Winter 2012/2013 Fiduciary PIERspective

By: Brant Griffin – February 4, 2013

Bankrupt City Takes on a Public Pension Behemoth


Pension heavyweight CalPERS (California Public Employees’ Retirement System) is squaring off against San Bernardino, a bankrupt California city of 210,000, in pursuit of delinquent pension payments. The world’s sixth largest pension fund with assets of nearly $250 billion is frequently cited as throwing its weight around in pursuit of its interests. The circumstances of this epic battle may send it all the way to the U.S. Supreme Court.

CalPERS manages the pension assets of 450 California cities, all of which make regular contributions on behalf of their employees. Rarely have member cities shrugged-off these funding obligations, even when faced with extreme fiscal duress. Case in point, during the recent recession, the city of Vallejo chose to stiff its bondholders rather than fall short on its payments to the pension fund. When municipalities have tried to renege on their pension obligations, CalPERS has dealt with them swiftly and aggressively through the courts.

San Bernardino has chosen to stand up to the CalPERS. After filing Chapter 9 municipal bankruptcy in August, the city discontinued its $1.7 million monthly retirement plan contribution. Due to its financial quandary, San Bernardino stated that it could not further restrict municipal services without risking public safety. San Bernardino proposed an emergency budget in November, where $13 million worth of payments to CalPERS would be deferred and “… negotiated with the creditor” at some point in the future. Soon after, CalPERS announced it would sue the city to reclaim the missed payments. They also filed a motion to remove the protection from lawsuits that cities entering bankruptcy normally retain. CalPERS also stated that it “reserves the option” of ending its contract with the city, leaving workers in an uncertain position.

In the lawsuit, the US Bankruptcy Judge ruled against CalPERS in its attempt to force the city to continue making its pension payments. The judge’s ruling stated that requiring San Bernardino to pay CalPERS would be a “death knell” to its efforts to rebound from their financial difficulties. Even though the hit to the pension fund is a mere sliver of its portfolio, CalPERS maintains that any settlement favoring San Bernardino will set a negative precedent that could eventually threaten its solvency and retirement benefits for millions of California’s workers and retirees. The fund indicated that Vallejo and Stockton, two other California cities that recently declared bankruptcy, continued making payments to their employees’ retirement fund and that allowing San Bernardino this leniency would undermine its position as a priority creditor for the municipalities of California. To make matters worse, municipal investors, including bond holders and insurers, challenge the idea that CalPERS should be paid back ahead of them. Bondholders have pursued a ruling that places CalPERS at the level of other unsecured creditors.

The legal issue is whether the pensions of government workers take precedence over other creditors in a municipal bankruptcy. CalPERS maintains that under California law, it has priority as a creditor and must continue to be paid in full, even in a bankruptcy. Bond investors and other stake holders disagree, arguing that federal bankruptcy law trumps state authority and puts them on a level playing field with CalPERS in court. CalPERS fear is that, as San Bernardino goes, so goes the state.

IBM Changes 401(k) Match

IBM, a longtime innovator in pension and 401(k) plans, recently announced some controversial changes to its 401(k) plan that could cut its retirement plan expenses. Although the formula will not change, the technology giant will no longer be making 401(k) matching contributions every pay period. Instead, IBM will make a lump-sum contribution on December 31 of each year. To be eligible for the new company match, a participant must be employed by the company on December 15.

This change could be a move to combat pressure from competitors with significantly lower benefit costs. The technology company makes generous plan contributions ranging from 6% to as much as 10% of an employee’s salary, or about $10,000 a year for the more than 200,000 eligible employees. This transition to an annual contribution will likely save the company tens of millions of dollars because it would not be making contributions to those employees who leave during the year (other than retirees). IBM stated that many of its tenured employees who will retire with the company would not be affected by the new policy. Further, the change is consistent with its commitment to invest in its 401(k) plans while maintaining its plan’s competitiveness.


This plan design shift is a continuation of the trend to examine the suitability of traditional plan match allocations. Many organizations are questioning the wisdom of these designs in the face of today’s challenging financial environment characterized by elevated competition and rising benefits (primarily heath care) costs. In recent years, many companies have chosen to jettison traditional match provisions in favor of elongating the formula to encourage additional savings (or one governed by profits to alleviate funding pressure on the plan sponsor during lean years).

Currently, end-of-year matches are only utilized by approximately 7% of 401(k) sponsors, according to benefits consulting firm Mercer. The savings attained through this design adoption would vary significantly depending on the organization’s turnover. A company may find it beneficial to allocate its cash to operations throughout the year, rather than funding a payroll-based matching arrangement. Ultimately, a plan sponsor must balance any benefits from expense savings and cash management with the costs and indirect consequences of such a move (namely, a potential drop in employee morale).

The American Taxpayer Relief Act Expands In-Plan Roth Conversions

To avoid the pending fiscal cliff, President Obama signed into law The American Taxpayer Relief Act of 2012. Included in this legislation is a provision to permit in-plan Roth conversions allowing plan participants to pay taxes on retirement savings now, and avoiding paying them later. According to the Joint Committee on Taxation, this legislation will pull forward an estimated $12.2 billion in tax revenues (putting additional pressure on future budgets) over a 10-year period to help defray the costs of a 2-month sequestration.


The rule change is a permanent amendment to the tax code. This new provision offers a broader route for employees who are considering Roth conversions in comparison to the previous opportunity provided by The Small Business Jobs and Credit Act of 2010. The prior law permitted the conversion only from those funds eligible for distribution from the plan (such as from terminating employment). However, the new amendment does not offer the same tax relief as the old rule, where conversion taxes were paid over a 2-year period. This law makes the Roth conversions taxable in the year that the funds are converted. For this reason, participants will want to carefully consider their tax strategy when considering an in-plan conversion. Some may want to convert a portion of their assets each year to minimize tax liability and avoid drifting into a higher tax bracket for that year. If this route is taken, participants are advised that the five-year tax rules prevent access to the converted money during that period.

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