Monday, December 27, 2010

Outstanding Loans at Retirement (also Deficits)

Tier 4 Outstanding Loans at Retirement (also Deficits)

Many Tier 4 NYCERS members retire with a pension loan outstanding. The member can choose to pay off the full outstanding loan or have his/her benefit reduced by the actuarial value of the outstanding loan.

The reduction is accomplished by dividing the amount of the outstanding loan by an annuity factor to produce the amount of the annual reduction of the full pension benefit. The annuity factor is a function of an interest rate and one of the two Tier 4 mortality tables (service & disability).

The loan statute specifies that the interest rate changes each year and is equal to the 30 year US Treasury bond rate on January 1 of that year. All retirements during that year are keyed to that interest rate. That means that the cost is dependent on the year you retire. The factors change every year.

I’ve listed below a small snapshot of the service annuity factors for Tier 3&4 loans over the last five years as well as Tier 1&2 loan factors which do not vhange each year. For some reason NYCERS does not list the full tables when discussing the pension benefit reduction for outstanding loans at retirement.

Loan reduction factors – Service Retirements
****Tier 3&4 Tier 3&4Tier 3&4Tier 3&4Tier 3&4 Tiers 1&2Tiers 1&2
Year20062007200820092010 all yearsall years
Interest raten/a4.81%4.45% 2.69%4.63% 4%(F)7%(U)
Age at
55 13.90313.47413.99217.10613.729 13.80310.941
56 13.68113.26613.76716.76413.513 13.50110.810
57 13.45213.05213.53516.41613.290 13.19310.673
58 13.21812.83213.29716.06213.061 12.88110.531
59 12.97712.60613.05415.70412.826 12.56610.383
60 12.73112.37412.80515.34312.586 12.24610.230
61 12.48012.13812.55114.97712.341 11.92310.072
62 12.22411.89612.29214.60812.091 11.5969.909

The Tier 4 loan annuity factors are different from the factors used for computing the reduction for optional pension benefits. At retirement, a retiree can pick these benefits in lieu of his/her full maximum pension benefit. Optional benefits provide payment to a beneficiary when the retiree dies, whereas the maximum benefits stops upon the death of the retiree. As of August 19, 1985 the interest rate for these annuity factors is 7% (see the Tier 1&2 factors in the table).

Tier 3&4 Members who retired in 2009 received a significant break on the benefit reduction for outstanding loans. This was tied into lower interest rates caused by the financial crisis that hit in late 2008. A $10,000 outstanding loan for 2009 retirement at age 55 caused a $584.59 (=$10,000/17.106) annual reduction. In 2008, the same $10,000 loan resulted in a $714.69 (=$10,000/13.992) annual reduction at age 55.

In Tier 1&2, the same annuity factors are used for both outstanding loans/deficits and optional benefits. They are based on a 4% (female mortality) or 7% (unisex mortality) interest rate depending on which produces the best benefit. The factors do not fluctuate from year to year. There is also a provision which allows Tier 1&2 members contribute excess contributions. This, in turn, allows for an additional annual annuity paid in retirement based on these additional member (not employer) contributions. Tier 4 makes no provision for excess benefits based on excess contributions.

Note: Prior to 1991, the start of the Tier 4 Loan program, deficits in contributions resulted in the loss of the service credit associated with the missing pension deductions. Since the loan program offered an actuarial reduction process, NYCERS extended this process to deficits. NYCERS then offered members, retiring with deficits, the opportunity to have the deficit treated as an outstanding loan. This allowed the member to take an actuarial benefit reduction rather than the loss of the service credit. Usually this would produce a lower benefit reduction.

Interestingly, from February 18, 2002 to February 8, 2006, the US Treasury did not offer 30 year bonds and therefore, there were no daily quotes for these securities during this period. It is not clear what interest rate the NYCERS actuary used for retirees between 2003 and 2006.