For the average teacher, though, pensions aren’t nearly so lavish.
In a new report for Teacherpensions.org, I argue we should be looking at pensions differently. Like Pac-Man, pensions are quietly gobbling up dollars that could otherwise be spent on salaries, pre-K, music, art, libraries or other services.
Teacher retirement costs today are at all-time highs, in both dollar terms and as a percentage of total compensation. They’re also an outlier. Retirement costs for teachers are higher than for any other profession, including other public-sector workers.
The solution to this situation can’t just be about cutting benefits for teachers. On average, pensions don’t have a generosity problem. Instead, they have two distinct issues.
Problem 1: Pensions distribute benefits inequitably
The first problem is about the distribution of benefits.
On average, states and districts are contributing 4.9 percent of each teacher’s salary toward his or her retirement benefits. From an employer’s perspective, it is the equivalent of offering a 5 percent match on a 401(k) plan, which is more than the typical private-sector employer offers but not significantly so.
For workers covered under 401(k) plans with a 5 percent match, employees would receive that amount in an individual, completely portable retirement account. But that’s not the way teacher pension plans work.
The 5 percent employer contribution and the employee’s own contribution go into a pot of money that grows over time. But teachers are not entitled to their fair share of this large pot. Instead, pension plans deliver benefits through back-loaded formulas that spike toward the end of a teacher’s career.
These formulas provide only meager benefits to teachers with less than 20 or 30 years of experience. These teachers will earn benefits worth less than the value of their employer’s contribution, and, in fact, many will get $0 in retirement contributions from their employer.
On the other end, a small fraction of teachers will get considerably more than this. Teachers who stay for 20 or 30 years in their state will qualify for pensions worth far more than the actual contributions made on their behalf, and their pensions will afford them a comfortable retirement.
But most teachers lose out from this arrangement. The average is deceiving.
Problem 2: The Value of a Pension Isn’t Based on Reality
The second problem with teacher pensions is how we fund them.
Unlike a 401(k), where a worker’s retirement benefits are equal to the total contributions plus interest earned over time, pension formulas are divorced from contributions. The state must match up how much they’ve promised in future benefits with how much they need to save today.
When those two things don’t match up, the pension plan begins accruing unfunded liabilities. And since state teacher pension plans are run by politicians, they have a tendency to over-promise and under-save.
The result is that the pension plans offered to teachers today don’t just cost that 5 percent. Instead, they also have to pay down debts from years of poor investment returns, unrealistic investment assumptions, badly-timed or ill-considered benefit enhancements, and elected officials’ failure to make the financial contributions they committed to.
This is called, in pension terms, the “amortization cost.” It’s a form of debt owed to the pension plans, but it’s not directly related to the benefits teachers actually receive.
Today, amortization costs make up the biggest share of teacher retirement costs. For every $10 states and districts contribute to teacher pension plans, $7 goes toward paying down past pension debt, and only $3 goes toward benefits for current teachers.
In the average state, this is equivalent to 12 percent of teacher salaries that must go toward paying down these old debts.
States and districts must pay both of these costs, the 5 percent for benefits plus the 12 percent of debt, and the numbers are rising. This presents a paradox. Teacher pension plans are extremely expensive, but they’re not actually delivering secure retirement benefits to all teachers.
The result is a bad deal for teachers: lower salaries while they work plus worse benefits when they retire.
We can’t solve these problems by addressing overall generosity. Cutting the average benefit from 5 percent to 4 percent, for example, wouldn’t address the distribution problem.
Capping maximum pension benefits, as many states have done, solves neither problem, because it still doesn’t address how to give short- and medium-term teachers equitable benefits, and it doesn’t address the underfunding problem.
Policymakers must address both the distribution and funding problems, or else the pension Pac-Man will continue to gobble up those school budgets.