WASHINGTON - The Internal Revenue Service and the Rhode Island State Treasury signed an agreement forcing the state to reimburse its pension fund $2 million for paying more benefits than federal law allows.
But a bill pending in Congress could release the state and other public funds from limiting benefits in order to remain tax-qualified plans.
After a two-year investigation of the $3.4 billion Rhode Island Retirement Systems, the IRS discovered the fund was violating Section 415 of the Internal Revenue Code, which limits contributions and benefit levels for defined benefit plans.
Section 415 prohibits a plan participant from receiving annual benefits that are higher than 100% of average pay for the three years of greatest pay. It also sets a dollar limit an employee can receive on an annual basis. In 1994, the limit is $118,800.
In Rhode Island, the IRS found 171 lawmakers were receiving pensions higher than the $10,000 limit under Section 415. In some cases, participants were receiving as much as $17,000.
The state agreed last month to pay the $2 million for the benefits that exceeded the federal limit. In addition, the state to repay $20.9 million it borrowed from the fund to cover the state budget in 1991.
Rhode Island also needs to pass legislation to codify the terms of the agreement between the state and the IRS. The bill unanimously passed the state Senate and is expected to pass the state House soon, a state spokesman said.
Some pension experts said other public pension funds face the same problem as Rhode Island. States are required to comply with Section 415 limits while being strapped with laws that set benefit levels enacted before the 1974 Employee Retirement Income Security Act.
An IRS spokesman said the IRS could be investigating other governmental entities across the country but could not comment on any specific investigations.
The states "are between a rock and a hard place," said Cathie Eitleberg, director of the Pension and Benefits Center at the Government Finance Officers Association, Washington. "Once (states) put in a benefit, it's considered a contract. So (states) either violate their own laws or federal (maximum) levels."
Currently, a provision in the tax code says public funds can be disqualified, losing their tax-qualified status, if they exceed the Section 415 limit.
Most public plans have complied with the Section 415 limit or have "grandfathered" a provision approved by the IRS that says states could opt to lift the Section 415 limit placed on employees becoming participants before 1990, provided that new members would fall under the restraints.
The federal legislation under consideration is part of the pension simplification bill, H.R. 3419, which was approved by the House Ways and Means Committee in November. It is waiting to be scheduled for debate in the House.
The provision would exempt public defined benefit plans from the 100% ceiling benefit based on the participant's highest average pay. It also would allow public plans to follow private plans' tack and create an excess benefit plan for those who exceed the Section 415's $118,800 dollar limit. Both provisions would allow government plans to keep their tax-qualified status.
The legislation has not had much luck in the past and is not expected to be successful this year, experts said.
Experts said the Section 415 limit was intended to make benefits fair among all employees, but the law actually hurts lower-paid employees who accrue a high retirement benefit through long-term service.
In 1990, the California Public Employees' Retirement System commissioned a study on how Section 415 would affect the participants who retired in 1989 and 1990. Of the 21,012 employees who retired during those two years, 166 are affected and would have received an annual initial monthly benefit of $287 less because of Section 415 if other programs were not enacted to make up the shortfall, the report stated. Of the 166 retirees affected, 52.17% received annual compensation between $40,000 and $49,000 before retirement, the report said.
"The people who would be hit the most were the people who could afford it the least," said Sandra Lund, assistant executive officer at the California fund. "And we didn't think that was the intent of the federal government."
The California retirement system opted for the grandfather clause and has placed new employees under the Section 415 limit, Ms. Lund said.