In New York City, teachers and other pedagogical employees can deposit funds into a tax-deferred annuity (TDA), managed by the public employee pension systems, that offers a fixed return investment option. These funds guarantee a 7.0 percent return for teachers in the Teachers Retirement System (TRS) and 8.25 percent return for employees in the Board of Education Retirement System (BERS).¹ These investment options are not available to other New York City public employees—and are overly generous as compared to other deferred compensation plans. Based on the recommendation of the City Actuary, the Preliminary Budget for Fiscal Year 2019 proposes to dedicate $50 million toward the TDA.² While this may appear to be a fiscally prudent step, reforming the TDA to reduce the cost—and risk—to taxpayers is a better approach.

Overview of the TDAs

In addition to contributions made toward their defined benefit pensions, New York City public employees can opt to invest in deferred compensation plans (DCPs). For teachers and other pedagogical employees, these TDAs are administered by the public pension systems, TRS and BERS. At the end of fiscal year 2017, the combined balance of the TDAs was $33.3 billion, $31.4 billion in TRS and $1.9 billion in BERS.³

Unlike DCPs for other public employees, the TDAs offer a fixed return investment option with rates guaranteed in state law. As part of a collective bargaining agreement between the Bloomberg Administration and the United Federation of Teachers (UFT), the State Legislature reduced the fixed rate for the UFT members (the majority of TRS TDA members) to 7 percent. For members of BERS, the rate remained 8.25 percent. At the end of fiscal year 2017, the balance of the TRS TDA fixed fund was $22.0 billion and the BERS TDA fixed fund was $1.4 billion.⁴

Growing Cost—and Risk—to Taxpayers

In an era of low interest rates, TDA fixed return funds—guaranteed at significantly higher rates than the market—have become an appealing investment option. More than 93,000 employees are actively making deposits into the TDA, and the share of TDA assets allocated to the fixed return has increased from 63 percent in fiscal year 2013 to 70 percent in fiscal year 2017.⁵ The guaranteed investment earnings credited to the two TDA fixed funds in fiscal year 2017 were nearly $1.6 billion.⁶

The pension systems manage the TDA funds. To provide the guaranteed return, TRS and BERS “borrow” from the fixed return funds and invest the proceeds. If the investment returns are insufficient, taxpayers make up the shortfall via an increase from the City’s budget contribution to the pension funds.

This is problematic for two important reasons. First, City taxpayers are providing a huge subsidy. Since TDA members can withdraw or transfer assets at will, the funds should be treated as short-term investments. Since 2008 short-term interest rates have been below 1 percent; in the past year, they have climbed but remain below 2 percent—far below the guaranteed rates of the funds. This means taxpayers have been on the hook for subsidizing $1.4 billion in excess of what these funds would have earned on the market in fiscal year 2017.⁷

Second, since the pension funds borrow from the TDA to invest the funds, they are highly leveraged.  CBC estimates that if TRS experienced market losses comparable to 2008 and 2009, the TDA would need to cover a $4.5 billion loss. ⁸

Budget Proposal Doesn’t Solve the Problem

The City’s pension funds assume 7 percent rate of return on investments; however, the TDA fixed funds continue to provide 8.25 percent returns to some members. The Preliminary Budget for Fiscal Year 2019 proposes an additional $50 million contribution to the pension fund annually to account for the difference. While this may appear to be fiscally prudent, it does not address the broader issues: The benefits offered by the TDA are fiscally irresponsible and unsustainable.⁹

The City should pursue state legislation to reform the TDA to eliminate the risk to taxpayers. One option is to eliminate the TDA and transfer the current TDA assets to the Office of Labor Relations to be managed as part of City’s deferred compensation plan. A more gradual approach would eliminate the TDA for new hires and convert the fixed return fund to a variable rate fund. Alternatively, the TDA fixed rate could be retained but set at a rate equal to the average market rate of outstanding long-term federal securities. Any of these options would put TRS, BERS, and by extension City taxpayers, on firmer ground.