Modernizing Teacher Pensions

Josh McGee and Marcus A. Winters
Publication Date: 
January 2015
While public pensions have gained significant national attention for their massive underfunded liabilities, Josh McGee and Marcus Winters argue that benefits and plan design have received comparatively little attention. The authors argue that states and local governments need to modernize pensions to better fit the needs of the current workforce. 
Nine out of 10 teachers participate in a defined benefit plan based on final average salary. Yet, plans disproportionately distribute benefits by handsomely rewarding teachers who stay an entire career in a single system while offering few benefits to those who do not. Teachers accrue very little during the first couple of decades of teaching. It’s not until they approach their plan’s normal retirement age—usually after 30 years or more for a 25-year-old teacher—that teachers begin to rapidly accrue benefits. For example, in New York City, a teacher earns roughly $3,500 per year of work for the first 20 years of service and then $30,000 per year for teaching years 30 through 38.
But more than half of new teachers will leave the classroom before qualifying for a pension. In New York, only a third of new teachers will remain long enough to actually receive full retirement benefits. As a result, the majority of teachers (who do not stay a full career in a single system) are subsidizing the benefits of the small percentage of teachers who do. Moreover, modeling the preferences of a risk-averse teacher from 10 of the largest public school districts shows that new teachers would prefer a less back-loaded plan. In the model, a risk-averse teacher would be willing to take a small amount of upfront cash rather than stay in a traditional pension plan.
The authors recommend a smooth accrual or cash balance defined benefit plan. Cash balance 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 the current system creates a few winners at the expense of a much larger pool of losers, a smooth accrual model would allow all teachers to gain secure retirement benefits from the onset of their careers.