Although the decision about when to retire is a personal one involving many factors, in most states there is a very clear window during which you can maximize your retirement wealth. As explained below, you can receive the most total money in pension benefits by following two rules: stay in the same pension plan for as many years as possible, and then retire at your state’s normal retirement age.
In the 401(k)-style plans common in the private sector, your pension wealth is tied directly to your contributions, the contributions of your employer, and the investment returns earned by these contributions. In most states, however, public school teachers receive a Defined Benefit (DB) retirement plan. In these plans, pension wealth is instead tied to a formula that calculates a monthly defined benefit based on years of service in that retirement system and final average salary (usually calculated as your average salary over the three to five highest-earning years of your career in the system). These two numbers are then multiplied together, and a small percentage of that factor — usually around 2% — becomes your monthly defined benefit.
These pension rules offer some clear guidelines about how to maximize your pension wealth. First, you should work as long as you can in one system. Because your defined benefit is calculated based on years of service in a system, switching systems will most likely leave you with two small benefits that, when combined, are less than the one large benefit you would have gotten if you had remained in one plan for your entire career.
In addition, you should not retire earlier than the normal retirement age. In California, for example, the normal retirement age is 62, meaning that a teacher who retires at that age receives a benefit based on the 2% formula multiplier. However, if you retire at the age of 55 — the earliest possible retirement age — the state will instead use a multiplier of 1.16% to calculate your pension benefit.
Finally, avoid retiring much later than the normal retirement age. You get your pension benefit in the form of yearly payments rather than as a lump sum of cash. This means that as you age, even if you receive a higher amount of money per year, you will have fewer years of life to receive these payments.
For example, imagine that you can either retire now and earn an annual retirement benefit of $50,000, or retire in five years and receive a retirement benefit of $60,000. By waiting five years to retire, you would lose more than $250,000 in pension wealth, then earn an additional $10,000 every year after that (not including inflation). This means that you would have to live 25 years past that later retirement date in order to receive the same amount of money as you would have if you had retired at your state’s normal retirement age. Therefore, you should keep in mind your health at your time of retirement and decide whether the slightly higher pension payments are worth the loss of years of annual payments. (This advice is merely about maximizing one’s pension wealth and does not consider a teacher’s desire to continue teaching.)
All of these factors combined create a structure in which pension wealth remains low throughout most of a teacher’s career, spikes at the state’s normal retirement age, then slowly declines from there. So an ideal window to retire begins at your state’s normal retirement age and continues for a few years after that. A typical plan provides a trajectory of pension wealth that looks something like the graph below:
With an understanding of this pension structure in mind, you should be able to make an informed decision about what retirement age is best for you and your family. For more information about your state’s pension plan, check out our state teacher pension plans page here, or look at your state pension plan’s member guide that can be found at your plan’s website. And for more information about how to calculate a teacher pension, read our explainer post here.
Teacher pension systems can be quite complex. There are specific rules that vary state-to-state that affect any given teachers’ annual pension benefit after retirement. There are wider contexts to consider as well. For example, in some states teachers are not covered by Social Security, unlike most employees who can count on Social Security on top of their 401k or pension once they retire. Add all this together, and it can be challenging for teachers to have an accurate sense of how their annual pension benefit is calculated and, in the end, determine the value of their yearly retirement.
So how are teacher pensions calculated?
The first thing to know is that most states have a minimum number of years of service teachers must meet before they are even eligible for a pension, also known as a vesting period. As such, teachers must work a minimum number of years, often five or ten years, to actually qualify for a pension upon retirement. If teachers leave before meeting that threshold, when they retire, they’ll only receive the money they’ve personally put in and, in some cases, a bit of interest on that investment.
For those educators who work beyond the vesting requirement, traditional pensions are based on the teacher's years of experience and a measure of "final average salary," usually the average of the teacher's salary in the last three or five years prior to retirement. In general, the longer a teacher has worked and the higher her salary, the higher her pension will be. There is one more factor: a state-set benefit "multiplier," typically around 2 percent, that literally multiplies all of these variables together to determine how much a teacher will receive yearly during retirement.
The example below is a typical state pension structure and illustrates how teacher retirement benefits are typically calculated:
That's not all. States also set a minimum retirement age, before which teachers can’t access their pension benefits, and years of service requirements that teachers must meet to receive full benefits. For example, some states employ the "Rule of 80," which sets the retirement age as the point when the sum of an educator’s age and years of service add up to at least 80. States also set early retirement ages, at which point workers can collect reduced benefits. How much early retirement affects benefits varies by state.
Researchers have found that traditional teacher pension benefits are back-loaded in that most of their value comes as the teacher nears the normal retirement age. That happens because pension plans use the "final average salary" in the years they were earned; they do not adjust for inflation, and someone who leaves the profession years before collecting a benefit will see their pension gradually wear away to inflation. As a result, teacher pension plans typically provide generous retirement benefits only to those who teach for multiple decades. On the other hand, those with shorter careers receive scant, and in some cases, no pension benefit.
Here are a few other things teachers should consider when thinking about their retirement:
- What is the state’s vesting period? In other words, how long do you need to work before you will qualify for a pension?
- How much are you contributing per month to your pension? How much does the state contribute on your behalf on top of that?
- Are you enrolled in Social Security, or are you solely dependent on your pension and your own personal savings?
- If you’re a new teacher, does your state offer alternative retirement plans that might be more portable than the traditional pension plan?
Generally speaking, due to how pension systems are designed, only about half of teachers ever earn a pension. Instead, they only receive their own contributions made to the pension fund. Among those who do earn a pension, only those teachers who spend most of their careers working in the same state are the true "pension winners." Current and prospective teachers, particularly those living in states with other retirement options, should think carefully about which retirement saving strategy works best for them.
Even though most educators are women, their salaries nevertheless lag behind their male colleagues. In a recent report, I analyzed educator salary data in Illinois and found that women – at every experience level – earn lower salaries than men. On average, a female educator earns $7,775 less than her male colleagues. The problems don’t end there. These lower salaries translate to lower pensions as well. The typical female educator’s annual pension is valued at $3,800 less.
Unfortunately, finding a gender pay gap isn’t altogether surprising. However, it does mean K-12 education isn’t inoculated to gender-based disparities by district salary schedules that regulate how much educators can earn based on tenure.
So what might explain these gaps? Although there no perfect answers, through a series of posts I will look into potential causes. Today’s piece is about differences across grade levels.
Aside from the “parenting penalty” that disproportionately and adversely impacts the earning potential for women, one reason women on average earn lower salaries and pensions is that they work overwhelmingly at the elementary level. The majority of men, on the other hand, work in high schools. As shown in the graph below, average salaries are significantly higher in high schools than in any other grade span.
High School Educators Earn the Highest Salaries in Illinois
Source: Author’s analysis of data from the Illinois Teacher Service Record (TSR), 2012. Data adjusted for cost of living using the Comparable Wage Index.
Around three-quarters of all educators in Illinois are women. And among women, 42 percent work in elementary schools, while only 17 percent work in high school. Comparatively, 47 percent of men work in high schools. This distribution contributes to the gender-pay gap among educators in Illinois. This may be due to greater extra earning opportunities at the high school level through clubs and athletics. Or, there could be a higher concentration of advanced degree holders in the upper grades. Illinois also has the most single-school districts in the country, which have significantly higher costs. It is possible that a disproportionate number of these districts may be comprised of high schools.
We will further explore features and potential explanations of the gender-pay gap in future posts.
How much do teacher pension plans cost? How have those costs changed over time?
Those may seem like simple questions, but there aren’t perfect data sources to answer these questions. At the national level, the U.S. Census Bureau tracks total benefit spending by states and school districts, which does include retirement costs but also includes healthcare and other employee benefits. The Bureau of Labor Statistics tracks national figures but only reports the data in terms of percentages and a per-hour basis.
Luckily, the Center for Retirement Research at Boston College (CRR) has done the yeoman’s work of collecting comparable data from state pension plan financial reports. The raw data still aren’t perfect to answer the questions I posed above—many states include teachers and other education workers alongside other public workers in the same plan—but with a little bit of work, I was able to narrow the data to look solely at teachers and other educators. (For simplicity’s sake, I’m going to use the term “teachers” throughout the remainder of the post, but the numbers also include other school support staff, principals, superintendents, and central office staff.)
With that throat-clearing out of the way, what do the numbers say?
Over the last 15 years, state and district spending on teacher pensions is up approximately 261 percent. Meanwhile, states have cut teacher retirement benefits and asked teachers to pay more for worse benefits.
I’ve written about these issues recently for particular states, but it’s also worth zooming out to look at the national picture. Nationwide, states and districts now spend about $40 billion on teacher pension costs, up from $15 billion 15 years ago.* Over a period where states struggled to invest in K-12 education, rising pension costs have meant even fewer dollars making it into classrooms.
Another way to look at pension costs is to look at contribution rates. As the next graph shows, mandatory member contributions have increased over time, from an average of 5.2 percent of salary up to 6.8 percent. Again, this has happened at the same time states have been cutting benefits for new teachers. Teachers are paying more for less.
Worse, the employer actuarially required contribution rates, the rate that actuaries estimate will be needed to pay for all the future promised benefits, has doubled from 8.3 to 16.4 percent.
These graphs don’t even include Social Security. If you factor in Social Security contributions, it would appear as if teachers have enormous pots of money being set aside for their retirements.
I say “appear” because that’s not how teacher pension plans work. Unfortunately, the increase in pension contributions is entirely due to paying for past pension promises that have not been adequately saved for, not to pay for actual benefits for teachers. States break down their contributions into two rates, the “normal cost” of benefits, which is the actuaries’ estimate of how much the benefits are worth on average, and the cost of paying down any accumulated debt, known as the “amortization cost.” As the graph below shows, the average normal cost of teacher retirement benefits has fallen from about 6.2 percent of salary to slightly less than 5 percent. These are averages across all members in a given plan; as states have cut benefits for new teachers, the figures would be even lower if we had accurate data about how much each of these tiers are worth.
Meanwhile, the amortization costs, aka the debt cost, of teacher pension plans have risen from an average of 2 percent of teacher salaries to more than 11 percent. To put it crudely, it’s as if states failed to make sufficient payments on their credit cards or their home mortgage, and now their interest costs have ballooned.
These costs will not go away any time soon, and states will need to think differently if they want to see any future changes. Left unaddressed, the mountain of debt is likely to keep growing, and teachers will see more and more of their compensation going toward paying off past pension debts instead of going into their pockets.
*Note: The numbers in this post are meant as estimates. They start with data from the Public Plans Database, with a few adjustments. About half the plans in the database include educators and non-educators alike, so in order to get a closer estimate of the education share, I applied weights used by the National Council on Teacher Quality which are based on the percentage of each plan’s membership who are educators. For most states, the data run from fiscal year 2001 through fiscal year 2016, but data were not available for all states and all years. A few states were missing random years of data, in which case I used the average of the years before and after. I took out Kentucky entirely, since it was missing all years prior to 2014. And a couple states, notably New Hampshire and Oregon, were missing data for the earliest years in this time period. For those states, I simply applied the later rates going backwards.Taxonomy:
The state pension plan funding gap is well-documented -- according to Pew, the gap between the promises states have made for public employees’ retirement benefits and the money they have set aside to pay these bills was at least $1.4 trillion in fiscal year 2016. For a blog dedicated to providing high-quality analysis and information on teacher pensions, it’s clear that there is a problem.
Let’s talk solutions.
While traditional, back-loaded pension plans fall short of providing adequate retirement benefits to all members, there are better options. And, contrary to a public debate that often pits pensions against 401ks, there are other alternatives that would better balance the needs of employers and employees.
As one alternative example, the Texas Municipal Retirement System (TMRS) is legally a defined benefit cash balance plan. As of December 2016, 872 Texas cities had opted into the plan, covering 108,500 active members and 59,000 retirees. Participating cities select an employee contribution rate (of 5, 6, or 7 percent), an employer match (1:1, 1.5:1, or 2:1), and the contributions go into a worker's account. The plan invests the money and guarantees a rate of return of at least 5 percent. This provides a more portable benefit with a steadier accumulation of assets than the typical defined benefit plan.
The plan also helps employees once they retire. When the employee reaches retirement eligibility, the money in their account is annuitized into regular monthly paychecks. These paychecks allow for sustained monthly income, mirroring the benefits and stability of a traditional pension plan without the back-loaded accumulation under traditional pension plans. (See more details of how the plan works here.)
No plan is perfect. Here, employees might be able to earn higher return in a defined contribution, 401k style plan, but to do that, they would have to sacrifice the guarantee. Employers still bear some risk, but it’s smaller than under a traditional defined benefit plan. Still, this system allows employers some level of customization, and the portability piece makes it appealing to employees. TMRS, a defined benefit cash balance plan, is just one of many retirement options that could better address the cost and portability problems that are prevalent in the plans offered to public school teachers.
By now it's become something of a joke on social media, but earlier this month MarketWatch tweeted that, "By 35, you should have twice your salary saved, according to retirement experts." The original source for the tweet is a set of calculations by Fidelity Investments. It may be funny to joke about--my favorites involve acquiring a wide variety of Tupperware, plastic bags, and electric cords--but the Fidelity targets were an earnest attempt to estimate how much people should have saved at various ages in order to be on a path to a secure retirement.
The Fidelity targets are ambitious, but they're not crazy. They start with the assumption that people should aim to replace 45 percent of their income every year in retirement. That level of savings, plus Social Security, should afford someone to comfortably retire at age 67. Fidelity works backwards from there to estimate how much people should have saved at every stage of their career. The targets are framed as a percentage of income on the assumption that people should aim for a similar lifestyle in retirement as they enjoyed during their working years.
Given the perception of teacher pensions as being extremely generous, I set out to compare the typical teacher pension plan against the Fidelity targets. Using data from the National Council on Teacher Quality, I created a "typical" teacher retirement plan and then compared how assets accumulate for a typical public school teacher versus what Fidelity recommends.
As the graph below illustrates, the typical state-run pension plan forces teachers to suffer from years of low savings. If a teacher leaves the profession short of a full career, she may qualify for a pension, but it won't be large enough to provide for a comfortable retirement. To reach the same level of retirement security, ex-teachers will have to save more in later years, retire later, work longer, or depend on family members.
The graph also shows the opposite end. For the fraction of teachers who do stay for a full career, the typical pension system works fairly well. If they stick it out and continue teaching well into their 60s, their retirement income will start to beat out the Fidelity targets. (Due in part to the way the plans are structured and when they allow teachers to retire, most teachers, even full-career teachers, retire well before their mid-60s.) Still, this level of retirement security is only provided to those who remain as teachers in one state for their entire careers. Depending on the state, that's only 15-20 percent of incoming teachers. The rest fall short.
Public school teachers could have their own personal investments that might make help make up the difference, but the graph above may be under-selling the issue somewhat, since Fidelity's targets take Social Security for granted. About 40 percent of public school teachers do not have Social Security, so they're even more vulnerable to back-loaded teacher pension plans.
As the jokes made clear, many people find the Fidelity targets unrealistic. And they may be for lots of young people facing other financial pressures. But they're simply one way to gauge retirement readiness. And public school teachers aren't passing the test.Taxonomy: