Finance Division Memorandum
Memorandum
Finance Division
September 9, 2022
Section 115 Trust – Questions and Answers
What is a Section 115 Trust? A Section 115 Trust is an IRS approved irrevocable trust that allows funding of essential governmental costs, namely prefunding of pension costs.
What are the benefits of a Section 115 Trust? The trust can help the City fund pension costs in two ways. First, the trust separates funds for pension costs from general assets, which then allows the City to invest trust funds like a typical pension fund. These assets would not be limited to investment restrictions imposed on pooled public assets (Government Code Section 53601).
The change to investment restrictions to Government Code Section 53609 addresses deferred compensation funds (including public pension funds) may result in higher returns. Second, the trust assets can be used as cushion by the City against the volatility of CalPERS employer contribution rates and changes to the employer contribution levels. Using the trust to fund significant increases in employer contributions could reduce the City’s dependency on the City’s budget in times of economic need.
A 115 Trust serves as a pension funding alternative source during economic downtowns or to address unanticipated increases from CalPERS actuarial impacts. The trust also reduces the financial statement pension liability without allocating investments to one specific pension plan.
The 2022 LTFP explains:
“Section 115 funds offer flexibility and opportunities for higher returns than the limited City investment pool assets. Funds placed in the trust are no longer limited to low risk, shorter term investments, but rather allows an investment portfolio similar to existing pension funds which include a variety of investments (bonds, mutual funds, and stocks), which have higher risk but over the long term average higher returns. Section 115 Trust assets could be utilized to offer better long term returns than the City’s investment pool portfolio but be invested more conservatively than CalPERS assets. The assets could fund any of the City’s multiple pension plans, assist in making required actuarial contributions in tight budget years, or bolster funded status for pension funds which experience poor actuarial effects.”
How would San Clemente fund a Section 115 Trust? Funding for a Section 115 Trust could come from one-time revenues, such as funds from a sale of land. In June 2022, City Council authorized
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a supplemental appropriation of $1 million. Additional funds could be contributed based on Council action once the Section 115 trust is established.
Options for San Clemente
Section 115 Plan Options. The City of San Clemente could use a multiple employer or single employer trust approach. The multiple employer trust reduces costs over the long term allowing assets to build and additionally save staff time and resources. As a result, the multiple employer option would be recommended by staff, rather than a stand-alone plan. The following table compares a multiple and single employer trust at various phases in the formation.
Comparing Multiple and Single Employer Section 115 Trusts1 Section 115 Phase Multiple Employer Single Employer
Set-up No set up is required as trust
already exists
Set up of new trust takes time and
would require costly legal review
IRS Private Funding Yes. Already obtained and covers
entire trust
No. Can no longer be obtained
Documents Existing master plan/trust
documents are used which have
already been vetted
Must be developed/created by
attorney or a prototype used
Ongoing Workload of City Little. Significant economies of scale and administrative
efficiencies are gained through a
multiple employer trust approach
Cost and effort to administer and
audit – stand-alone trust can
create significant work. Additional
GASB reporting disclosures may
be required
Compliance Assistance provided by Trust
Administrator
Responsibility of employer and its
attorney
Investments Both pooled and customized
options available
Only customized options available
Economies of Scale Yes No
Fees Lower due to economies of scale
and decreases with asset growth
Higher due to limited scale
Provider Options to Administer Trust. San Clemente could use CalPERS or a private company, such as PARS, to administer a multiple employer Section 115 Trust.
CalPERS offers the California Employers’ Pension Prefunding Trust (CEPPT) Fund to prefund employer pension contributions. Administrative costs are recovered through a single, low cost percentage fee that covers compliance, custodial, record-keeping, investment fees, and other administration costs. The current fee is 0.25%, however this is subject to change.
1 Public Agency Retirement Services, RFP No. 19-03: Section 115 Trust Fund Administration & Investment Management Services, September 2018 (Costa Mesa)
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Typically, with other providers, there are separate administrative fees for the trust and for the investments. Hence these fees typically are slightly higher for the administration, in exchange you often have more option for investments or reporting.
Investment Strategy Options. Investment strategy will vary based on level of risk. For example, CalPERS offers two strategies; strategy 1 is a moderate strategy, and strategy 2 is more conservative. A summary of each strategy is attached and the portfolio breakout is defined below:
Asset Class Allocations Strategy 1 Strategy 2
Global Equity 40% 14%
Fixed Income 47% 73%
Treasury-Inflation Protected Securities 5% 5%
Real Estate Investment Trusts 8% 8%
The City has not gone through the formal RFP process and would need to complete that process to provide up to date information. Other providers have more investment strategies, ranging from very aggressive to very conservative. The following strategies are based on past RFP’s (dated in 2018) to other cities and summarized from websites:
PFM (Source: From website)
Asset Class Allocations Strategy 1 Strategy 2 Strategy 3 Strategy 4 Strategy 5 Russell 3000 49% 39% 33% 20% 13%
MSCI ACWI (ex US Stock) 26% 21% 17% 10% 7%
Barclays Aggregate 25% 40% 50% 70% 80%
Keenan (Source: From 2018 Costa Mesa RFP)
Asset Class Allocations Strategy 1 Strategy 2 Strategy 3 Strategy 4 Strategy 5 Strategy 6 Domestic Equities 39% 30% 22% 16% 7% 0%
REITS 7% 5.5% 4% 3% 1% 0%
International Equities 30% 25.5% 19% 15% 8% 0%
Fixed Income 24% 39% 55% 67% 84% 100%
PARS (Source: From 2018 Costa Mesa RFP)
Asset Class Allocations Strategy 1 Strategy 2 Strategy 3 Strategy 4 Strategy 5 Equity 76% 61% 51% 31% 16%
Fixed Income 22% 36% 46% 66% 78%
Cash 2% 3% 3% 3% 6%