Many state and local governments will never be able to properly fund the retiree medical benefits they have promised their employees. Even when the economy recovers, there will be so many other claims on future revenues that many of these "other post-employment benefits" (OPEB) plans are likely to be reduced or restructured.
Look at pension costs. These are now projected to increase by another 2 to 4 percent of most public employers' payroll. They will take precedence over future contributions to OPEB plans. That means triage, which will translate into cutbacks on future retiree medical benefits.
From the employer's perspective, sustainability of the benefit is the primary concern -- the ability to keep funding these plans at levels taxpayers will support. For employees, sustainability is also important, but they want to be assured there will be a benefit there when they need it -- even if it is somewhat reduced. But they also want to know that the benefit will be sufficient to meet their needs in retirement.
Here's one way for employers to assure sustainability and sufficiency of public employee retiree health plans: Offer a voluntary supplemental savings vehicle that will enable workers to put away the extra money they'll need to fill the gap between their future health care costs and what the employer and Medicare will provide. That may be easier said than done. Unfortunately, the vehicles available for such savings are not as convenient and flexible as they need to be.
Employers could, for instance, set up a retiree health savings account under Section 115 of the Internal Revenue Code, but the IRS disallows variable, voluntary contribution rates and changes in these plans. So, everybody must contribute the same percent of pay each year. Although these 115 accounts are tax-free when used for qualified purposes, they are just not very employee-friendly.
Another, more feasible approach is to use a variation on the 457 deferred compensation account. State and local workers can contribute voluntarily to these accounts, which are similar to corporate 401(k) plans. They pay income taxes either when the money is withdrawn (a conventional 457 plan) or before they make the contribution (a Roth 457). Under 457 rules, they can change their contribution amounts at any time. But, they cannot withdraw money for medical benefits without paying taxes, as a less flexible 115 plan allows.
What public employees need for retirement health (RH) savings is the best of both worlds: a "457-RH" feature that lets them save as much as $5,000 annually in an individual workplace savings account, at whatever savings rate they can afford at any time. Presently, public safety employees are allowed to take a small dab of money out of 457 plans for medical costs each year, but Congress needs to expand that provision to permit all state and local government employees to open a separate 457 account with additional contribution limits. These special separate tax-free savings limits could start at $2,000 annually and be increased to $5,000 over the following five years in order to smooth the federal budgetary impact.
When employees are empowered to save sufficiently to supplement the tax-free benefits provided by their employers, it will be easier for public employers to redesign their benefits plans and start sharing more equitably the financial responsibility for this ever-increasing cost. Giving employees a federal tax benefit as part of the deal will also make such arrangements more attractive to labor groups.
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