Q Case Discussion 18: New Jersey State Pension System New Jersey’s defined-benefit pension system for state employees is fully portable across all jobs for which the employer is the State of New Jersey. It has a five-year vesting schedule, and pension benefits depend on: 1) a worker’s years of service in state employment, 2) the age at retirement, and 3) the average of the three highest years of state employment. Notice that the third variable averages the three highest years of state employment, which means that a worker could hold multiple state jobs simultaneously, in which case the worker’s state employment for a given year would be the sum of compensation received from all of those jobs in that year. All jobs “count”, even part-time jobs with very short hours, as long as the employer is the State. The plan also allows (or did at one time) a “buyback feature”, which works as follows. Workers who are vested in the pension and subsequently leave state employment can choose either to remain in the pension (meaning that they can begin collecting pension benefits once they reach retirement age and submit an application) or they can “cash out” of the pension system by taking a one-time, lump sum payment when leaving state employment, in which case they are out of the pension system. If a worker cashes out, leaving the system, and then re-enters the system (starting over from scratch) in a future year, that worker is allowed to buy back the cashed-out years from the earlier years of service, at a fixed per-year price that the State determines. That fixed price is based on the worker’s current state employment income. The higher the worker’s current state employment income, the higher the worker’s future pension income will be, and, therefore, the higher the price the State will charge to allow the worker to increase “years of service” by buying back the years of service that had been cashed out previously. A worker who is vested in the system, cashes out, and then re-enters the system has to start over from scratch, which means completing another five-year vesting period. Once vested, the worker can choose to buy back the earlier years. If the years are bought back, they “count” just as much as all other years worked, which means they can also contribute, potentially, to the “3 highest years of state employment income”. 1. From the perspective of the State of NJ, what are the advantages and disadvantages of selling prior years of service to employees who cashed out of the system and then re-entered it later? 2. What is the rationale for basing the “buyback price” on a worker’s current state employment income? What are the advantages and disadvantages of such pricing? 3. Describe a specific strategy a worker could potentially use to exploit these rules, particularly the rules surrounding the buyback provision, to make a lot of money at the expense of the State. 4. How concerned should the State be about the issue you identified in #3? Are such exploitations more likely to be exceptional cases, or widespread abuses? 5. How would you modify the system to prevent (or mitigate) the problem identified in #3? Explain the advantages and disadvantages of your proposed solution.