The VRS solution

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Print this page By James M. Shepherd, CPA

Over the years Virginia has used various political budgeting techniques that enabled a reduction in the amounts needed to properly fund the Virginia Retirement System (VRS).The underfunding for VRS, now reported to be $19.9 billion, threatens the future retirement benefits of all state workers. 

Leadership is needed to address this problem, but it becomes easier to make hard decisions when there is no choice. While change clearly needs to be made, state employees should be recognized for their hard work, and they deserve the benefits that were promised. What makes their compensation competitive is not their salaries, but the pension plan and health insurance benefits.

Over the last 20 years, private-sector employees have seen their companies’ defined-benefit plans terminated in favor of self-contributory 401(k) plans. Unlike the state, the private sector did not have the option of underfunding its retirement plans. It had to meet funding requirements or face the wrath of federal pension regulators. As funding became prohibitive, many companies came to the conclusion that they could no longer provide this benefit.

As a result, many American workers must fund their own retirement accounts, and many will be unable to retire with the same comfort as their parents. What employees do not realize is that it takes a massive amount of personal savings to equal the benefit they would have received from a defined-benefit pension plan. This is the reason the commonwealth is having such a difficult time with the VRS, as it takes enormous amounts of funding, which was easy to sidestep until now.

While the main problem with the VRS has been underfunding, that becomes increasingly problematic when coupled with unrealistic return assumptions. The VRS used to assume an investment return rate as high as 8 percent, but reduced that to 7 percent in 2010 — still high compared to most private-sector plans. Although the investment management of the VRS has performed reasonably well in light of difficult circumstances, we cannot and should not rely on future investment performance to make up the large deficit. It is also not prudent to try to make up for lost time by taking on additional risk. More and more state and municipal pensions are trying to enhance returns through increased use of more expensive active managers and private-equity exposure. The choices that we make now will affect all of us for many years, and we must demand that our leaders use reasonable assumptions and make responsible decisions.

The state is now faced with correcting its underfunding, and there is no responsible way to correct it without pain to all Virginians. Current cost-saving measures that are being “floated” to existing employees include changes to the cost of living calculation, a reduction to disability benefits and modification to the average final salary calculation. These measures alone won’t correct the problem, and existing employees should not have to pay this price in addition to asking them for more funding. So what is the most responsible way to approach this deficit funding issue?

The federal government dealt with a similar situation in the 1980s. They changed from the Civil Service Retirement System (CSRS) to the Federal Employees Retirement System (FERS). In essence, a demarcation line was drawn giving new federal employees a watered-down pension plan, inclusion in Social Security and a 401(k) option, while current employees remained under the CSRS. Structuring the solution for the VRS system like the federal plan and phasing out the state’s current defined-benefit plan would help solve the problem. Creating a pension system with a more flexible combination of 401(k) options and a reduced pension benefit for younger employees, new hires and short-term employees makes sense, but we must also continue to honor the existing benefits (without change) for existing employees. It is not right to penalize those who have worked for years under the assumption that they would have a retirement benefit.

Changing the structure alone, however, is not enough. Increased contributions by state employees and the state’s matching contribution will be necessary. State employees will feel the pain that many employees in the private sector have felt over the last 20 years, and it will not be popular. 

As citizens, we elect our state leaders and hope they will look beyond the next election, to make difficult decisions courageously and lead us through adversity with a long-term vision that is in the best interest of all Virginians. It took guts to address this situation, and I do applaud the current administration for doing so. That may mean there will be discomfort or pain. All of us must understand we have contributed to a long-term problem, and we must be willing to be part of the long-term solution.

As a CPA, l help individuals, nonprofits and companies make difficult financial decisions. I often have to tell people things they don’t want to hear. Our VRS problem can’t be fixed unless someone has the courage to tell us the truth and get us on the right track to correct it. I am calling on state leaders to do the right thing for all Virginians. Look at the facts of this sensitive situation, bring us together to make the difficult choices and lead us to a fair and unified solution.

James M. Shepherd, CPA, PFS, CFP®, is managing director and founding shareholder of Kuehl Shepherd Kozlowski & Associates Inc. He is a vice chair of the Virginia Society of CPAs (VSCPA).

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