Nationally, teacher pension funds have amassed more than a trillion dollars in assets. But those funds cannot just sit in a bank somewhere; that money needs to grow. It needs to earn high returns so that pension funds can pay down debts and meet burgeoning financial obligations to their members. In fact, states often base how much they need to save today on ambitious assumptions about the expected rate of return they’ll get on their investments.
Most pension funds engage in a strategy that’s called active investing. Under this approach, money managers make decisions about which company’s stock should be bought and sold, and when. With smart people making such decisions, the idea is that active investing will produce greater financial gains than a “passive” approach of regularly buying an index of equal amounts of all companies in the market.
The evidence, however, tells a different story.
As Ben Carlson, the author of A Wealth of Common Sense, pointed out in a tweet earlier this fall, over the last 15 years “passive” index funds overwhelmingly outperformed traditional, “actively” managed mutual funds. Among the different types of funds analyzed, index funds outperformed the actively managed mutual funds at least 80 percent of the time. In many cases, index funds performed even more strongly. For example, small-cap growth funds were outperformed by their benchmark 99.35 percent of the time.
These data suggest that passive investing could provide a safer and, over the long-term, a more productive investment, for teacher pension funds. Passive investing, such as through an index fund, spreads investments widely. This produces a highly diversified portfolio that covers the entire market, rather than trying to make guesses about which particular companies or sectors will do well at a given time. This strategy insulates investors from more dramatic swings of volatility in individual stocks and, as shown above, can often produce returns that outperform managed accounts.
Taking a more passive investing approach could benefit teacher pension funds in other ways as well. Passive investing also typically incurs lower fees, meaning teacher pension funds can pay less for these returns on their investments. Furthermore, electing to passively invest will severely reduce the need for pension fund employees to pick the right money managers, who in turn will pick the right investments. Studies of this practice suggest that it’s a lose-lose situation, that investors tend to chase after positive performance rather than capturing it themselves, and that states might be better off making passive investments with a leaner team.
As an added bonus, passive investing would help to eliminate some of the politics around pension funds. As my colleague Chad Aldeman previously noted, the American Federation of Teachers (AFT) black-listed certain money managers who ran afoul of the union’s priorities. Or conversely, some unions will attempt to make socially conscious investments such as avoiding weapons manufacturers. Passive investing allows pension funds to avoid these political issues.
To be sure, passive funds are not fool-proof. They follow the market, and if the market tanks so will they. A passive investment also won’t produce dramatic returns like someone who bought Amazon stock in the mid-1990s, or Bitcoin in more recent years. But index funds produce a greater than average return when the market is doing well, and can limit losses during a downturn. It is precisely this kind of investing strategy that pension funds need to grow their assets and meet their members’ financial needs.Taxonomy:
I was recently chatting with an education-sector friend who asked about good side jobs for teachers, and it gave me pause. I wasn’t put off by the question, per se. I had spent my own teaching years making extra cash with regular babysitting gigs, summer school classes, and a paid testing coordinator position. But when I actually stopped to think about it, the best second job for a teacher is no second job.
Teachers, no matter how new, shouldn’t need a side hustle to make ends meet.
But, conservatively (and without including summer work), 16 percent do.
Put simply, we don’t pay teachers enough. This is true by multiple measures. In 2015, American teachers’ earnings were 17 percent lower than comparable college-educated workers in other developed nations. There are countless factors tied up in this, gender included. The Teacher Salary Project has more, but that’s a whole other blog post. Or six. How do we make it better?
One solution? Pension reform. Right now, states pay, on average, $6,800 per teacher toward pension debt. These payments aren’t going to future benefits, but instead to pay down existing debts. If we compare those numbers to the amount teachers report earning through side hustles, teachers in at least 47 states and Washington D.C. would benefit (these states have at least some pension debt that’s costing teachers money) and of those, 26 (highlighted below) would out-earn their average side hustle. Without pension debts, states could raise salaries enough that teachers wouldn’t need to spend their free hours waitressing or driving for Uber.
* Maine and Ohio do not report debt separately
Pensions are often touted as a retention strategy. But in fact, studies show defined benefit plans do very little to entice new and mid-career teachers to stay, and only marginally push or pull veteran teachers’ decisions. It may be that a fair salary, one providing family sustainable wages, would be an even stronger retention strategy. To be sure, finances are not the first reason teachers cite for exiting, but in the most recent national survey, 18 percent of teachers who left the profession attributed their decision to financial reasons.
Teachers deserve to feel valued while they are on the job, not just in retirement. And if teachers are forced to take on second jobs to make ends meet, many may be pushed out of the profession before they qualify for a decent retirement benefit. Pension debts affect all teachers, but they’re paying for retirement systems that only benefit a fraction of them.
Last month, I wrote about a recent report comparing apples and oranges. More precisely, the National Public Pension Coalition (NPPC) claimed that state-run defined benefit plans offered better benefits than defined contribution plans.
As I pointed out at the time, the NPPC report ignored how much money was going into each of the plans, and they looked only at the retirement benefits offered to 35-year veterans, which sidestepped the question of how benefits accumulate over time.
But what if we take their comparison seriously and show what retirement benefits actually look like over the full career of a teacher? Before I show you the results, consider the inputs.
The NPPC report compared charter schools to traditional pension plans in eight states, California, Florida, Indiana, Louisiana, Michigan, North Carolina, Pennsylvania, and Wisconsin. Since I already had data on the traditional defined benefit pension system in Pennsylvania, I decided to focus there. Although Pennsylvania recently made changes to its retirement plan for new teachers, for illustrative purposes I’m going to show the system for current teachers. From the NPPC report, I pulled info on the defined contribution plan offered in their Pennsylvania comparison school, the Chester Charter School for the Arts. I assumed immediate vesting in the 403(b) plan, but otherwise I took the same investment return and inflation rate assumptions as the NPPC used*. Here’s what those plans look like:
Pennsylvania’s Traditional Defined Benefit Plan
Chester Charter School for the Arts 403(b) Plan
Employee contributions (as a % of salary)
Employer contributions for benefits (% of salary)
Employer unfunded liability (% of salary)
Total contributions (% of salary)
Investment return assumption
Normal retirement age
Age 65 w/ 3 years of experience, or any age w/ 35 years of experience (and age + experience is greater than 92)
As the table shows, it’s obvious that the NPPC report is comparing apples and oranges. To begin with, the contributions into the system are different. Teachers and employers are contributing far more money into Pennsylvania’s state-run defined benefit plan than they are into the Chester Charter School 403(b) plan. However, the state plan has run up huge unfunded liabilities, so traditional Pennsylvania districts are also contributing almost 21 percent of each teacher’s salary just to pay those down. After accounting for those liabilities, the traditional Pennsylvania system costs three times as much as what the charter school is offering.
As it will be clear later, when it comes to pension plans, retirement plan costs do not always translate into retirement plan benefits, and the Chester Charter School is offering a pretty good retirement plan. Its 6 percent employer match would put it in the top 10 percent of private retirement plans nationwide, and the total employer plus employee contribution rate of 12 percent should provide at least a floor of adequate retirement benefits. (Unlike teachers in 15 other states, Pennsylvania teachers in both plans are enrolled in Social Security.)
Ok, on to the results. In the graph below, the blue line shows how benefits accumulate under Pennsylvania’s old defined benefit plan. As in other states, benefits accrue very slowly for many years, and it isn’t until teachers near the state’s 35-year mark that the pension value really starts to climb. In contrast, the red line shows how retirement assets would accumulate under the Chester Charter School for Arts plan. Workers at all ages are accruing decent retirement benefits, regardless of how long they stay.
So which plan is “better” for teachers? The NPPC is right to point out that a 35-year veteran is better off under the old Pennsylvania defined benefit plan, at least based on retirement benefits alone. But that’s only part of the story. Remember that more than a third of her salary is going to pay for that benefit, and only a select group of teachers will reach that peak. According to the state’s own estimates, less than 1 percent of Pennsylvania teachers will stay that long. After zooming out and looking across the full working career, it becomes clearer that a portable benefit plan would be better for most teachers.
*For the sake of argument, I’ve taken the NPPC’s investment and inflation assumptions verbatim, but those result in a far lower return than what Pennsylvania assumes in its official projections. It’s not the main point of this post, but recent research has questioned whether defined benefit plans really earn a premium above what individuals earn in their defined contribution plans.
This piece was coauthored by Chad Aldeman and Max Marchitello
State teacher pension systems are in serious need of reform. Aside from skyrocketing costs that eat up a growing portion of states’ education budgets, teacher pensions simply do not provide the majority of teachers with a valuable retirement benefit. Whether because they don’t meet the vesting requirements, they move states, or only teach for a portion of their career, more than half of teachers either do not earn any pension, and less than one-in-five earn a full pension.
Despite these problems, states are still slow to change. One possible reason for that reticence is a misconception that under-funded plans need an influx of new teachers to help pay down past debts. That is, there’s a belief that closing existing plans would destabilize the system for all current teachers and retirees.
Fortunately, this need not be the case. In fact, switching new teachers to a new type of retirement plan, such as a defined-contribution plan, can be cost neutral.
Consider the following example of a state with a total pension contribution of 20 percent of teachers’ salaries. In this example, teachers contribute 5 percent of their salary and employers contribute 15 percent of each teacher’s salary. Unfortunately, two-thirds of that employer contribution, or 10 percent of each teacher’s salary, has to go toward paying down past debt, and only 5 percent goes toward paying for actual teacher benefits (what actuaries call the “normal cost” of the plan). We chose round numbers here for illustrative purposes, but they are broadly representative of the average teacher pension plan today.
Now let’s look at how a state can close the plan to new employees and still keep paying down its debt. In the example below, all teachers keep making the same 5 percent contribution. The 10 percent of teacher salaries necessary to pay down debts remains constant. However, since new teachers will be enrolled in a defined contribution plan, they will not have a “normal cost,” but instead a direct 5 percent contribution toward their retirement fund. The total costs to the system stay the same, and teachers receive the same value of retirement savings, but new teachers are now enrolled in a new plan with more portable benefits for them and no more debt accruals for the state.
Now, we're simplifying a bit here. Pension plans would have to adjust their investment strategies as more of their membership aged closer to retirement, just as individuals must do with their own investments. Plans with young members can take more risks, because they won't have to pay benefits for many years in the future. Once a state closes a plan, the membership will slowly age over time and plans would need to make more conservative investments. Still, that transition could take place over decades, as current workers gradually age into retirement, and states could instead phase in changes slowly over time. On a cumulative basis played out over decades, the costs of these changes would be relatively small, and meanwhile the state would stop adding to their current debt loads.
To be clear, some recent pension reform proposals have come with high price tags. But those are not because of the change in pension plans. Rather, in the case of recent proposals in Kentucky and Michigan, the increased costs were due to the fact that the states were simultaneously shifting new workers into a new system AND changing the way they paid down existing debts. Sort of like a homeowner switching from a 30- to a 15-year mortgage, those states are attempting to front-load their costs to pay down their debts more responsibly. While this is also a good idea, it's separate from the change in retirement plans.
All of this is to say that states can make the shift to new retirement plans easier than pension advocates claim. They could enroll new teachers in a new retirement system without incurring much in the way of additional costs, stop adding to their already large pension debts, and better serve the majority of teachers.
For an organization that claims to care about workers, the Economic Policy Institute (EPI) is awfully dismissive* of how teacher retirement policies play out for individual teachers.
In a new report for EPI, Monique Morrissey asserts that, “teachers and schools are well served by teacher pensions,” and attacks our work looking at how many teachers benefit from today’s teacher retirement plans.
The debate centers on one critical question: Should we care about individual workers’ lived experiences in a given profession, or should we take a snapshot of the current workforce as representative of all those who experience it? How you think about that question will inform how you think about how well most teacher pension systems work today.
Morrissey wants us to consider a snapshot, or cross section, of the active teaching workforce. Today’s teachers have a range of ages and experience levels. Some are just entering the profession, while others are closing in on retirement. It’s hard to capture that diversity and Morrissey attempts to take this cross-sectional approach and answer the question of how many teachers will reach the 30-year mark. In her estimation, 80 percent of today’s teachers will do so.
But here’s the problem with that method: a snapshot of today’s teachers omits anyone who once was a teacher and is no longer. For every teacher who’s closing in on 30 years of experience today, there were many others who started out at the same time who are no longer part of the picture today. We know this because state pension systems maintain good data on participants and what they are owed. For instance, about one-third of new, young teachers in North Dakota will make it to 30 years, compared to only about one-in-ten teachers in North Carolina.
A snapshot, then, is irrelevant to determine what percentage of all teachers will receive adequate retirement benefits, because employees accumulate retirement savings as individuals. It’s also a misleading way to analyze the data. Under defined benefit pension plans, like the ones serving most public-school teachers, teachers receive retirement benefits according to their own salary and their own years of experience. If they serve only a short period of time, they don’t get much in the way of retirement benefits. Moreover, pension plans don’t deliver benefits in a linear fashion, and they provide disproportionately large benefits to teachers who stay for a full career.
We don’t have to speculate about this or come up with hypotheticals; every state posts their data on pension plan websites.
That’s why our work on teacher retirement looks at the chances any particular teacher has of reaching various retirement milestones. And again, our figures are not derived from speculative models, we use data from the state pension plans themselves, which use the same data in their own financial calculations.
Pension plans have to estimate how many teachers will reach various stages of their career and, in turn, qualify for pension benefits. Every pension plan publishes these assumptions in their financial reports, and they conduct regular “experience studies” to see if their assumptions are correct or if they need adjustments. (Perversely, state policymakers use this data to make pension plans even harder to qualify for in order to shore up their flagging finances, for instance in 15 states it takes ten years to vest for even a minimal teacher pension; that’s a problem for workers that EPI quickly glides over).
Since Morrissey relies heavily on a prior research paper on California (which I’ve written about before), I'll use an example of California’s most recent experience study, adopted in 2017. The graph below shows the pension plan’s estimate for voluntary (“withdrawal”) by the teacher’s year of experience. This graph is for females, but the state has separate, albeit similar, assumptions for males and for other sources of turnover, like retirement, death, or disability.
In the graph, the skinny blue line was California’s prior assumption, and the bars represent the actual experience from 2016 and 2011, respectively. Based on its observations, the state is slightly tweaking its assumptions going forward, to the orange line.
Again, every state needs these assumptions to be accurate, or else it could risk over- or under-saving for future pension payments. After running their experience studies, states publish their final assumptions in tables like the one below. The way to read the table is that, for any female member in her first year of service, California expects 15 percent to leave and 85 percent to stay. Out of the remaining 85, California assumes another 9 percent will leave in year two, another 7 percent in year 3, and so on.
What we’ve done in our work is to look at a typical teacher starting out in a state and ask, if we follow the state turnover assumptions, what are a teacher’s chances of reaching the state’s vesting requirement, when she’ll first qualify for any benefit? And, what are her chances of reaching the state’s normal retirement age?
We believe those are the right questions to ask. They’re the questions any given teacher should ask in planning for his or her own retirement, and they’re the questions the pension plans are asking themselves.
The answers to those questions show that pension plans are not working well for large majorities of people who enter the teaching profession. In the median state, about half of all new teachers won’t stay long enough to receive any pension at all, and only about one-in-six will stay for a full career. That’s not a typo. That’s how few teachers make it.
No one is in dispute of these estimates. They look slightly different for men or for people who begin teaching at various ages, but in reality the main driver of teacher turnover, at least early in his or her career, is years of experience, not age or gender. (For simplicity’s sake, we typically only report the survival rates for new, 25-year-old females, but a more sophisticated study by Bob Costrell and Josh McGee found similarly depressing results even when looking at teachers who enter at all different ages.)
EPI doesn’t try to challenge these numbers either—on page 5 of her report, Morrissey concedes “the critics’ calculations may be accurate,” but then she tries to change the conversation to the snapshot approach. That’s a fundamentally flawed way to look at retirement security, because it discards large numbers of former teachers and ignores the basic facts about how individual teachers accrue benefits over time.
Reasonable people can disagree about what to do about this problem. Some advocate 401(k) style approaches while others favor traditional pensions but with some tweaks. And there are hybrid options like “cash balance” plans that have aspects of both of those approaches. The reality is that there are trade-offs with every approach and it’s possible to design lousy pensions and good 401(k)s and vice versa. What we shouldn’t disagree about, however, is that this conversation is too important not to be informed by the best data and honest straightforward analysis of what it means and what those trade-offs and choices are.
*Note: This piece is mainly about EPI’s methodology, but their report also includes a number of alarming statements about teachers. For example, at one point they admit that “vesting requirements are primarily cost-saving, not retention, devices,” essentially waving away the fact that half of all new teachers won’t stay long enough to vest and sticking a knife in literally millions of American workers. Moreover, this statement concedes the point Kelly Robson and I made in a recent article for Education Next that showed that pensions are not a retention incentive for the vast majority of teachers.
WalletHub recently released its new rankings of the best states for teachers. This year, there is a new best and worst state. New York grades as the best state overall, while Arizona came in last.
WalletHub graded states based on their opportunity and completion, which included salaries, pensions, growth, and even tenure. They then also took into account the state’s academic and work environment, which among other things, was based on student-teacher ratios, turnover, and union strength. Altogether, this ranking is based on a breadth of variables.
WalletHub made at least one key improvement from its rankings last year: They amended how they evaluate teacher pensions. Previously, they rated states solely on the average pension paid out to retirees. As I wrote last year, it is a big problem to evaluate a state pension system this way, because average pensions don’t tell the whole story of a state’s pension system. Less than half of teachers even qualify for a pension. Take New York, WalletHub’s highest rated state. It has an average pension of around $44,000 but only 40 percent of teachers stay long enough to qualify for one in the first place.
To their credit, WalletHub responded to this criticism and upgraded how they assess the quality of state pensions. They now also include the percent of teachers whose pension doesn’t break even. In other words, teachers whose pension benefits are less valuable than their own contributions to the pension fund. This is a good decision by WalletHub that improves how they evaluate teacher pensions across the country.
We have our own 50-state ranking of state pension systems. Check out how your state measures up.