Tier 2 Pensions and the Safe Harbor Issue: Explained

November 07, 2023

Policy Brief: Tier 2 Pensions and Safe Harbor Explained

The Civic Federation partnered with the Civic Committee of the Commercial Club of Chicago to draft this policy brief to explain Tier 2 pensions in Illinois and the Safe Harbor issue.  

Most public employees in Illinois do not pay into Social Security as long as they are covered by pension plans that provide retirement benefits deemed equivalent to Social Security benefits. The IRS provides standards to determine whether public pensions meet this requirement, known as the Safe Harbor test. Recent concerns about some public pension plans in Illinois falling out of compliance with Safe Harbor have prompted the introduction of several legislative proposals, some of which would enhance benefits beyond the changes necessary to directly address Safe Harbor compliance. The Civic Federation and Civic Committee created this explainer in response to these legislative proposals billed as Tier 2 “fixes” and to serve as a resource to policy makers and the public.  

This explainer covers:  

  • Why the additional tier of pension benefits known as Tier 2 was originally enacted and how this tier of lower benefits has helped to control Illinois’ growing unfunded pension liabilities; 
  • A description of the Safe Harbor tests that public pension plans must pass in order to comply with IRS standards related to Social Security benefits;  
  • The basis for concerns that Tier 2 benefits are falling out of compliance with Safe Harbor rules; and  
  • Solutions to ensure that Tier 2 pension benefits comply with Safe Harbor. 

The Civic Federation supports the simplest and most effective solution to achieve compliance with Safe Harbor: increasing the Tier 2 pensionable salary cap to match the Social Security Wage Base, which is the upper salary limit that can be used to calculate Social Security Benefits. The Federation has also been on the record calling for an actuarial study of both State and local pension plans to estimate when pension plans will fail to meet Safe Harbor compliance, and what the cost of any enhanced benefits would be to government employers, before legislation is passed. It is critically important that the Illinois General Assembly get any Tier 2 fixes right, because once pension benefits are provided, they become protected under the Illinois Constitution and cannot be reduced.  

Click here to read the policy brief.