Agency will examine N.J.'s 7 pension plans, including how benefits accrue and who is eligible — What it won’t look into is how they were underfunded by $54 billion
Former state pension director Fred Beaver, seen here in this 2006 file photo, said he began seeking IRS approval before he stepped down last year.TRENTON — Like taxpayers, states don’t usually volunteer to open their books to the Internal Revenue Service.
But that’s exactly what New Jersey is doing with its troubled public employee pension funds, and now the state is waiting to find out if it’s in compliance with the federal tax code.
In January, the state Treasury Department asked the IRS to review the tangle of rules and regulations that guide the pension plans, currently valued at $70 billion, for hundreds of thousands of state employees and issue what is called a determination letter, essentially signing off on how the plans are being administered.
Former state pension director Fred Beaver said he began seeking IRS approval before stepping down last year because he was concerned about the impact of changes to laws regulating the funds through the years.
"I was concerned about an audit, and I wanted to make sure there were no surprises," Beaver said.
The federal review comes as the state’s pension plans face uncertainty and increased scrutiny. With a shortfall of $54 billion, they are among the most underfinanced in the nation and at the center of a tug of war between Gov. Chris Christie and Democratic lawmakers over how to stabilize the system.
Last month, Standard and Poor’s lowered the state’s bond rating to among the lowest in the country, citing the poor financing levels of pension funds.
After the review, which could take years, the IRS might sign off on the pensions or suggest changes that if ignored could result in the agency stripping the plans of their tax exempt status.
Beaver said that with the IRS and the Securities Exchange Commission focusing their attention on the problematic state pensions, he assumed he would get a call from them. So he decided to call first.
Seeking IRS approval of how retirement plans are administered has been common practice for nonprofit groups and private businesses for decades. But financially stretched state and local governments, which have had to juggle their funds in recent years to meet their budget demands, have been reluctant to follow suit. Why look for trouble from the IRS, they figured.
In New Jersey’s case, the agency will examine how the state’s seven pension plans for public employees are being overseen, including how benefits are accrued and who is eligible for them. What it won’t look into is how the plans became underfunded by $54 billion.
San Diego and New Hampshire received stamps of approval from the IRS in recent years, but only after lawmakers adopted significant changes that touched off an outcry from public worker unions and a legal challenge in New Hampshire. The changes sought included the elimination of special benefits for union leaders, the capping of pension payments and the separation of pension funds from medical benefit accounts.
Not every state has had to amend its pension plans. For instance, Maine got an OK from the IRS in January after a six-month review that resulted in no changes, according to Sandy Matheson, executive director of the Maine Public Employee Retirement System. "We were all surprised," said Matheson.
On the other hand, Beaver said, the process may be painful, costly and eventually force legislators to make politically difficult changes,
For that reason, New Jersey has contracted the law of firm of Ice Miller of Indiana, which specializes in pension fund cases, to handle the filing. So far, the state has paid the firm $163,500, and another $112,194 is awaiting final approval, according to the Treasury Department. Attorneys from Ice Miller declined to be interviewed for this report.
The state submitted 15 pages of changes it is seeking, records show, including limiting pension calculations to the first $200,000 in salary and empowering the director of the Division of Pensions and Benefits to make changes to ensure compliance with the federal tax code.
The other changes, mostly technical, deal with how employees can roll over funds and purchase service credits. The state hopes the changes will be the only ones necessary.
"If federal law doesn’t change, then we think we’ll be fine," said Andrew Pratt, a spokesman with the state Treasury Department. "But, if not, we’ll do whatever we need to do to make sure we’re in compliance."
He added: "It’s also good to have a great working relationship with the IRS," saying opening the books to the IRS would help ensure leniency, should problems arise,
It is unclear if Christie or administration officials notified public employee unions of the filing, though the state indicated that was the case on the IRS application.
Steve Wollmer, a spokesman for the New Jersey Education Association, said the teachers union was aware Christie was considering filing for the determination letter, but was never formally notified.
Marcia Wagner, a managing director of the Wagner Law Group in Boston, which specializes in employee benefits, said an increasing number of states and local governments are seeking such letters since the IRS has made it easier to submit to a review.
"In the end, this is a good thing," Wagner said. "The IRS finally got its act together and is looking at pension plans, and they tried hard to assuage people’s fears, and it has worked."