Many state and local governments will not be able to properly fund their retiree medical benefits. Even when the economy recovers, there will be so many other claims on future revenues that post-employment benefits are likely to be reduced or restructured.
It starts with pressure on pension costs. These are now projected to increase by 3 to 5 percent of most public employers' payrolls and will take precedence over future contributions to other post-employment benefits. Budgetary triage will translate into cutbacks on future retiree medical benefits.
For employers, sustainability of the health benefit is the primary concern. They want to be able to fund these plans at levels taxpayers will support. For employees, sustainability is also important. They want to be assured the benefit will be 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 try to ensure sustainability and sufficiency: Offer a voluntary, supplemental savings vehicle so that workers can put away extra money 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. Vehicles 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 percentage of pay each year. Although these 115 accounts are tax-free when used for qualified purposes, they are just not very employee-friendly.
Another 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 They pay income taxes either when the money is withdrawn (a conventional 457 plan) or before they make the contribution (a Roth 457). They can change their contribution amounts at any time, but cannot withdraw money for medical benefits without paying taxes, as they can under the 115 plan.
What public employees need is what I call a "457-RH" - the RH is for retirement health. It would be the best of both worlds, letting them save as much as $5,000 annually in an individual workplace savings account and withdraw those funds tax-free for medical expenses. Presently, only public-safety employees are allowed to take a small bit of money out of their 457 plans tax-free for medical costs. Congress should expand that provision so all state and local government workers can do so.
When employees can save money to supplement the tax-free benefits, it will be easier for public employers to redesign benefits in ways that share the responsibility for this ever-increasing cost.
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