|
|||||||
|
|
|
|||||
|
|
|||||||
Savvy People, Real Money
How To Gain Purchasing Power Without Any Pain
Submitted by MERF to City leaders and labor representatives
July, 2000
The City can provide employees a tax incentive plan to save for retiree health care expenses at no cost to the City.
Background
Retiring City employees from MERF and Police and Fire are generally under age 65. Approximately 1,000 new MERF and Police and Fire employees are eligible to retire over the next eight years.
Many of these young retirees accept new employment and work for five or more additional years.
Retirees under 65 pay the full cost of health insurance, which currently costs
$650 per month for family coverage. Retirees must pay for health care with after tax dollars.
Current City policy pays out unused vacation at retirement and pays out a portion of unused sick leave over five years as a taxable benefit. The average retiree is in his (or her) highest tax bracket when these payments are received and taxed.
Improved Alternative
Public sector employers can adopt a retiree health care trust to allow bargaining groups to convert taxable sick leave and vacation payments (hereinafter referred to as severance) to tax-free payments.
Each bargaining unit can independently decide if they want to elect this alternative. All members in the bargaining unit is treated the same once the election is made.
Each bargaining unit has broad discretion to not elect or to elect all or a portion of the severance payments as eligible for tax free status due to its dedication to retiree health care needs.
Un-represented employees can also participate if the council or board adopts the tax-free alternative for this group.
Each employee within an electing bargaining unit has an individually owned account. The employee can choose to spend the severance payments on immediate health care costs or can elect to save the money for future health care needs. If the employee dies, his (or her) heirs can use the funds for health care needs on a tax-free basis, or they can pay the tax and use the funds for any purpose.
Employees have 13 investment options including stocks, bonds, money market accounts and mixtures of the options. Individual employees may select the investment option they are most comfortable with, much like deferred compensation. All earnings on the account are tax-free as long as they are spent on health care.
The fees to maintain each account are generally less than 1% per year and are paid by the employee through a reduction in the earnings on the account.
Employees enjoy higher returns through professionally managed funds and would be expected to earn more than if the money was invested in money market or savings accounts.
Employees have an incentive to maintain their accounts to allow the account balances to grow.
The purchasing power of the employee’s severance payment is enhanced by at least 53% and can be enhanced by 142% or better if the employee keeps the funds in the account for five years or more.
With the exception of pension plan coverage and deferred compensation, employees have few options to grow savings on a tax deferred or tax free basis. Unlike pensions and deferred compensation, which are taxed as money is received, retiree health accounts are never taxed as long as they are used for health care.
The increased purchasing power value of this alternative to an employee is shown on Exhibit I and II.
Bargaining units can elect to dedicate a portion of future raises to the retiree health care trust accounts.
Each bargaining unit has the option to consider dedicating a fixed dollar amount or a percentage of future raises to the retiree health care accounts. There is no requirement that any unit elect to do so. However, there is a considerable tax advantage in dedicating a portion of the raises to these accounts because the amount is not taxed, earnings are not taxed and any payment is not taxed if used for health care. The election is made as part of the final collective bargaining contract. A Memorandum of Understanding can be used to elect coverage through modification of an existing contract, so the bargaining unit can choose to include the option in some contracts, can eliminate the option in future years, or change the amount from year to year.
Employees terminating employment may elect to maintain their account or they can terminate the account and pay tax on the refund. Unlike pension refunds, there are no penalties if an employee terminates the account when he leaves employment.
Unlike many fringe benefits used as retention tools, this option does not cost the City, but still encourages employees to maintain their employment with the City.
EXHIBIT 1
Meet Mary Johnson Example
Mary, age 52, will retire from the City this year. She has worked in Finance for 30 years and looks forward to a change in pace. Her husband, age 58, works at 3M. Mary will work at Lunds in the accounting department for five years and plans to retire permanently to gardening and the lake at age 57. Her husband will also retire then at age 63.
Mary and her husband will be in the 40% tax bracket (federal and state). Mary will receive $200 in sick leave severance for sixty months. Under the retiree health care plan, it is assumed that Mary will earn 9.5% per year on her severance contributions and that she will leave each severance payment in her account for five years. Under the current city policy, it is assumed that Mary invests in a money market account that earns 3% after taxes.
EXHIBIT 1 (Continued)
Mary will pay tax on $200 and have $120 to invest. The total value of Mary’s 60 months of severance will be $8,100.
Mary will be able to invest the full $200. The total value of Mary’s 60 months of severance is $18,900.
EXHIBIT 2
Meet Paul Swenson Example
Paul, age 50, is retiring from the Minneapolis Police Department. He has worked for 25 years and looks forward to a less stressful job. He plans to move to Arizona and join the staff of the State Corrections System, where he will work for ten years.
Paul is single and is currently in the 35% tax bracket. Paul will receive $200 in sick leave severance for sixty months. Under the retiree health care plan, it is assumed that Paul will earn 9.5% per year (the expected return for mixed stock and bond accounts) and that he will leave each payment in his account for ten years. Under current City policy it is assumed that Paul will invest the severance money left after taxes are paid in a money market account that earns 3% after taxes.
Paul will pay tax on $200 and have $124 to invest. The total value of Paul’s 60 months of severance after 10 years will be $9,676.
EXHIBIT 2 (Continued)
Paul will be able to invest the full $200. The total value of Paul’s 60 months of severance after 10 years will be $29,760.