PROVIDENCE, R.I.—Rhode Island state leaders and union officials announced a deal Friday that would end legal wrangling over a landmark pension overhaul that's been a model for other states seeking to rein in runaway pension costs.

The proposed settlement must win legislative approval and the endorsement of union members and retirees. But if enacted, the changes would retain the most significant portions of the 2011 pension overhaul, which raised retirement ages and suspended pension benefits to save billions of dollars in future costs.

"This is a very good deal for the people in the pension system and the people of Rhode Island," said Treasurer Gina Raimondo, a Democrat who crafted the original law and is now running for governor largely on her success in bringing the pension system in check. "I do hope other states follow our lead. We have shown that Rhode Islanders can come together and tackle big issues."

Rhode Island had one of the most troubled pension systems in the nation before lawmakers passed the sweeping changes during a special legislative session in 2011. The so-called Rhode Island Retirement Security Act was designed to save an estimated $4 billion for the economically troubled state over the next 20 years.

But many of the 66,000 state workers, teachers and municipal workers and retirees covered by the state retirement system complained that the changes amounted to broken promises and an unconstitutional change to their benefits. Their legal challenge has been the subject of closed-door settlement talks for more than a year.

The proposed settlement would give retirees a one-time 2 percent pension increase on the first $25,000 of their pension, and then increases of up to 3.5 percent every four years beginning in 2017.

The existing law suspended the increases for five years. Regular increases will return when the state's retirement fund is 80 percent funded. Currently it's roughly 60 percent funded.

Also, as part of the deal, employees with 20 years of service can keep their existing pension plan instead of receiving a hybrid plan that combines a pension with a 401(k)-type account. All other workers would receive the hybrid plan, though governments would contribute slightly more to workers with more years of service.

Employees would also pay slightly more toward their own retirement than under current law.

While workers and retirees won some concessions in the settlement, much of the significant portions of the 2011 law would remain. Lynette Labinger, lead counsel for the plaintiffs, said that while unions and retirees didn't get everything they might have wanted in the settlement, they'll receive pension increases far sooner than under current law. It also avoids what could be a risky legal fight.

"It provides certainty," Labinger said. "You don't usually get everything you want."

The settlement would raise the annual pension costs for the state and its cities and towns. In the fiscal year beginning July 1, 2015, the state would have to set aside an additional $13 million. Cities and towns would see their retirement bills increase by $11 million.

Overall, the changes would raise the state's unfunded pension liability from $4.8 billion to $5 billion. But it would maintain nearly all of the $4 billion in savings created by the 2011 law.

While many states have made efforts to rein in pension costs, none have taken the steps Rhode Island did. The pension overhaul was cited as an example during debates in states like California and Illinois that face their own pension problems. Raimondo's efforts to pass the law were hailed by The Wall Street Journal and Time magazine.

Collectively, states face a $757 billion gap between what they've promised in retirement benefits and what they have set aside to pay for it, based on a study by the Pew Charitable Trusts, and Rhode Island was widely seen as a test case for efforts to rein in pensions elsewhere.

The settlement now moves into what is likely to be a complicated and time-consuming approval process. Union members and retirees will likely be asked to endorse the settlement by mail ballot. The state's retirement board endorsed it Friday, and lawmakers will be asked to approve the deal this year—though it could be May or June before any vote is held. 

If they reject or modify the settlement proposal, the lawsuit would likely proceed to trial.

Lawmakers have criticized the closed-door negotiations that yielded the settlement, and Rep. Joseph McNamara, D-Warwick, said he expects lawmakers to closely scrutinize the deal.

"I'm not going to rubber stamp anything," McNamara said. "We spent months on public hearings and studying data for the initial reform act. We're going to have lots of questions about the impact on both the employees and the cities and towns that will have to pay for this."

Indeed, Cranston Mayor Allan Fung—a Republican candidate for governor—blasted the process behind the settlement and said it's going to burden cities and towns that are struggling with deficits and a lagging economy. Rhode Island's unemployment rate is 9.1 percent, the highest in the nation.

"They sold out the taxpayers," he said of the state officials involved in the mediation. "This is a significant amount of money they're asking the cities and towns to pay. And they're just kicking the problem down the road."

The settlement is certain to play a leading role in the governor's race this fall. Raimondo has campaigned on her efforts to rein in pensions. One of her rivals in the Democratic Primary, Providence Mayor Angel Taveras, has campaigned on his successful efforts to negotiate pension changes with city unions without unilateral action or litigation. Clay Pell, the grandson of the late U.S. Sen. Claiborne Pell, is also running for governor as a Democrat. Fung faces businessman Ken Block in the GOP primary.