Blog: Retirement Insecurity

The research field of teacher pensions has been a relative backwater, but lately it just keeps getting more interesting. Yesterday, the Fordham Institute released a new paper from Marty West and Matt Chingos analyzing a 2002 policy change in Florida which allowed teachers to choose between a traditional defined benefit pension plan and a 401k-style defined contribution plan. The authors were able to track who chose which plan, what subject they taught, how effective they were in the classroom, how long they remained teaching, and whether the pension plan’s structure had any effect on retention.

Perhaps not surprisingly, they found that math and science teachers, teachers with advanced degrees, and charter school teachers were all more likely to opt for the portable defined contribution plan. These teachers may enter the profession not planning to stay for long or, in the case of charters, may anticipate switching to another school that’s not enrolled in the Florida defined benefit system (Florida charters have a choice on whether to participate or not).

Important, they did not find any differences in effectiveness between those who chose the defined benefit plan and those who chose the defined contribution plan, but they did find differences in attrition rates. Teachers who opted into the defined contribution plan were one percentage point more likely to leave before their second year and nine percentage points more likely to leave after their fifth year. This will give fodder to the crowd that claims that defined benefit plans do a better job of retaining employees than 401k-style defined contribution plans and support those seeking to preserve the status quo in most other states.

But wait, there’s more to this story. If you care at all about the thousands of teachers who will one day become ex-teachers, this paper puts numbers on just how many there are and how much money they’re losing. In the seven years of the study, Florida districts hired 92,000 first-time teachers. The authors found that roughly 40 percent of these beginning teachers stay less than six years, the amount of time Florida required a teacher to be employed before becoming eligible for pension benefits. By not meeting the vesting requirement, the authors estimate each of those ex-teachers will lose out on retirement savings of up to $27,784 in today’s dollars.

It was outside the scope of the study, but Florida recently lengthened the vesting period from six to eight years, meaning even more teachers are likely to become ex-teachers before qualifying for pension benefits, leaving even more money on the table. (See how Florida’s vesting requirements compare to other states here.)

Articles on retirement security, like this one from the NY Times, are good to read and know about. The short version is that few of us are saving enough for retirement, so we’re going to see more “retired” people working part-time, retiring later, or, worst case scenario, looking for a government fix. The situation is even worse for younger Americans.

One thing that’s particularly relevant for this blog is that defined benefit pension plans are more or less a thing of the past for most workers, and in the next five or ten years we’re going to have a whole class of workers becoming eligible for retirement age who’ve never had a DB plan in their entire working career.

To see why this matters, check out the chart below from a recent McKinsey report.  It’s divided by age and income, and it shows how much, or how little, workers have saved for retirement and what form that savings takes. At the bottom right-hand side are workers aged 60-65 who earn $20-50,000 a year. Sixty percent of their retirement income will come from Social Security, 22 percent will come from a defined benefit pension plan, only 1 percent will come from personal savings, and they’re facing a 17 percent shortfall between what they have saved and what they’re likely to need. Looking at the next youngest age bracket, workers aged 40-59 earning the same amount, they can expect 48 percent from Social Security, only 4 percent from a DB plan, an 6 percent from personal savings (including 401k plans and IRAs). They face a 42 percent shortfall.

These figures would be improved, although not erased, through a stock market boom. The awful truth is that Americans just aren’t saving enough for retirement.

In the midst of an excellent piece arguing unions aren’t winning negotiations on salaries–they’re winning negotiations on everything else–David Leonhardt makes a really important point:

Unfortunately, though, politicians do not have the same incentives to be tough negotiators on issues besides money. Why not? Because most government agencies are monopolies. They face no competition. Whether they perform beautifully or miserably, they cannot be run out of business. They also can’t be run out of business by pushing off costs until a future day. So they delay too many costs and don’t perform their jobs well enough.

The delaying of costs is obvious. Both politicians and union leaders have decided that generous future benefits offer the easiest way to hold down spending and still satisfy workers. The result is government pay that’s skewed too heavily toward pensions and health insurance.

Study after study has found that public-sector workers have traded lower salaries for better benefits, but there’s no particular reason that trend must continue. A smart governor would approach the public-sector unions in her state and ask to trade some of the expensive, unpredictable health care costs and back-loaded pension benefits for higher salaries**. This could even be a revenue-neutral trade that manages to make both sides better off.  The governor would be getting greater predictability in her budget, while union leaders would put more cash in the pockets of their members. A smart union leader would take the deal, because people tend to value cash more than they do in-kind contributions, so union members may even feel like they’re better off. Perhaps most importantly, it would help put public-sector worker compensation more in line with that of private employees.

**In many states, it’ll illegal to reduce the accrued retirement benefits of workers, but the courts have found such reductions acceptable if they’re accompanied by increases in compensation. 

This blog entry first appeared on The Quick and the Ed.

New Jersey Governor Chris Christie has been in the news a lot lately for his handling of the Garden State’s budget crisis around government-worker benefits. The New York Times did a piece earlier this week on a confrontation between Christie and teacher Marie Corfield around cuts to education funding, and 60 Minutes featured Christie in a wide-ranging piece on the state of state budgets. Neither of these stories has fully gotten to the heart of why the state now has a $20 billion liability for teacher pensions, and neither of them mentions the fact that only eight years ago the state had a teacher pension fund surplus.

So what happened? A stock market crash certainly hurt, but the state has made its own problems along the way. Through a combination of low contribution rates and benefit enhancements, New Jersey starved the pension beast.

Traditionally, Starve the Beast has been employed by fiscal conservatives to force budget deficits, which in turn lead to demands for reductions in the size of government. The argument goes that if the government spends more than it takes in, it should stop spending. As the chart below shows, this tactic has certainly been employed in New Jersey’s Teachers’ Pension and Annuity Fund. The blue line represents what the state’s actuaries have told the legislature it needs to invest in order to cover its future teacher pension obligations. The red line represents what it actually put in. In only one year of the last 13 did the state meet its actuarial obligation, and it only met it that year, 1997, because the state issued pension obligation bonds to help retire previous underfunding debts. In two years, 2001 and 2002, the state actuary decided the fund required no contributions, and the state gladly complied. In the other ten years, the state has failed to invest enough to cover its teacher pension obligations. Collectively, the difference between what New Jersey should have invested and what it actually put in–the difference between the blue and the red lines–is $5.2 billion.