View the March 29, 2016, program presented by IMRF Executive Director Louis Kosiba and CFO Mark Nannini.
Pension Spiking and The Accelerated Payment Webinar
IMRF presented the webinar Pension Spiking and The Accelerated Payment: Facts and Good Practice on Tuesday, March 29. Louis Kosiba, Executive Director, and Mark Nannini, Chief Financial Officer, conducted an in-depth program that defined pension spiking and its impact on employers and taxpayers. The speakers also detailed legislative mandates, including the Accelerated Payment. More than 350 attendees participated in the webinar, representing diverse employers from across the state.
Refer to this resource page to download the presentation's slides, view the complete webinar program in its entirety, and review the questions and answers submitted during the presentation.
- "This was one of the best IMRF webinars I have attended.
- "Thank you for getting through as many questions as possible."
- "Thank you for the webinar. My suggestion is all presentations for IMRF be webinars."
Question and Answer Presentation
Webinar attendees were invited to submit a diverse range of questions during the presentation. To better serve as a resource, the questions have been categorized into groups focusing on topic categories. The presenters' in-depth answers follow each question.
Group 1 - Vacation and Sick Time Payouts:
Q – Employees are paid unused sick and vacation accruals upon retirement, which often results in an Accelerated Payment due to IMRF. Is it possible to avoid reporting this lump sum upon retirement? Why do we have to report that payment to IMRF? Why are unused sick and vacation accruals not an exemption for Accelerated Payments?
A – Compensation for your employees should be considered as a whole, not on a piece-by-piece basis. Any compensation, including lump sum payments for accrued vacation and sick time, is IMRF earnings and must be reported to IMRF if paid during the employment period or in the month following the month of termination. If paid after the month following the month of termination, it is not reportable to IMRF. This is part of the IMRF definition of earnings and cannot be changed by an employer. While vacation time must be paid out immediately under 820 ILCS 115-5 – which is the Illinois Wage Payment and Collection Act, not the Pension Code – unused sick time can be delayed until the second month after termination (payments in the second month after termination are not reportable as IMRF earnings.)
While the payout for unused sick and/or vacation time is not a salary increase, the payment does increase the member’s pension – which also increases the cost to the employer. This increased cost was not funded over the working career of the member, as provided for under Generally Accepted Accounting Principles (GAAP) and created an unfunded liability, or shortage, in the Employer Reserve. If these wages were exempt from AP, the employer would be required to pay higher contributions in the future to pay for both the shortage in their reserve plus interest. The interest is necessary to provide for the missed investment opportunity because the funds were not at IMRF.
Q – What would be the best practice when cashing out vacation days? Our employees have banked vacation days and they are to be paid out when the employee either retires or resigns. For example: An employee has 100 days and their rate of pay is $250 /day. This employee is paid these days on their last day. Is this reflected in the FRE?
A – All reported wages, including cash-out of vacation time, is used to determine the FRE and the monthly pension.
If you wish to manage the amount on any AP invoice, then paying the amount in a single month during the last three months of the FRE period will allow the 125% rule to partially protect the employer. The 125% rule limits the amount during the last three months of the FRE period that will be used to calculate the FRE, which then limits the Accelerated Payment required.
Q – Do you have a recommendation on how to write a personnel policy for payment of accumulated and/or accrued vacation days to prevent salary spiking?
A – Each employer is unique and while we cannot offer advice, we can recommend you review policies that have been established to approach this.
Q – Our Collective Bargaining Agreement with our teachers allows us to pay out sick time after the teacher has been retired for more than one month. Would something similar be permissible under IMRF? Can you delay paying accrued sick time two months after retirement?
A – Unused sick time can be paid the second month after termination. The wages reported in this manner are not reportable to IMRF, and therefore will not increase the member’s pension and the cost to the employer.
Q – What if you are paying out vacation pay but the person is not vested nor near retirement age; does an Accelerated Payment still need to be paid?
A – It depends. If the vacation payout is not used in the calculation of the pension, no AP is required. The pension is calculated using the highest consecutive 48 months (for Tier 1) or 96 months (for Tier 2) in the final 10 years of service.
Q – Can accrued, unused vacation days be "taken" at the end of employment? For example, if the last working day is June 1 and the employee has one month of vacation, can their date of retirement be July 1 and the vacation paid out during the month of July as regular salary to avoid the Accelerated Payment?
A – Use of vacation time is not addressed in the Pension Code, which would make such a plan acceptable. Such a practice would be entirely up to the employer, subject to their policies, procedures, and possibly other considerations.
Q – If the final payout with vacation pay is April 15th, so there is only one paycheck that month, does that amount count as the total month's pay and therefore mitigate some spiking effect of paying out vacation?
A – It depends, as the total compensation for that starts when the vacation payout and the salary are added together.
Q – How does IMRF handle vacation payouts at the end of a career with their own employees?
A – IMRF’s vacation policy limits the vacation that can accrue. We also pay the accrued time during the period in which the pension calculation is limited by the 125% Rule.
Group 2 – Salary Increases:
Q – What does IMRF consider to be an average salary increase or a typical range?
A – On average, our actuary assumes a 3.5% increase in wages. Please remember that the AP invoice is only issued for wages that exceed the higher of 6% or 1½ times the Consumer Price Index-Urban (CPI-U).
Q – What if [the salary increase] is part of a Collective Bargaining Agreement? Is the employee responsible paying 4.5% on payments determined to be "spiked," even though IMRF does not base the pension on the spiked amount?
A – A salary increase that creates an unusual pension increase – an annual increase in reported wages over 6% – is considered for an Accelerated Payment invoice. A Collective Bargaining Agreement does not negate that a spike in the pension cost occurred. Employees must contribute 4.5% of all compensation reported to IMRF, whether the 125% Rule will apply or not.
Q – How does a job promotion and related pay raise in last three years of employment affect IMRF and Accelerated Payments?
A – Accelerated Payment invoices due to earnings increases from job promotions are eligible for an AP exemption. If an employer requests an exemption due to job promotion, the increased cost reflected in the AP is then funded by future rate increases, including interest that would have been earned if the amount was at IMRF being invested.
Q – Please talk about overtime – whether mandatory or voluntary. Did I hear correctly that this is an exemption?
A – Overtime can create a higher pension for the member and therefore a higher cost to the employer. The Pension Code allows the employer to request an exemption from the Accelerated Payment amount created by overtime. Like the exemption request due to job promotion in the above question, if an employer requests an exemption based on overtime, the increased cost represented in the AP is then funded by future rate increases, including interest that would have been earned if the amount was at IMRF being invested.
Q – Will the Accelerated Payment apply to a situation where a multi-year employment contract was entered into in 2005 and was extended each year for an additional year? However, in 2010, the employee was provided with a letter identifying a retirement incentive with 20% increases, where the last action to extend the contract with those increases occurred in 2011? The new contract, by extension, terminates in 2016.
A – Assuming that the contract was entered into in 2011 and no amendments adjusting the salary paid have been added to the contract, which would create a new contract, then the employer may request an AP exemption. If an employer requests an exemption based on the pre-existing contract, the increase cost reflected in the AP is then funded by future rate increases, including interest that would have been earned if the amount was at IMRF being invested.
Group 3 – The 125% Rule:
Q – The 125% rule: Does IMRF adjust for employers that pay bi-weekly – some months with three paydays and some months with only two paydays?
A –The Accelerated Payment calculation uses 12-month periods. Usually, each 12-month period would have two three-payroll months, so a bi-weekly payroll does not inherently create an AP situation.
If a 12-month period has three months with three payrolls, this would create a higher pension and a higher cost for the employer. Since the Pension Code does not provide for an adjustment of the pension calculation for the member, IMRF cannot adjust the AP calculation because it represents unfunded pension costs that should have been funded over the working career of the member.
Q – If an employee's earned, unused vacation pay puts him or her over the 125% cap in the last month of his or her employment, but there was no increase in salary over 6%, will the 125% rule apply?
A – The 6% is part of the AP calculation. It is not part of the 125% rule. The 125% rule tries to limit end-of-career payments that would inflate the FRE and make the FRE more closely reflect the member’s actual salary.
Q – If we have current negotiations for Union employees, would their new contract date apply as the "amended policy" date for the 125% rule or would the normal company policy date apply?
A – A contract “amended” date could be part of IMRF’s review of an AP exemption request. It is not part of the 125% rule. The 125% rule applies to the final three months (24 months for Tier 2) of reported earnings during the FRE period (48 months for Tier 1 or 96 months for Tier 2), regardless of the source of the wages or any other circumstances. Contracts entered into on or after 2012 do not exempt any increases they contain from the AP.
Q – Using an example, please explain how the 125% rule affects the payout of accrued vacation in the last check. For example: Is the Accelerated Payment limited to the difference between 6% and 25%?
A – The 125% rule comes first and determines the wages used to calculate the FRE. Then the FRE wages are used to calculate the AP.
Let’s use a simple example: Assume a member with 47 months with reported wages of $1,000 and $10,000 of reported wages in the last month. The highest month in the first 45 months is $1,000. 125% of the $1,000 is $1,250. Wages in the final three months of the FRE period will only be considered to the extent that they do not exceed $1,250. The annual FRE for this member would be 47 months at $1,000 plus one month of $1,250 (total of $48,250) divided by 4 which equals $12,062.50 (the monthly FRE is $1,005.21).
The AP calculation would compare the $12,000 in the third 12-month period to the $12,250 in the final 12-month period to determine if a pension spike had occurred.
Group 4 – Pay Rate (6%):
Q – Sorry, I'm confused on the 6%. Is it a 6% increase in one month? Specifically, 6% of a full-time employee’s days worked is about 15 days. Does that mean the limit for payout to an employee for unused vacation days is a maximum of 15 days to avoid the Accelerated Payment invoice? Would you repeat the explanation about the example of 6% increases during the final four years? At what percentage will you safely not incur an Accelerated Payment?
A – The AP calculation looks at the four 12-month periods in the FRE period. A 6% increase in a single month would not create a 6% increase during a 12-month period. Different FRE earnings can result in different AP calculations; i.e. the 125% rule may limit the reported earnings from increasing over 6%. To determine the increase we use to calculate the AP, compare the earnings you will report in the last 12 months of the FRE period to the 12 previous months and determine if the increase is greater than 6%.
Q – Our pay dates are every two weeks. Wages can fluctuate from one year to the next by 8% due to the timing of months with three pay periods, even though there is no change to the pay rate. Is there an exemption for this type of increase?
A – No. About 1 in 8 years will have three 3-payroll months. If one of the four 12-month periods in the FRE period has three 3-payroll months, the pension is calculated using the spiked wage which, in turn, creates a higher pension for the member and an increased cost for the employer. Without the AP, the employer would pay for the higher pension through higher employer contribution rates in the future to include the additional cost plus missed investment earnings because the funds were not at IMRF being invested.
Q – What happens if the contract allows for a 4% salary increase the last four years before retirement?
A – An annual increase of 4% is less than the 6% allowed in the AP calculation and therefore no Accelerated Payment amount would be due.
Q – What can an employer do if an employee requests to be paid over 18 pays versus 24 pays the last year of employment? This has caused our district to receive an Accelerated Payment even though the employee only received a 2.5% increase from the prior year. IMRF encouraged this practice.
A – When an employee is paid over 18 pays in the final year, the result is 50 months of earnings used to calculate the FRE, resulting in a higher pension for the member and a higher cost for the employer – including an amount that was not funded over the working career of the member. Each employer must look to their policies, procedures, and contracts to determine how this should be handled to reduce the cost of the pension and the required AP. Employers should be aware that this causes pension spiking and could result in an AP.
Q – How will IMRF handle pension increases because the DOL raises the salary level for exempt status and a PD decides to increase wages to avoid overtime pay?
A – Assuming the increase in wages occurred during the FRE period, the reported earnings created a pension that was not funded during the working career of the member. Since the increase in reported earnings was not due to one of the five exemptions in the Pension Code, IMRF would calculate an AP for that increased compensation.
Q – If a member reduces their payout because they contribute to their 457 plan, will this amount be exempt?
A – Contributions to a 457 plan and changes in a member’s contribution to the 457 plan do not affect the wages reported to IMRF. The contributions, or change in contributions, would not cause an AP. The amount contributed to a 457 plan is IMRF earnings and should always be reported to IMRF.
Q – At our school, we have a four-year irrevocable retirement clause that an employee can enter whereby salary for the last four years is increased 6%. Will we be charged an Accelerated Payment?
A – If the contract was entered into before January 1, 2012, and not modified, that contract would allow the employer to request an exemption and pay the increased cost of the pension through future employer rate increases. An increase created by a contract entered into or modified after January 1, 2012, would not be eligible for an exemption for any additional cost created by any increase in reported wages during the FRE period.
Q – Can an employer pay the retiree the retirement bonus a month after the retirement? So the bonus won't spike the employee's final earning? And it won't be credible earnings?
A – Earnings in the month after termination are reportable to IMRF and can be used in the calculation of the member’s pension. A bonus can be paid in the second month after termination and thereby avoid reporting to IMRF.
Group 5 – Accelerated Payment Logistics:
Q – What percentage of the 3,258 Accelerated Payment invoices were dismissed for legitimate Accelerated Payment Exemptions?
A – The 3,258 AP invoices covered an amount of $76,103,896.83. Of those invoices, 1,146 exemptions were approved (35%) for an amount of $46,399,283.92 (61%).
Where an exemption was approved, the amount was not dismissed. Instead, the increase cost represented by the AP is funded by future rate increases, including interest that would have been earned if the amount was at IMRF being invested.
Q – How long does it take IMRF to review Form 7.2, along with the backup documents that were submitted, and provide a decision?
A – The minimum time is two weeks. However, varying factors may extend this timeframe beyond two weeks.
Q – If the Accelerated Payment is under $5,000, will an invoice for that payment be mailed or is it rolled into regular payments?
A – Accelerated Payment calculations that result in an amount under $5,000 will not have an AP invoice created. Any unfunded amount created would be funded through future employer contribution rates.
Q – If the Accelerated Payment is not paid after three years, where does it go on the employer's receivable account? Can you see the amount as it is transferred into the employer's account?
A – After three years, IMRF will issue a charge advice and the amount, plus interest, will appear on the employer’s accounts receivable. The employer will be able to see the charge when they receive their copy of the charge advice.
Q – What is the penalty for not having the Accelerated Payments made by the three- year agreement? We have a seasonal employee who has changed hours and months off, and we've now received an Accelerated Payment invoice. Does this qualify under “Item E” on the form?
A – The Accelerated Payment is often mischaracterized as a penalty. If the employer paid the AP invoice and never saw the money again, that would be a penalty.
However, when an employer pays an AP invoice, 100% of the money goes into the employer reserve which is used to fund the pensions of employees. Another way to explain it is that the AP invoice tries to restore proper pension funding to the employer account when a member’s end-of-career earnings spike created a shortage.
The Pension Code allows the AP invoice to be paid within 90 days without interest. During the remainder of the three-year period, the Pension Code requires the AP to be paid with interest of 7.5% per year. After three years, the AP amount plus interest is charged to the employer’s accounts receivable account. In that account, the interest charged is a penalty.
With regards to the seasonal employee, the employer should look at the position to see if the hours required changed and therefore would allow the employer to request an exemption. If an employer requests an exemption based on “increased hours,” the increased cost reflected in the AP is then funded by future rate increases, including interest that would have been earned if the amount was at IMRF being invested.
Q – Can we use our reserve balance to pay the Accelerated Payment, and if no, why not?
A – The Pension Code does not allow this.
Q – I have submitted two exemption requests since the beginning of the year and was asked by the Financial Relations Manager for a copy of our entire 100+ page employee manual. Is that necessary? What documentation is needed when increases are given that fall into one of the exemptions?
A – IMRF uses this documentation to verify the details of our fact-finding.
Q – Would it be handled differently if an employee resigned then officially retired, say two years later?
A – No, the retirement date has no effect on the FRE.
Group 6 – Legal/Legislative:
Q – Has IMRF tried to have corrective legislation passed to get exemption relief from the bi-weekly pay or legally required payment of unused vacation? If not, why not?
A – No, because the Accelerated Payment is a funding issue.
Q – What is the latest on legislation stopping the reportable earnings for these payouts?
A – None at this time.
Q – Vacation payout is the likely reason for accelerated payout by most employers. Is IMRF doing anything legislatively to make vacation payout another exemption?
A – While not proposed by IMRF, legislation has been created to remove the cash-out of sick and vacation pay from the definition of reported earnings. If such a change is approved, it would only affect members hired after the effective date of that legislation.
Since the higher pensions and higher employer cost created in these circumstances produced a pension cost that was not funded over the working career of the member, we would not be following Generally Accepted Accounting Principles (GAAP) if we were to request a legislative change to allow an exemption in these circumstances.