Episode 76 – Sorting out contribution rate changes
Every two years, contribution rates for Washington’s retirement plans change and that can raise questions. When a relative asked Amber why employer rates went down, she realized it’s just as important to understand decreases as increases. In this episode, we unpack how these rates are set, why they fluctuate, and how you can feel confident that Washington’s pensions remain a reliable, guaranteed source of income.
Episode transcript:
[music intro]
Jenny
Welcome back to Fund Your Future with DRS. Back in July, it was announced that the contribution rates for Washington retirement plans has changed and even though this rate changes every two years, it sometimes causes a little concern. So we wanted to take a little closer look at this. We’ve invited Amber to the podcast studio, who’s a team member here at DRS to talk a little bit more about this and your experience with some family members.
Amber
Yes. Thank you. I’ve had a family member approach me at a barbecue and, needed to know all of the details.
Seth
One of my favorite things about working at DRS is just the random questions you get from people. It doesn’t really matter what you do it, you’re going to get questions. And Amber shared this story with me and we said, let’s record an episode about this because I’ve answered this question a few times over the last couple of months, and it does seem like every time contribution rates change, people have an opinion on why they changed, how they should have changed differently…maybe.
A number of years ago, contribution rates were going up every two years. And every time they went up, people would say, “but the stock market did great last year, why is this happening?” And there’s a lot of underlying reasons why contribution rates change.
So Amber, could just tell us a little bit about what happened. Like as far as your experience, what question you received and how you tried to answer it?
Amber
Yeah, it was interesting because I’ve been on those phone calls with members who want to know why: Why is this changing? What’s different? And this was completely different. Caught me out of left field because usually it’s “why did it increase?” And this time it was “why did it decrease? Why don’t why don’t you need these funds anymore?”
So, I was at a barbecue and my uncle said, “hey, I need to know what’s going on. Why did employer contribution rates decrease so drastically?” And I don’t work in the customer facing area anymore. And I knew my member contribution rates decreased. I don’t pay any attention to the employer rates because I know that they don’t impact my benefit amount.
So, I didn’t care. So, I had to ask him to tell me more. What do you mean “decrease so drastically.” And he came at me with numbers on the math and I have it written down here. He said “my PERS 2 employer rate was 8.9, now it’s 5.3. That’s a 40% decrease in funds.” And I couldn’t do the math. We’re at a barbecue, I’m like, “what do you mean 40%? And he’s like, it’s 3.6, but 3.6% difference when we’re talking about 8.9 total. If you do the math, it turns into a 40% decrease total.
He’s like that’s huge. You know, of course you want to extrapolate to something more drastic. It’s like that’s 50% difference. And I explained that we have the select committee, we have the actuaries office, we have all of these other governing bodies and people who do forecasting and look at these and determine every two years what should happen or what could change with our contribution rates.
And then they make those changes accordingly. He was convinced it was the legislature, politicians making those decisions. I’m like: “That’s not generally how that works.” So I tried to explain what typically happens. He definitely wasn’t satisfied, though.
Seth
Yeah, so much to unpack there, which is great. Maybe the general first piece of background information that can be helpful for people to know is that generally Plan 2, for PERS and school employees and teachers is designed to be a cost share, an even split. So, half the amount that gets paid in is paid by employees. As you mentioned, your contribution rates went down slightly as a PERS 2 member, and then the other half is paid by employers.
So, they’re in general paying the same amount. However, over the last decades, employers have paid an extra contribution amount to help fund Plan 1s in PERS and the Teachers Retirement System. Because those plans had been underfunded and we did a previous episode, I think we talked a little bit about this with Matt Smith, the state actuary. When he was on episode about this plan to get the Plan 1s, up to fully funded.
Employers have been making these extra contributions for a long time, and what has happened recently is that the Plan 1s have gotten very close to fully funded, and some people might argue that they’re already fully funded because there’s a little bit of lag. As both of you have said, the contribution rates change every two years, but that’s based on data from the year before. And then then you’re projecting contribution rates for the next two years, and that decision is made the year before that. So, there’s this whole kind of lag process in the system.
And so, what happened in July of 2025 – and really it was the legislature in the last legislative session that said, “we’re going to take a pause on this extra contributions that are being paid into Plan 1, for the next four years.”
So even though the percentage of salary dropped by 3.9%, roughly that employers were paying in most of that drop was from the unfunded liability part that was being paid for Plan 1. So the extra amount that employers were paying in and over the next four years, as you mentioned, as well, the Select Committee on Pension Policy and the office, the State Actuary and the Pension Funding Council and all these different entities that study pension funding are going to look at this and see: is Plan 1 in PERS and TRS fully funded or do we need to put some more money in, in the future?
But generally this is good news. We’re getting really close to fully funded of these older plans and the amount that is necessary, even, as you said, for the Plan 2 person, for the employee rates, those dropped as well. Usually we expect people to be excited about that. And so that’s probably part of what caught you off guard in the conversation.
Amber
Absolutely. I was like, well, aren’t you happy about this?
Seth
Isn’t that good news?
Amber
“Your rate decreased too. Isn’t that great? That’s a little more on your paycheck.” He’s like, “I don’t want it. I don’t want it.” Of course he’s in that 5 to 10 year gap before retirement. So, he’s like “everything put it away towards retirement. I don’t need it right now. I’ll need it then.” So, any bit that isn’t going there anymore is a concern.
Yeah. Very different from what I’m used to hearing. Or if the employer contribution decreases more than the member contributions, why can’t the member contribution decrease? It’s never “Please continue to take more money.” That’s never been, the case that I hear.
Seth
I was thinking about this in terms of, like, more like a personal finance question. If a person just had a 401(k) and, you know, they said, oh, you should put away 10%, if you start putting away 10%, you’re going to be good by the time you reach retirement. And somebody kind of panicked a little bit and said, “well, I’m going to put it in 15 just to be safe.”
And then they get really close to retirement and they’re like, “oh, actually, maybe I put in more than I needed and now I can back it down.” And some people might be okay with that, and some people still might feel uncomfortable and say, “well, I want to make sure I have extra, I want to make sure I have a cushion.” And I think one of the things that always makes people nervous is, is their pension going to be there?
As you’re saying, your uncle is getting close to retirement. “Am I still going to have that guaranteed benefit ten, 20, 30 years down the road?”
Amber
Yes. That was a big concern for him because he’s also, of course, looking towards retirement, looking at Social Security and seeing history of that Social Security age, continue to increase, go up a bit before they can have their full Social Security benefit. So he’s concerned that either the pension won’t be funded when he is either ready to retire or 20 years after he’s retired and, you know, still needs that monthly pension payment or that something will cause how we calculate a benefit to change, to decrease in order to kind of bridge the gap between an unfunded pension and continuing to pay a retiree.
Jenny
Well, I think that’s why it’s all the more reason to say that we’re actually very close to having these pensions fully funded so that we, I would assume, hopefully not have to change how much we’re contributing in. And like you said, it hopefully shouldn’t worry too much because it is based on that factor of how many years you worked.
You know, a percentage times your salary and all that. But I could see how his concern was that even that would change.
Amber
Yes.
Seth
It is hard because some people will always be skeptical. The Social Security example is a really good example. People have seen negative impacts. And I think, you know, our Plan 1 folks in PERS 1 and TRS 1, previously had a COLA in their plan and currently don’t receive a COLA because it was something that could be taken away through legislation.
Most things within the state retirement benefits can’t be taken away, but it is hard to get into that nuance of what is legally allowed, what is not legally allowed. A court has to maybe even make a decision on that. It could be in a court case for a long time. So there certainly are unknowns there.
But I think, Jenny, to your point, it is helpful to reinforce to people… and the State Actuaries office actually just released their most recent evaluation report that shows across the board the plans in the state. If you add them all together, they’re 100% funded. Now, that’s not the way the plans work exactly. There are some plans that are overfunded and some plans that are underfunded. But once again, it’s a position of strength for the state. And that doesn’t mean that we can stop putting money into the plans. Now for these closed plans like the Plan 1s, maybe we can, but for our Plan 2s and 3s, we’re still actively contributing.
As Amber was saying, she’s an employee that is still paying into the plans that just means we need to continue on that same sort of trajectory. And one of the things that’s really good about the way the Washington plans are set up is, as you both have said, we revisit this at least every two years: Are we on track? And we’re looking back. We’re not just like in the very exact moment, like, “oh, the stock market went up yesterday, we can put in less money.” We’re looking at over a long period of time, both backwards and forwards.
Amber
That was going to be my next question is: could you explain how that sort of evaluation works. Are we just looking back to see how the last two years have gone, or if we’re also looking at future projections on where markets may be at that time?
Seth
Yeah, I don’t want to speak too much for the Office of the State Actuary, and we’ve talked about this a little bit with both Mitch and Matt in previous episodes. So yes, to all of that, we are as a state, looking back over the last two years. The state actuary actually does a very deep dive over the last six years.
And what has happened in that time period, and did it match what they thought was going to happen? And then every two years they project forward over the course of the next — I’m not going to get this number right — something like over the next 20 years. What do they expect to happen over the next 20 years or 30 years or 50 years? How long do they expect people to live?
But really, the main assumptions that they look at every two years are: what is inflation expected to be over that next ten, 20, 30 year period? And what do they expect investment returns to be over the next ten, 20, 30 years?
So, when I started working here almost 15 years ago, at the time, the state was projecting future investment returns to be 8%. Since then, that number has decreased. So, they decreased, I think, to 7.5 down all the way to seven. And what that means is that if investment returns are going to be lower in the future, that means we need to be putting more money into the retirement plans.
And so that was one of the reasons over the last decade or so, contribution rates have been going up. People have been needing to pay in more because they’ve been expecting that the investments are going to earn less. And just recently, in the most recent legislative session, they actually increased that assumed investment return from 7% to seven and a quarter. Now, some people might say, well, that’s kind of playing with the numbers or it makes it so we need to put a little bit less in going in the future. But I don’t know, who’s to say what investment returns are going to be in the future? Is 7% right? Is 8% right?
I know, Jenny, you and I have talked about this on the podcast. Like, who knows? You kind of flip a coin. You think about it in terms of a range. And what the actuaries have to do is make a recommendation on one number that they project everything going forward in the future. But once again, they’re reviewing this every two years.
They’re reviewing what has happened in the past as well. Did we meet those assumptions? If we did, great. If we were under that means we might need to put a little bit more money in if we were over. If investment returns did better, maybe we can put a little bit less. And one of the things I really like about the pension systems in Washington is we’re always making these small tweaks, so we don’t ever get to out of whack, with our Plan 2s and 3s.
Amber
You said something I didn’t know, and that is that the forecasting looks further than 2 to 4 years. So, we’re looking at ten, twenty potentially even more, which I think is really helpful to sort of alleviate that worry.
I think if I had known that and could have explained that to my uncle, he would have felt a little less anxious about it, because I believe he was sort of under the impression that when forecasting, it’s probably looking at the markets today, in the next couple of years, and he’s saying “the next couple of years and 40% decreases, how can you plan on that?” But yeah, knowing that we’re looking so far ahead and again, revisiting that every two years is really helpful.
Jenny
Yeah. And kind of back to your example, Seth, I love that what you said about, you know, someone who had started saving for retirement when they were 20 and they started saving 15% for retirement. And then you get to age 50 and you’re like, okay, now I’m feeling pretty good. I feel like I can scale back and just save like 10% for retirement. So, it’s a little bit of that is probably the best way that I’ve understood it.
Seth
Yeah, I think I mean, they’re always trying to dial in the right amount and factors change. And that maybe changes how much you need to put in or out. As I mentioned, that the actuaries look at what they call the demographic experience, what has happened in the last six years and then make tweaks based on that. And they’re actually in the process of finalizing that report right now.
And when it’s finalized, I’m sure we’ll have somebody from their office come in and talk about what projections were they making that have varied over the last six years? I think, Amber, to your point, markets can be really volatile in the short term. And that, I think oftentimes makes people feel uncomfortable and scary. And it’s easy to focus on the times when things went really badly.
And I think one of the wonderful things about having a fully funded pension system is that when the market does really well, we all benefit from that. I don’t think people realize this. I’m not going to get these numbers exactly right, but it’s like in 2021. So, I said our assumed rate of return was like 7%. I think it was something like 24%.
Jenny
Wow!
Seth
So, when you think about $100 billion invested, they’re hoping to gain $7 billion in that year and they gained $24 billion. That’s good for the overall pension system. And it doesn’t mean that we stop putting money in because it’s very possible that the next year it’s going to be -5% or whatever, like there is this fluctuation that happens and the actuaries have a whole process for smoothing out those variables, so that our contribution rates don’t go from 20% to 0% to 3%.
And 15% like that, try to have some stability within the system. But it still changes every two years that people still see it go up and down. So, I think you had a follow-up conversation with your uncle about this after we talked a little bit more? I did.
Amber
He was very thankful to have some additional information. [He] understood more about how the change was made and the process for reviewing that. But he was still very skeptical. Still very difficult to really swallow the 40% number. Like, that was just a big sticking point is: how could anything sustain a 40% decrease in funds? But now, after sort of hearing what you said about that….because I’ll admit he had me concerned as well.
And I’ve already said, I don’t ever care about my employer contributions because I know that’s not how my benefit is calculated. But thinking about retirement in 20 plus years, wondering the sustainability of that choice in the very, very, very long term, had me anxious as well. But knowing that part of that decrease was due to the underfunded portion being removed.
Seth
Yeah.
Amber
Kind of helps that a bit. I feel like it was around 2%.
Seth
2.5% I think at one point. And this was all the different funding bodies that interact with this contribution rate had talked about, “do we step it down over time or do we just hit this cliff?” And there had been a little bit of stepping down over the last few years. But either approach is reasonable. And I think taking a pause for a little bit of time to see where do we end up.
There’s also a, I think, a really open question in pension funding of what’s your target funding percentage? Is it 100%? Some people feel much more comfortable at 102% or 105%. Some people feel much more comfortable at 95%, because you can always put a little bit more money in later. It’s more expensive to do it that way because you have these plans all based on a lot of assumptions.
Are your assumptions always a little bit too conservative? Are your assumptions always a little bit too aggressive? I think the actuaries would say, they know all of their assumptions are wrong, but they hope they kind of cancel each other out. And once again, because we’re reevaluating these every couple of years, it’s okay to be wrong. You’re of course correcting.
Amber
Yes.
Seth
As you go along.
Amber
That was my uncle’s biggest takeaway was knowing that it is relooked at, at minimum, every two years. I think that gave him the feeling of more of a safety net to know if things go wrong, in the next two years, something happens where it’s realized that this is not sustainable. How much damage can happen in two years, and I’m sure a lot of damage can happen in two years.
But if we have these governing bodies, who can look at that and recognize that that needs to change, then in two years or less, it could increase again. And refunding or, you know, giving a bit more into the funds.
Seth
And I think it’s really hard. Because it’s hard to know if you’re totally off track in two years.
Amber
Was it just a bad year?
Seth
Right?! Or oh, COVID or you know, that’s changed everything or… There’s always so much uncertainty in the process. In the late 90s, you all may know or some of our older listeners would remember, the stock market did crazy good: dot coms, everything, investments were doing great.
And at the time it looked like contribution rates could go very, very low. Like almost a zero like, “oh, at this point we don’t really need to put any money into the plan because investments are doing so great.”
Well, the dot com bubble bursts. Eventually the Great Recession hits. But when contribution rates get so low, they eventually have to come back up. And everybody got used to not putting much money in. And it feels good when you’re not putting the money in, you can go spend that money on other things.
And so actually, one of the things that came out of that time period, it was called the Happy Valley and then the Terror Mountain, those are like inside pension nerd things, Terror Mountain, like, “oh my gosh, we got to keep paying more and more in.” But one of the things that came out of that was minimum rates. So even if it looks like we could afford to only put in 3% or whatever, and I don’t remember what the minimum rates are off the top of my head, but something like 5% like you as a Plan 2 member [and] the employer still have to pay in these minimum rates to make sure we’re not dropping too low in those contribution amounts they’re going in, because we need to put those contribution amounts in so that they can then be invested and grow and have the advantage of the market gains during that time.
Amber, I really appreciate that you shared this story with us. Hopefully your uncle is also okay with having this conversation, but this is something that our team members, as you said, hear quite frequently.
And I think the other conversation that comes out of this oftentimes is, “well, what happens if the pension fund just fails? Or what if there’s no money left?” And I think oftentimes our common answer in the office is like, if that happens, you’ve got lots of bigger problems to deal with. And if that is a real worry, then maybe you need to figure out what your own savings are, how you’re generating your own electricity, or whatever those problems really are to focus on.
Because the pensions in Washington are a contractual right, they’re a guarantee of the state. The state has a lot of other guarantees that they need to pay as well. But we have this dedicated trust fund that helps pay these benefits out. It’s not I think oftentimes as you as you mentioned, people think about Social Security and it’s just money coming in and going straight back out.
That’s not the case with the pension funds. The money is coming in, going into the trust fund invested by the state Investment Board. And then that turns around in ten or 20 or 30 years and pays out the pension benefits, plus all the gains that were earned on that money during that time period.
Jenny, any final questions or thoughts?
Jenny
No, I think you guys covered it.
Seth
Great. Thanks, Amber.
Jenny
Yeah, thank you so much for coming in and sharing your story.
Amber
Thank you!
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Disclaimer
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