government Finance Officers Association (GFOA) supports strong fiduciary standards set in law by state and local governments and the prudent investment of plan assets. Strong standards should be codified in governing statutes through the "prudent person" rule. This type of oversight holds plan fiduciaries to a high performance standard while not restricting their efforts to achieve the most efficient returns with appropriate risk. Finally, GFOA recommends that efforts to impose specific restrictions on the investments of public funds, such as legal lists and percentage limitations on particular asset classes, be avoided, as they generally result in inferior returns in the long run.
Recommended for approval by the GFOA’s Executive Board, February 22, 2008.
Approved by the GFOA’s membership, June 17, 2008.
2 As OPEB trusts are relatively new, some are currently governed, at least for the time being, by a sole trustee (e.g., finance officer, treasurer) rather than by a board. Ultimately, however, the governance structure of an OPEB trust should evolve to resemble that of a pension trust. return
3 A fiduciary is an individual, corporation or association to whom certain property is given to hold in trust according to a trust agreement. In the case of post employment trusts, fiduciaries typically include the board of trustees and certain administrative staff who have discretionary decision-making authority such as the plan administrator and chief investment officer. return
4 It is important to note that defined contribution plans have their own fiduciary obligations. return
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