“Catastrophic” Tax Consequences of Minnesota State Pension Errors?
Believe it or not, accurate state pension performance and cost reporting does matter. Inflating results can have serious consequences.
When large public pensions misstate their investment performance results—whether intentionally, or unintentionally—it matters to participants who depend upon the plans for their retirement security and stakeholders, including taxpayers.
Less obvious, the tax consequences of performance errors can be “catastrophic,” according to tax experts.
In 2021, when internal documents at Pennsylvania’s largest pension fund—the Public School Employees’ Retirement System—revealed a performance calculation error, the FBI and SEC launched investigations, the fund’s board began its own probe and 100,000 public school employees reportedly suddenly faced paying more into the retirement system. The error related to “data corruption” in just a single month—April 2015—over the near-decade-long period included in the performance calculation.
During the December certification, the fund’s annual investment return was pegged at 6.38%. Although this fell short of the pension fund’s assumed rate of return of 7.25%, it barely surpassed the 6.36% threshold needed to avoid an increase in pension payments for 100,000 school workers. The state’s “risk sharing” law means school employees, along with taxpayers, have to contribute more when the pension’s investment portfolio underperforms.
The mistake may have inadvertently prevented an increase in teachers’ pension contributions while at the same time passing the costs onto the commonwealth’s taxpayers. According to The Philadelphia Inquirer, teachers would have had to pay an estimated $25 million a year extra if returns had come in lower.
While the one-time error was small, it falsely boosted the $64 billion fund’s performance over a financial quarter just enough to wrongly lift the fund’s financial returns over a key state-mandated hurdle used to gauge performance.
The board had little choice but to fix the number. A top tax lawyer warned the board that failure to do so would be “catastrophic” and force half a million current and retired school workers to pay future income taxes on pensions immediately.
So, what’s this got to do with Minnesota’s state pensions?
In connection with our crowdfunded forensic investigation of two Minnesota pensions, the State Board of Investment (SBI) and Teacher Retirement Association (TRA), we identified certain significant performance and costs errors. Specifically, performance results were overstated and investment costs massively understated.
Since both TRA and SBI failed to provide any of the documents we requested related to these datapoints, we cannot know for certain—and can only estimate—the magnitude of any potential errors or omissions. Further, we cannot know the tax consequences, or other legal or regulatory implications of any pension intentional or unintentional calculation errors.
However, with respect to the two Minnesota pensions, the suspect outperformance is consistent over all periods of time (1, 5, 10, 20 and 30 years), not merely a single month in a near-decade-long period as in Pennsylvania. Coincidentally, the outside consultant ultimately found responsible for the error at the Pennsylvania pension was the same consultant used by both TRA and SBI.
Putting aside any potential IRS issues, are there any potential Securities and Exchange Commission worries for states that misrepresent their pensions’ health?
In 2014, the Securities and Exchange Commission brought securities fraud charges against the state of Kansas stemming from a nationwide review of bond offering documents to determine whether municipalities were properly disclosing material pension liabilities and other risks to investors. According to the SEC’s cease-and-desist order instituted against Kansas, the state’s offering documents failed to disclose that the state’s pension system was significantly underfunded, and the unfunded pension liability created a repayment risk for investors in those bonds.
In 2013, the Securities and Exchange Commission charged the State of Illinois with securities fraud for misleading municipal bond investors about the state’s approach to funding its pension obligations. The SEC investigation revealed that Illinois failed to inform investors about the impact of problems with its pension funding schedule as the state offered and sold more than $2.2 billion worth of municipal bonds from 2005 to early 2009. Illinois failed to disclose that its statutory plan significantly underfunded the state’s pension obligations and increased the risk to its overall financial condition. The state also misled investors about the effect of changes to its statutory plan. This enforcement action marked the second time that the SEC had charged a state with violating federal securities laws in their public pension disclosures. The SEC charged New Jersey in 2010 with misleading municipal bond investors about its underfunding of the state’s two largest pension plans.
So, any erroneous Minnesota pension performance or investment fee calculations—whether intentional or not—may be of concern to the SEC.
Does Accuracy in Public Pension Reporting Even Matter?
Given that our nation’s public pensions almost universally inflate their investment results and funding levels, as well as understate investment costs, it’s easy to believe that accuracy in reporting their financial health really doesn’t matter. State officials profit from the financial shenanigans and federal officials are wary of venturing into state politics. Even in those rare instances when wrongdoing is exposed, nothing happens—problems are swept under the rug, or pushed off for decades.
It’s easy for state politicians (like Gina Raimondo in Rhode Island) to propose bogus pension “fixes” with resulting losses that won’t be fully realized for years or even decades. There’s no downside to making promises to the public which will be broken long after the elected official has moved on.
It’s easy for state politicians (like Gina Raimondo in Rhode Island) to propose bogus pension “fixes” with resulting losses that won’t be fully realized for years or even decades. There’s no downside to making promises to the public which will be broken long after the elected official has moved on.
But, make no mistake about it: Every now and then, someone gets caught.
Particularly if you are a participant in a public pension—depending upon the plan for your retirement security—it’s up to you to doggedly watch over your savings. To assume someone else has your best interests in mind would be a huge mistake.