Education funding is hard to come by these days. Most states still haven’t raised their school funding to the pre-recession levels. In Illinois, for example, the Chicago Public School system is almost bankrupt. Earlier this year in Michigan, Detroit teachers staged a “sick-out” to protest the deplorable conditions in their schools.
But, the grass is much greener in Maryland. For the second year in a row, they have a surplus of state funds. Included in the surplus, the state legislature allocated around $20 million to help counties fund their teacher pension systems.
But, Governor Larry Hogan won’t release the money.
Hogan argues that he is withholding the funds because the money is tied to “good and bad things,” and since it was a package deal, he chose to fund none of them. Understandably, teachers are upset and accuse the Governor of cutting the education budget.
Governor Hogan disputes this claim and points out that his administration has raised the state’s K-12 budget to record levels, even without the additional funds. While it is true that Maryland’s total spending on K-12 education is up, districts still did not receive the full amount of money allowed by the state funding formula. Therefore it becomes clear that withholding the additional funds set aside by the legislature to help counties pay their teachers’ pensions only adds to the problem. Moody’s credit rating service warned that the decision could adversely affect the counties’ bond ratings.
This fight over teacher pension funding raises an important philosophical question: Does money spent on teacher retirement count as education funding?
The answer is yes.
If states and districts consider funding teacher retirements as separate from their investments in K-12 education, it becomes much easier for legislators and governors to kick the funding liabilities down the road and leave them for others to sort out. It also creates the odd situation like the one we see in Maryland in which the state is both raising and cutting education funding. This happens because the state increased its allocations to districts, but those districts will be required to come up with a larger share of the funding for their pension funds. In other words, Maryland is robbing Peter, the county pension funds, to pay Paul, the state funding formula.
There are a few key reasons why teacher pension spending is education spending and should be recognized as such:
First and foremost, a pension is part of the deal that states and districts made with teachers: less money in salary in exchange for a healthy and sustainable retirement. In other words, pensions should be thought of as part and parcel of teacher compensation. With that in mind, pensions are certainly education spending.
Even though, as my colleagues have pointed out, pensions are not an effective way for the majority of today’s teachers to save for retirement, that isn’t an acceptable reason to retreat on existing pension obligations that current teachers rely on and need in their retirement. States may want to consider offering alternative retirement plans for new teacher to better meet their needs since only around half of teachers leave the profession with a pension. Furthermore, this would help states avoid adding to their existing pension liabilities. While such a change would not erase a state’s current obligation, it would help to make sure that the problem doesn’t grow.
Regardless of the model chosen, spending on teacher retirement should be counted as education funding since such investment cannot be extracted from the state’s general K-12 budget. This is because – as is the case with Maryland right now – each jurisdiction will need to make up for that lack of pension funding. To do that, districts either need to raise additional tax revenue, which will disproportionately burden low-income communities, or they will need to cut back on other education expenditures. The third option would be to ignore their pension liabilities altogether. But, that approach can be disastrous, just ask Illinois or New Jersey. Finally, thinking of funding for teacher pensions as education spending will force policymakers and the broader public to reckon with the fact that teacher retirements spending is extremely high, rising, and cutting into the available funds for teacher salaries.
For many governors and state legislators, funding pensions can seem politically challenging. It’s not a sexy topic, either. And for some constituents, it can seem less relevant to education than more direct budget items, such as new books or a computer lab. Nevertheless, investing in teacher retirement and in schools are intertwined. Thus, resolving the impending pension crisis in many ways in not only integral to school funding writ large, it is fundamental to high quality schools.
Most teachers in the United States won't be teachers for their entire career. They might leave the profession altogether, by choice or as the result of a life circumstance, or maybe put their teaching career on pause to pursue other personal or professional goals.
So, if almost every teacher will transition into and out of a pension plan, it makes sense to pay attention to how pension plans treat teachers at those transition points. Every state, with the exception of Alaska, relies on some form of a defined benefit (DB) pension plan, a retirement benefit based on years of service, age at retirement, and final compensation, to determine a teacher’s retirement benefit. Due to the structure of DB plans, they penalize employees for changing states or leaving the teaching profession.
One way retirement plans penalize mobility is through vesting periods. This is true for retirement plans in the public or private sector, but as Chad Aldeman has pointed out, federal law sets limits on vesting periods in private-sector DB plans, and there is no comparable rule for public-sector workers like teachers. States can and do set longer vesting periods than what would be required in the private sector. These long vesting periods makes it hard for new teachers to acquire retirement benefits. If they leave before they are fully vested, they will walk away with only their own contributions, sometimes with interest (keep reading to see why this matters).
Increased vesting periods aren’t the only rules states use to penalize teachers. The National Institute on Retirement Security (NIRS) recently collected state-specific information that illuminates how pension plans enact barriers that penalize teachers at various transition points across their careers. These sorts of barriers can reduce teacher pensions by 50-75 percent, depending on the state and the severity of their penalties.
To illustrate how those barriers affect teachers, consider a hypothetical teacher we'll call "Ms. Mover." In this example, Ms. Mover was born and raised in Florida near the Florida-Georgia border. After 15 years teaching in a Florida public school, she received a teaching opportunity in Georgia that she couldn’t pass up. Knowing she could continue living in Florida while working in Georgia, Ms. Mover accepted the position without regard to her future retirement benefits. We'll use this hypothetical story of Ms. Mover to illustrate four additional ways that state pension plans limit the ability of teachers like Ms. Mover to choose their own professional path:
1. Low Interest Rates on Employee Contributions
When a teacher chooses to leave prior to full retirement age, she can pull out her own contributions. However, not all states pay interest on those contributions. In some cases, this means that the teachers get back exactly what they put in and states get to keep any interest that accrued on those contributions. The table below groups states based on the interest rate they pay on employee contributions.
The average state pays an interest rate on employee contributions of 3.45%. This is better than the interest on a common savings account today, but it’s about half of what states assume they will earn on their own investments. In many states, teachers are essentially giving the state an interest-free or low-interest loan, because the state turns around and invests those contributions and expects a return of 7.5 or 8 percent. Even if the pension plan hits those 8 percent targets, teachers won’t see a dime of that interest.
For example, as Ms. Mover leaves Florida, she would be eligible to receive her own contributions back but without any interest. (She would qualify for a pension from Florida, but it might be worth less than her own contributions.) She would have been better off putting those contributions into a savings or investment account.
2. High Interest Rates on Service Credits
The inverse trend occurs when a teacher attempts to buy back into a plan. If they exit a pension plan but then decide to come back, they must come up with the interest that would have accrued on their contributions had they remained in the pension plan. Of the 31 states that told NIRS what they charge teachers, 19 used a different rate for re-purchases than they paid out to teachers. That means that they’re paying teachers less than what they ask of them if they want to return. If a teacher did want to buy back in, they’d have to somehow come up with the difference between the two sums of money.
Unlike the previous table, “Interest Rate on Employee Contributions,” the states in this chart are clustered closer to the right side. States like Alabama, Arizona, and Colorado, ask teachers to not only make up for any employee contributions, but pay up to 8 percent interest on those contributions.
Ms. Mover, our teacher from Florida, left Florida with only with her own contributions. If she ever tries to go back into the Florida pension system, she would have to come up with all the money she took with her, plus 6.5 percent annual interest.
This discrepancy essentially forces teachers to remain in the pension plan if there’s any question at all about whether they might return, because the risk of having to pay the difference between the two rates is too great. Meanwhile, every year they don’t withdraw their contributions is a year they’re stuck with relatively low investment returns. That makes for a complicated choice, and it’s one reason why so many teachers leave their money in state pension plans even when it might make financial sense to withdraw it.
3. Limits on Purchasing Service Credits
Defined benefit pension formulas rely on years of service, so more years of service means a greater pension benefit for the rest of that teacher’s lifetime. All states offer teachers the ability to purchase additional "service credits," but many place a cap on the number of years of credit an individual can purchase. Those limits are another way that states limit teacher portability.
If we turn our attention back to Ms. Mover, we see how limiting these restrictions can be. Her fifteen years of teaching in Florida don’t travel with her. Instead, Georgia only allows her to purchase a maximum of ten years. Even if Florida gave her a decent interest on her own contributions, and even if Georgia allowed her to purchase credits at a comparable rate, caps like this will limit her future benefits. When she goes to retire at the end of her teaching career, at least five years of service won’t be factored into her retirement at all. The table below groups states based on the maximum number of years available for purchase.
As the table suggests, most states limit how many service credits a teacher can purchase. Only ten states allow teachers to purchase as many service credits as they would like. The most common or modal state restricts teachers to purchasing only five years of service credits.
4. Limits on Types of Qualified Service
Just because a state offers teachers the ability to purchase service credits doesn’t mean it allows them to purchase credit for any purpose. Limiting the types of qualified service (or absence from service) is another way states limit teacher portability.
In fact, 9 states deny teachers the ability to purchase service credits based on years of teaching in another state (they might allow someone to purchase credits for being in the military or serving in the Peace Corps, for example, but not for teaching service). As it turns out, Ms. Mover chose to move to the wrong state. Even though Georgia allows for the purchase of up to ten years of service credit, her 10 years teaching in Florida don’t qualify. Even if there were no transition costs, Georgia wouldn’t allow her to purchase service credit for her any of her time teaching in Florida.
These pension plan rules place constraints on teachers. When making professional decisions, teachers might not see the full picture or how they factor in their retirement. They might not realize the true cost of their movement across sectors or state lines until they reach retirement age.Taxonomy:
The teacher pensions world can get a little lonely. While nearly all of us could benefit from a brush-up on retirement saving practices, teacher-specific advice is hard to come by. To better understand how best to tackle the unique challenges educators face, I connected with NerdWallet's Arielle O'Shea. O'Shea has been reporting on and writing about personal finance for over a decade, and her work has appeared in Esquire, Money, The Billfold, Women's Health and XO Jane. You can (and should!) follow her on Twitter @arioshea.Kirsten Schmitz: First, I'd love to hear more about your background at NerdWallet. What brought you to the investing and retirement space, and what keeps you here?Arielle O'Shea: I've been with NerdWallet for about a year, covering retirement and investing. I just recently launched the Arielle Answers column, and I also contribute to Forbes. I've been writing about all things personal finance — with an emphasis on investing and retirement — for over a decade. I love NerdWallet because its mission is essentially to do what I love: We want to bring clarity to financial decisions. Money can be so intimidating, and I want to make it approachable. This is a random story, but it kind of captures why I love what I do: Over the weekend I was in Lowe's buying some lumber for a project. I was so out of my element — I am not a DIYer but of course I was trying to save money by building a shed door myself — and as I was nervously waiting to ask the employee to cut the wood for me, it dawned on me: This is how most people feel about managing their money. I was so intimidated...I didn't know how to explain what I wanted, I wasn't even sure what I wanted, I didn't know the right language to use. So, I want to help put people at ease when they think or talk about money, and I think about that goal with everything I write.
Schmitz: Our work focuses on teacher retirement. About 90 percent of all teachers are enrolled in defined benefit pension plans, but our work suggests many teachers won't stay long enough to qualify for a decent benefit from the pension system. What advice would you have for teachers who aren't certain how long they'll teach?O'Shea: The biggest piece of advice in investing applies to this as well: diversify. Don't rely exclusively on your pension; contribute to an individual retirement plan like an IRA as well. If you're wondering about Roth vs. traditional, Roth is often the obvious choice — but there are a few factors you should weigh, including if you expect your tax rate to go up in retirement. For most people, this will be true, which is why the Roth is a great option — you'll be able to pull the money you contributed, plus investment earnings, out in retirement tax-free. You're effectively locking in today's lower tax rate since you don't get a deduction on contributions. Still, it's worth taking a look at your specific situation before you decide. Here is some more on this, from a post by my colleague.
Schmitz: With relatively high turnover in the teaching profession, many teachers will leave without vesting into the pension plan, or they'll qualify for only a relatively small pension once they retire. For those departing teachers, how should they decide what to do with their own contributions?O'Shea: For most people, the right choice is to roll what you can take with you over into an IRA. If you do it directly, you'll avoid any taxes and penalties — ask your plan how to do that, or the rollover IRA provider can help you. IRAs can be very low-cost — assuming you choose the right one — and you'll have access to a wide range of investment options. Choose low-cost index funds or ETFs to further keep expenses down.
Schmitz: I often see mixed messages about millennial savings habits. Either we're all drowning in student loan debt, ubering everywhere and postponing big purchases, or we're actually doing better than expected, and saving more than people think. How would your advice vary for younger or older teachers? Are there any things young teachers in particular should be aware of?O'Shea: This is one of my pet peeves for sure! You can find a study to support your views on millennials and money, whatever they may be: They're terrible at saving, they're saving more than their parents, they spend too much, they don't spend at all. I actually think millennials are doing well, considering all of the obstacles in their way (that student loan burden is real). But they're not ALL doing well, and of course how they're doing with their money is directly related to how much money they have. My advice for younger teachers: Save early and often. You don't have to save a lot if you save for a long time. You don't have to be an expert investor. Consistently saving small amounts of money adds up if you start young, due to compound interest.For older and younger teachers, some of the same advice applies: Know what you're working toward (a retirement calculator helps), limit debt, don't try to keep up with the Jones — for all you know, they're in debt! — and invest appropriately, which means taking risk, especially when you're young and you can weather market fluctuations. As you get older and closer to retirement, you can dial back that risk, but you still want to invest, not just save — saving alone, especially with today's interest rates, won't be enough to make your money grow and last through retirement.And then finally, limit investment expenses. These can really eat up your returns, and these days, you can get low-cost investments like index funds and even low-cost advice from robo-advisors. There's really no reason to pay 1% or more for your investments, unless you have a complex financial situation and you need a financial advisor.
We expect a lot of teachers. We ask them to teach math, reading, and arithmetic, yes, but also to be “nation builders” and to instill civic virtues.
We also expect them to make incredibly complicated financial decisions about their retirement.
But wait, you might ask, aren’t most teachers covered by state-run pension plans that take care of retirement savings decisions? Yes, they are, but most teachers won’t remain in those pension plans their full career. And when they leave, they’ll be faced with a difficult decision about what to do with their retirement money.
About half of all teachers won’t vest into their pension plan at all; they won’t be eligible for any pension from the pension system. These teachers are eligible to withdraw their own contributions, sometimes with a small amount of interest, but only two states provide any employer contributions. These teachers need to decide whether they should keep their money in the pension plan, or whether they're better off withdrawing their money and rolling over their savings into an Individual Retirement Account (IRA).
That’s a tough decision, particularly if the teacher is simply taking time off to start a family or is thinking about returning at some point in the future. But it’s nowhere near as tough as the decision faced by teachers who are vested.
A vested teacher will qualify for a pension upon her retirement, but that may be many years away, and her future pension will be based on her salary today, unadjusted for inflation. What is her pension worth today, in real, inflation-adjusted dollars? That’s a much tougher calculation, and it depends on how fast you think inflation and investments will grow over time. Smart economists have different answers to these questions, so what’s a teacher to do?
According to a recent study on the behavior of Illinois teachers, most teachers take the conservative route of inaction. Looking across all departing, vested teachers, 73 percent opt to leave their money with the pension plan (in addition to the 62 percent of teachers who won’t vest in Illinois, that means roughly three-fourths of Illinois teachers will either fail to qualify or choose not to receive a pension). Those rates vary somewhat by type of teacher. Males are more likely than females to withdraw their money. Hispanic and, especially, black, teachers are more likely to withdraw than white teachers.
But are these teachers making the “right” financial decision? That depends, again, on their personal situation and how fast they might be able to grow their investments on their own.
In the Illinois study, economist and EdChoice’s Director of Fiscal Policy & Analysis Martin Lueken calculated, for every teacher, their current net pension wealth based on their age and years of experience. If teachers had an expected pension wealth above what they would have been able to withdraw and invest on their own, he considered them to have a “positive” net pension wealth. If not, he classified them as having a “negative” net pension wealth. Then, he adjusted their net pension wealth based on potential investment returns. The higher the investment return teachers could earn themselves, the less likely they were to have a positive net pension wealth (that is, the better they were at investing, the less valuable the pension amount became).
If teachers could take their own money and earn an investment of only 2 percent above inflation, just 14 percent of vested Illinois teachers would leave with a negative pension wealth. That's a very modest assumption, and most teachers would be better off leaving their money in that circumstance. But if teachers could do a little better with their investments and raise their investment return to 4 percent net (still not an outrageous return), then 73 percent of teachers would leave with negative pension wealth. They would be better off pulling their money than leaving it in the pension plan. (At 6 percent, a high investment return but not far from what the state itself thinks it can earn, 88 percent of teachers would be better off pulling their money.)
For each of these scenarios, Lueken’s calculations allow us to see how many teachers made “correct” or “incorrect” decisions*. Depending on the assumed investment return, somewhere between 32 and 64 percent of teachers were making incorrect decisions. The chart below illustrates where teachers would fall under the 4 percent assumption. In this moderate scenario, more than half of all departing teachers are making the wrong decision. About 32 percent of teachers with positive pension wealth cashed out but shouldn’t have, and 63 percent of teachers with negative pension wealth should have cashed out but didn’t.
Now, teachers are well-educated, intelligent people, but we’re putting them in an impossible situation. We’re asking them to predict whether they’ll return to teaching and to compare their pension wealth, in future dollars, versus how much it might be worth if they invested their money elsewhere. That’s super complicated stuff, and it’s something most teachers don’t have the time to contemplate.
In comparison, most workers in the private sector have much easier decisions. We may have to decide our own investments, but we’re given a limited list of options. Increasingly, private-sector employers are nudging workers into making good decisions. And, when we leave a job, our choices are simpler. We can either leave our money in the existing funds, or we can roll it over to IRAs. The questions for private-sector workers are really about choices and fees, and they’re much more straightforward than the decisions teachers face.
States, on the other hand, systematically force public school teachers to make extremely complex financial decisions. Saving for retirement is hard enough; we shouldn't force teachers into such complex decisions.
*"Correct" in this context is hypothetical, based purely from a financial standpoint, and it assumes teachers had full information about the value of their pensions. In real life, individual teachers don’t have perfect information and must weigh trade-offs from their own unique perspective. As with all of our work here at TeacherPensions.org, this post is illustrating public policy choices and is not intended as personal investment advice. Teachers should consult a qualified financial professional before making consequential financial decisions.
It’s no secret that we need to get more STEM teachers into our classrooms. These fields are high-growth and high-paying. But there’s a problem: we currently don’t have enough STEM teachers already in classrooms to get today’s students interested and prepared for these fields.
So how do we get more STEM teachers? One idea is to convince folks leaving a STEM job to start a second career in the classroom. 100Kin10 and Troops to Teachers are two among many organizations that recruit nontraditional candidates into schools.
But there’s a catch for these would-be teachers.
Career-changers, particularly in STEM fields, would most likely have to accept both a significant pay cut and lower retirement benefits.
To most people, the decrease in salary is probably obvious. But the lower retirement savings could come as a shock. This happens because these individuals will have two separate retirement saving plans. And, unfortunately, they will be unlikely to realize the full benefits of either.
Most likely someone who is switching careers from the private sector to become a teacher already has a 401k or similar retirement plan to which she and her employer have contributed. These plans are pre-tax and grow through regular contribution and returns on investment. However, to grow significant wealth these plan depend on regular contributions that can then grow through the life of a worker’s career.
For many, the pension plan they enroll in as a teacher won’t be enough to make-up for the lost years of contributing toward their 401k. This happens because teacher pensions take a long time to accrue wealth. On average, it takes a 35-year-old new teacher about 19 years for a teacher to build a pension that is worth as much as the amount of money they put into it through pre-tax paycheck contributions. It will take 13 years for a 40-year-old new teacher.
This carries serious consequences for a teacher who started teaching mid-career. She will need to teach a long time just to avoid taking a loss. To make matters worse, her 401k from her previous career will have grown only through interest while she was in the classroom. In all likelihood, a mid-career teacher will have far more money in her retirement if she had remained in her previous job, or if she had taught for her entire career.
With these facts in mind, changing careers to teach is a far more costly transition than previously thought. It’s clear that we need more STEM teachers in our schools. What’s not clear, is why those teachers who have years of professional experience in the field should have to take a significant pay cut and have their retirement benefits slashed in order to help our students. It’s unfair and makes it more difficult to recruit people with years of real-word experience to teach STEM.
States will need to develop innovative ways to ensure that highly valued mid-career STEM teachers do not face two barriers to the classroom: lower salaries and lower retirement savings. One way could be for states to forgo the pension system and instead contribute to the 401k of teachers who changed professions mid-career, or at least give teachers the option to do so. This way these teachers can continue to grow their 401k investments and avoid significant losses to their retirement funds.
Cassie Thompson is working toward balance. As a Head Start teacher in Cincinnati, Ohio, Cassie has strived to lead her 17 students, ages three to five years old, in both developmentally appropriate socio-emotional learning and academically rigorous kindergarten preparation. Says Cassie, “It isn’t supposed to be just finger-painting and running around – but finding a consensus on what pre-k should be, even within Head Start, is difficult.”
Early childhood education is challenging and often thankless work. A recent, comprehensive report out of the Center for the Study of Child Care Employment at the University of California, Berkeley detailed the abysmal salaries, work environments, and professional development opportunities afforded to early educators nationwide. My Bellwether colleague, Marnie Kaplan, has more on this here, and the Department of Education released similar findings this June.
But as state and local policymakers seek to expand pre-k opportunities and improve support for early childhood teachers, they must also ensure educators like Cassie are given a viable path to save for retirement. Perhaps unsurprisingly, many of the benefit inequities we see at the K-12 level trickle down to the early childhood sector as well. Here’s a quick breakdown:
The workforce is fragmented
Some pre-k teachers work in school districts, while others, like Cassie, are employed by community-based providers. This distinction alone means two early childhood teachers with identical qualifications could have dramatically different retirement benefits. Further, even those early childhood teachers who are eligible to enroll in a traditional teacher pension plan are still unlikely to benefit from the rewards promised – their tendency to be lower-paid and more mobile keeps them from reaping the back-end rewards of a state plan.
The workforce is underpaid
Early childhood educators are often compensated at much lower levels than K-12 school teachers—even when they work in publicly funded programs such as Head Start and state-funded pre-k. Pay is tightly linked to the ability to save for retirement. It isn’t that lower-paid workers are less cognizant of the need to save for their future, but rather, they simply have less money to save. We see this same scenario play out when analyzing women’s saving habits. While women are more likely to participate in retirement plans and contribute higher amounts, the average woman’s retirement account balance is half that of the average man’s. This isn’t because women are bad savers – in fact, they’re better – men just make more money and thus have more money left over to save.
In addition to differences in salary, lack of access to pensions and other retirement benefits available to K-12 teachers exacerbates salary inequities for early childhood workers. Although a growing number of policymakers, funders, and early childhood advocates recognize the need to improve the compensation of early childhood workers, retirement security issues are rarely included in these conversations.
This is unfortunate, because most early childhood workers lack retirement savings options altogether or have the option to join only meager, poorly structured 401(k) plans. Lack of access to employer-provided retirement plans is also a major area of inequity between preschool teachers working in public schools, who are enrolled in public pension plans, and those working in community-based organizations, who may not be enrolled in any retirement plan at all. The latter group is often made up of smaller providers, who face the same obstacles to providing benefits as other small companies. Here’s a bright spot: we’ve covered some of the state-based efforts to address this problem broadly; while there’s still work to be done on these, if enacted, pre-k teachers would be beneficiaries.
But what about Cassie? Her non-profit employer offers a 403(b) retirement plan, giving her the portability to take her savings with her as she pursues a new opportunity outside of the classroom. The downside? Cassie’s employer does not match employee contributions unless they stay for several years – though Cassie was with her employer for two years, she won’t receive any match on her own contributions.
If Cassie is any example, increasing pre-k salaries is only the beginning. In order to enhance the status of the profession and build a more stable corps of educators who can seamlessly transition across sectors and locations, the early childhood sector needs to expand its reform efforts to include retirement offerings, too.