Better Pay, Fairer Pensions II: Modeling Preferences Between Defined-Benefit Teacher Compensation Plans
Pension debates often frame traditional defined benefit plans versus 401k-style defined contribution plans. But in practice there are many more options to choose from. This second Manhattan Institute report by Josh McGee and Marcus Winters examines an alternative defined benefit plan. The authors (one of whom works at a foundation that funds some of Bellwether’s pension work) call one alternative plan a “smooth-accrual defined benefit plan” or SA-DB. In a traditional defined benefit plan, benefits are heavily backloaded; teachers receive minimal benefits in their early years but quickly earn substantial benefits as they near their plan’s prescribed “normal retirement age.”
In contrast to a traditional defined benefit plan, an SA-DB plan accumulates wealth at a constant rate. This means that early-career teachers, who usually gain little to no benefits from traditional plans, can receive more benefits from the start. The benefits of that approach, the authors argue, is that SA-DB plans wouldn’t necessitate higher taxes and could mean greater retirement security for more teachers.
The SA-DB plan is essentially what others have called a “cash balance” defined benefit plan. These plans allow teachers to earn a constant percentage of benefits; pension wealth is smooth and even, in comparison to the sharp, backloaded spikes in traditional plans. While there are only a few winners and a much larger pool of losers in the current system, a smooth accrual model would allow more teachers to gain secure, retirement benefits from the onset of their careers.
The Manhattan Institute report looks at which plan a teacher would prefer: a traditional defined benefit or an SA-DB plan? They use economic modeling and pension plan assumptions from 10 of the largest public school districts to predict what a risk-averse teacher would prefer. They find that:
- Newly entering teachers should prefer the less backloaded, SA-DB plan.
- How much an entering teacher prefers the SA-DB plan depends on how backloaded the competing traditional plan is and the how likely the teacher will stay in the plan. In most districts, newly entering teachers would have a strong preference for the SA-DB plan.
- Newly entering teachers working in heavily backloaded plans should be willing to receive a rather small amount of money upfront rather than stay in their pension plan. For example, in Hawaii, a teacher should prefer to pass over her traditional plan in exchange for just $279, because the current plan is so heavily backloaded and turnover is high. According to current plan assumptions, most Hawaiian teachers (77 percent) won’t earn even $279 in retirement benefits before they leave the system.
- Newly hired teachers in six districts who expect to stay for 10 years would also prefer the SA-DB plan.
- Teachers who expect to stay for 20 or more years would prefer the traditional plan. These teachers (a relatively small pool) are unlikely to leave the system because they are close to earning maximum pension benefits.