A proposal before the Minneapolis police pension board to set aside $10 million before the police pension fund merges with a state fund is likely illegal, said State Auditor Rebecca Otto.

Otto said this year's law to merge the pension funds requires all of the Minneapolis fund's assets to be shifted to the state Dec. 30. Yet a pension fund board member has proposed setting aside the $10 million to cover potential costs from a five-year-old lawsuit with the city over benefits.

The Legislature approved the 2011 merger of the closed police fund and the state fund at the request of the city, which faces skyrocketing costs to maintain the police fund. But withholding $10 million in a trust fund would erase some of the merger's savings for the city.

Mary Most Vanek, the state fund's executive director, agreed with Otto. She also said a trust isn't needed because the new law gives the state fund the power to pay any bills owed by the police fund, and the trust spending doesn't appear authorized under state pension law.

"It's not necessary, nor do I think it's allowed," Most Vanek said.

Police fund board President Larry Ward acknowledged Monday that the proposal could pose problems, and board attorney Brian Rice said he's still researching it. But Rice said the simplest way to avoid the trust would be for the city and fund to settle the lawsuit.

The proposal is scheduled to be discussed by the fund's board Friday after board member Mike Sauro proposed it at a board meeting last week. Sauro is a police lieutenant who is one of the last unretired people covered by a pension fund closed to new members since 1980.

The trust proposal arose when the board discussed trying to settle the lawsuit. Sauro said in an interview he wants the trust fund to settle claims if a member successfully sues for pension benefits frozen during the lawsuit; a judge earlier denied a bid by the fund for that.

There's an unfavorable precedent for setting up a trust when a merger is pending. The Minneapolis Teachers Retirement Association did so in 2006, weeks before it merged into the state teachers fund, setting aside $1.5 million for various expenses. Then-auditor Patricia Anderson issued a blistering report a few months later, and a judge revoked the trust.

Anderson said the Minneapolis teacher fund actions "go beyond failing to act in good faith and constitute a deliberate violation of state law they had a duty to follow." But Rice noted that the teacher trust fund was for different purposes than Sauro proposes.

The Star Tribune reported last week that four employees of the soon-to-be-defunct Minneapolis police and fire pension funds will leave their jobs with at least $400,000 in severance benefits, although all four have preference for jobs with a statewide pension plan that is absorbing their organizations.

Steve Brandt • 612-673-4438