Current Pension Topics:
End Guaranteed Interest Rate

By JOEL L. FRANK

Q.: I am a Teacher and voluntarily participate in the Teachers' Retirement System's (TRS) 403(b) program. I consider myself well-read on retirement matters. I am very upset and shocked with your answer to G.A. (Current Pension Topics of Jan. 12 issue). Article V Section 7 of the New York State Constitution states:

"After July first, nineteen hundred forty, membership in any pension or retirement system of the state or of a civil division thereof shall be a contractual relationship, the benefits of which shall not be diminished or impaired."

It is this clause of the Constitution that compels the New York taxpayer to guarantee 8.25-percent interest on TRS 403(b) accounts. My position has been verified by the United Federation of Teachers (UFT) and the TRS. The UFT newspaper of Oct. 19, 2006 states: "TDA (403(b)) investment choices ... the 8.25 percent is guaranteed until June 30, 2009. At that time, the State Legislature will decide whether to keep the same rate, raise it or lower it. The rate cannot be reduced to less than 7 percent because of New York State's Constitutional provision which prohibits pension benefits from being diminished or impaired."

Would you please publish a corrected answer to G.A.'s question as soon as possible?

M.A.

A.: Thank you for quoting the "impairment clause" of the State Constitution. It has, however, absolutely no relevance to the answer I furnished to G.A. My answer is correct. It's not the first time that the TRS and UFT are wrong and they have been wrong on this one ever since the TRS 403(b) program began on Jan. 1, 1970.

The "impairment clause" applies to the TRS's Qualified Pension Plan (QPP), not to TRS's voluntary salary-reduction 403(b) program. The 403(b) program is not a "pension or retirement system." It is simply a voluntary pre-tax savings/investment plan. The 403(b), like the 457(b) and 401(k), supplements the benefits derived from the "pension or retirement system." The 8.25-percent interest rate is a constitutionally-protected benefit only when it is applied to the Annuity Savings and Increased-Take-Home-Pay accounts of members of Tiers 1 and 2 of the QPP (the "pension or retirement system"). The "impairment clause" is the very reason we have had, since July 1, 1973, a QPP Tier structure. The Tier structure does not apply to the TRS 403(b) program because the "impairment clause" does not apply to the supplemental 403(b) program.

The "impairment clause" allows for a "diminished" benefit structure for employees who first become members of the QPP as of a certain date in the future. This is why it is constitutional to credit members of Tiers 3 and 4 with 5-percent interest on their contributions to the QPP rather than 8.25 percent. If, to theorize, the taxpayer wanted to reduce the guaranteed rate to 4 percent, the Legislature could constitutionally do so only by establishing a 5th tier and state that all those hired on or after a certain date in the future are members of Tier 5 and earn 4-percent interest on their QPP contributions.

For more than 15 years the "impairment clause" has been used as the legal cover to credit TRS 403(b) participants with a higher rate of taxpayer-guaranteed interest than that generated by the capital markets. In an earlier era (the 1970s and '80s), the direct opposite was true. 403(b) participants earned a much lower rate of taxpayer-guaranteed interest than that generated by the capital markets. So during that period, the TRS 403(b) participant was subsidizing the taxpayer.

The taxpayer and the 403(b) participant should never be put in a position where, based on a free-market economy, one automatically profits on the back of the other. This, however, is what a taxpayer-guaranteed interest rate does. It is poor public policy.

A guaranteed interest rate option for a public supplemental savings/investment plan should be a function of free markets, not artificially set by an act of the Legislature. The Legislature should repeal the taxpayer-guaranteed interest rate option forthwith. The UFT/TRS should finally come clean and admit that the taxpayer guaranteed interest rate for the TRS 403(b) program has always been the result of just bargaining/lobbying with Albany and City Hall, and just like the city's Deferred Compensation 457(b) and 401(k) Plan has nothing to do with the "impairment clause."

Please note I am using a "Tier 5" simply to illustrate how the "impairment clause" of the Constitution protects members of Tiers 3 and 4. I am strongly opposed to the diminution of benefits by enactment of a Tier 5.

Mr. Frank is a fee-only Retirement Financial Planner. He can be reached by telephone at (732) 536-9472, or via e-mail at rollover@optonline.net .