It's legal, but really bad policy. In years when investment earnings are high on the state and public school employees pension funds, the state takes part of those earnings and distributes them to the retirees. This is on top of their regular pensions and COLA increases. From 1982 through 2002, this "supplemental" payment has totaled nearly $880 million: 

This is how an official with the retirement system explained it to the retirement board in a 1997 memo:

The supplemental payment . . . is defined in Public Act 300. [The payment] dates back to the post-inflationary period of the early 1980s. Much concern had been expressed by the Board and other interested parties regarding the effect of inflation on retirees' pension checks. They worried about the erosion of retirees' purchasing power . . .

However, the State's budgetary problems at that time precluded the establishment of a permanent cost of living adjustment (COLA). In fact, it was not until 1986 that a permanent COLA was put in place . . . In the meantime, the [supplemental payment provision] was amended into the retirement act. This solution was less desirable than a permanent COLA because its uncertainty and unpredictability precluded it from being utilized by our members and retirees in their financial planning.

It would have seemed sensible to rescind the supplemental payment provision when the COLA was enacted in 1986, but apparently that didn't happen.

In the same letter, the official explains how the payment is calculated:

• The actuary determines the present value of projected pension benefits payable to current retirees and beneficiaries.
• The Department of Management and Budget (DMB) determines the rate of investment return, based upon methods established by the Board.
• The rate of return (minus an 8% assumed rate) is multiplied by the present value of projected pension benefits to determine the amount available for the supplemental payment.

I became aware of the supplemental payment in the early 1990s, when I was working as a programmer/analyst for the Bureau of Retirement. It was my understanding at that time that after the COLA was enacted in 1986, the amount available for the supplemental payment (if any) was first used to fund the COLA, and only the excess was distributed as a supplemental payment. If that is the case, investments must have done very well in 1987, when over $300 million was distributed.

Here's more from the 1997 memo:

At the time the [supplemental payment provision] was established there was a belief that it had no cost because it was merely a distribution of "excess" interest. This thinking was flawed [to put it mildly] because by distributing investment returns in years when they exceeded 8%, it became impossible to average 8% because in years when returns were less than 8% money was not returned to the system. By increasing the plan's unfunded liability in this way, the funding ratios of the plan are weakened and future costs are increased.

It is awfully hard to believe that the supplemental payment provision is still law. It was a bad idea from the start, and made no sense whatsoever after 1986, when COLAs were established for state and public school retirees. Apparently, pension fund investment earnings haven't been high enough since 2002 to warrant a supplemental payment. But if and when we do get a good year, the extra earnings should stay in the pension fund rather than get handed out to retirees who probably don't even understand why they are getting it.

Although no supplemental payments have been issued since 2002, the Office of Retirement Systems is prepared to make the payments should investment earnings exceed 8%. There is a line for the supplemental payment on pensioners' EFT notices.

The COLA, by the way, is 3% a year, regardless of the inflation rate. The increase is not compounded, but does accumulate. For state retirees, the increase is limited to $300 a year. For more information, see the Office of Retirement Services website.

To my knowledge, the whole issue of the 13th check never got any attention after I posted the above in January 2008. Of course, no one reads this website routinely, and I don't remember what I did back then to call attention to the story. Recently, however, the issue is getting some attention - in Wayne County and Detroit. This is from a June 24, 2012 letter to the Detroit Free Press from Wayne County executive Robert Ficano:

The impact of the 13th checks [on Wayne County's pension fund] has been severe. The annual bonus payouts alone have drained the fund of $391.9 million since 1986, and $91.5 million since I took office in 2003.

The pension fund's actuarial service, Gabriel Roeder Smith & Co., wrote in September of 2010: "We estimate that the Wayne County Employees Retirement System would be approximately 90% funded on a funding value basis as of the last actuarial valuation (Sept 30, 2009) if there had never been a 13th check program."

And on September 15, 2013, the Detroit Free Press printed a report of an investigation into the causes of the Detroit bankruptcy by reporters Nathan Bomey and John Gallagher titled How Detroit Went Broke. One of their findings:

Pension officials handed out about $1 billion in bonuses from the city’s two pension funds to retirees and active city workers from 1985 to 2008. That money — mostly in the form of so-called 13th checks — could have shored up the funds and possibly prevented the city from filing for bankruptcy. If that money had been saved, it would have been worth more than $1.9 billion today to the city and pension funds, by one expert’s estimate.

Since this last report came out, I've been trying to revive interest in the state's 13th check provision, calling reporters and politicians' attention to this story. And on September 23, I sent a FOIA request asking for details of 13th check payments to state and public school employees from 1982 to the present.

For state employees, the law covering the 13th check is Section 38.20g of the State Employees' Retirement Act, Act 240 of 1943; for public school employees, it is Section 38.1404a of the Public School Employees Retirement Act of 1979, Act 300 of 1980.