California’s pension problems have been well-documented. The state has racked up an enormous pension debt owed to public workers. Paying off this debt will be difficult, but manageable, so long as the state takes up responsible funding policies. Less discussed is how the structure of these pension plans often works to the disadvantage of many public workers.
California, like most states, offers most public workers a defined-benefit retirement plan based on years of service and pay. These so-called “final-average-salary” plans yield heavily backloaded benefits – workers tend to earn relatively meager benefits through the first couple of decades on the job and only become eligible for more valuable benefits late in their careers.
“An estimated 72 percent of teachers will leave the profession before 20 years... [many] will leave with savings that amount to little more than their [pension] contributions and interest.”
Most public workers, however, simply do not work under a single retirement plan for an entire 30-plus year career. According to figures from the National Center for Educational Statistics, an estimated 72 percent of teachers will leave the profession before 20 years. Under many current retirement systems, they will leave with savings that amount to little more than their contributions and interest.
We focus on teachers here because they are the largest single group of public employees in each state, with plans representing the majority of state-level pension debt.
The California State Teachers’ Retirement System includes in its annual report a summary of benefits paid each year. While some teachers earn a generous benefit, approximately 70 percent of beneficiaries receive payments of less than $5,000 per month, averaging only $2,500 per month on an average service of 19 years.
The top-earning 19 percent of beneficiaries, on the other hand, receive an average $7,300 per month and worked for an average of 36 years. Some have called CalSTRS average benefit payment of $3,777 modest, but this average masks a system that creates a few big pension winners sitting atop a mound of small-benefit losers.
In an earlier paper for the Manhattan Institute, we showed that teachers who were at all risk averse would prefer to earn retirement benefits more evenly across their careers. This is because when teachers first enter the classroom, they generally do not know how long they will work under the same retirement system. And, as the numbers above show, the current retirement system carries a high probability of receiving a low payout. Teachers would likely trade a more moderate full-career benefit for increased retirement savings and greater security in the early and middle portions of their careers.
Putting teachers in a less-backloaded retirement plan would likely make sense from school districts’ standpoint as well. A wide body of research shows little to no relationship between teacher quality and experience after the first several years of teaching. Academics and education reformers have long pointed to these data to argue that pay should be less heavily dependent on experience.
In a new report for the Manhattan Institute, we show that the retirement plan dramatically amplifies the premium paid to experienced teachers when compared with their similarly skilled, but somewhat less-experienced, counterparts.
A Los Angeles teacher with 35 years of experience earns about 14 percent more than does a similarly credentialed teacher in his fifth year. But the premium paid to the late-career teacher jumps dramatically when we account for retirement benefits. In L.A., our fifth-year teacher will earn the present value equivalent of about $3,355 in retirement benefits for his next year of work while the teacher in year 35 will receive the present-value equivalent of $36,304. That’s more than a 10-fold difference in retirement compensation for the same year of work.
The true premium that school systems pay to late-career teachers is thus much larger than commonly understood. Taking into account both salary and pension benefits, a 35-year L.A. teacher receives 82 percent higher compensation than does a fifth-year teacher. That vast difference in total compensation exists despite research giving us every reason to suspect, on average, a similar classroom performance.
A better system would base a teacher’s yearly retirement benefit on a fixed percentage of their salary that year. Some states now offer teachers the option to participate in 401(k)-style defined-contribution systems. Alternatively, states could offer cash-balance plans that maintain the guaranteed investment returns of traditional defined benefit plans – but allow teachers to earn retirement benefits evenly across their careers.
Rising retirement costs have strained state and local budgets and fueled reform discussions in nearly every statehouse. But generally missing from these conversations is a consideration of how well current public retirement plan designs support and compensate pubic employees, like teachers, at each stage in their careers.
Under today’s retirement plans, young teachers earn very meager retirement benefits so that the public’s money can be used to pay large premiums to a few senior colleagues. Teachers deserve a compensation structure that puts them on a secure path to retirement, and schools would benefit from a system that more closely aligns a teachers’ effectiveness with their compensation.
This piece originally appeared in Orange County Register