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Lesson 3.11

Pensions:
How Good is a Teacher's Pension?

Teaching pays better than you think, because…

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Obviously, no one gets filthy rich on a teacher's pension.

Teachers aren't lavishly paid, but each year of teaching comes with a significant promise toward a financially secure retirement. It is easy to underestimate the value of the pension system in the "big picture" of teacher compensation.

Teacher pay is better than it looks

A teacher's total pay is better than it looks. (Unless something goes terribly wrong, that is. It might. But we're getting ahead of ourselves.)

Teachers' pensions in most states, including California, are "defined benefit" systems. That is, when a teacher retires, he or she receives payments in a manner defined by the rules of the pension system. Those rules involve factors beyond the amount he or she has paid in.

Most workers pay into Social Security. Teachers pay into STRS.

The pension system for teachers is a "defined benefit" system, like Social Security.

The amount you get out of a defined benefit system in retirement does not directly connect to the amount that you pay in. While working, you pay the system. When retired, the system pays you. The amount that the system pays out is determined by a formula that blends your pay when you retire, your age when you retire, and the number of years you work as a teacher or administrator in the STRS system.

It's like Social Security for Teachers

California teachers pay into the STRS system in a way that resembles Social Security. A portion of gross wages is withheld from each paycheck. After retirement, they receive payments from the system. As with Social Security, teachers receive larger payments from the system if they retire older than if they retire younger.

Image: Projected Tenure of Current California Teachers - by Nari Rhee, PhD and William B. Fornia, FSA, UC Berkeley Labor Center, February 2016

There are differences. The Social Security system doesn't differentiate the age at which you make your money, the kind of work you do or the number of years you have worked in a particular profession. These are central factors in the California STRS system because it has a particular mission: it is engineered to provide a strong pension for those who make teaching their life's work. According to STRS, about half of California's teachers stay in the profession at least 30 years.

In the private sector, many employees commit a portion of each paycheck to a personal retirement savings accounts such as an IRA or 401(k) account. This approach is known as a "defined contribution" model. Teachers can use defined contribution accounts, too, but the main pension system for teachers, the State Teachers Retirement System (STRS) is a defined benefit system.

The Newest Teachers Get 2% at 62

California's teacher pension system has gone through significant changes over time. Recent policy changes tweaked the system in particular for teachers hired after Jan 1, 2014, who will retire decades from now. The new pension schedule for these young teachers is known as "2% at 62" because those who retire at age 62 receive an annual retirement benefit of 2% of the average of their last three years' pay for each year they paid into the system.

An example helps.

The chart below shows how the new schedule works for "Bee", an imaginary freshly-minted teacher in Oakland Unified.

diagram of California's new 2 at 62 pension system

In this example, Bee begins teaching in California at age 29 (the national average — though the median is 26) with a Bachelor's degree. Ten years later she has earned 60 graduate course credits, which raises her salary (See Lesson 3.8). She works without interruption until retiring at age 65. She draws a pension until age 86, the national average life expectancy for white women not in poverty.

The columns show the portion of Bee's lifetime compensation, including both salary and lifetime pension, earned in each year of her employment. In the first four years, she receives only her salary, minus the portion she pays into the STRS system for her retirement. In the fifth year, however, in addition to her salary she earns the future right to a small annual pension for the rest of her life. The lifetime value of sticking it out for that fifth year is more than $75,000 — easily greater than the year's salary.

As the chart indicates, things get really interesting after Bee turns 55. The pension formula is dramatically back-loaded. Lifetime teachers qualify for a huge portion of their lifetime earnings in their last few years of work.

Most Teachers Get 2% at 60

The pension system works a little differently for "Ava", an imaginary freshly-minted teacher in Oakland Unified who began work the year before Bee. For teachers hired prior to Jan 1, 2014 (that is, most teachers in the system), the pension system is described as 2% at 60.

Many features of the system are similar for these two new teachers, but the vesting schedule is even more abrupt for Ava because of a bump in the 30th year of employment (known as the "Career Factor").

Another difference between these systems for Ava vs. Bee is the definition of "Final Compensation" in the formula that determines how much each will receive in their monthly pension check.

For Ava, "Final Compensation" is defined as the amount of pay she earns in her final year of teaching. This produces a major incentive for her to boost her pay in her last year, if she can: One year of extra work for higher pay (at the school district's expense) leads to bigger pension checks for decades (at the pension system's expense). In extreme or fraudulent cases, this practice is known as pension spiking.

For Bee, "Final Compensation" is the average of her last three years' pay. This provision was added to reduce the incentives to game the system.

Stabilizing an Unbalanced System

If you study the charts above, they might seem intuitively out of balance. How can such small contributions from teachers (the red bars at the bottom) balance the comparatively large salary and pension payments represented by the green and orange bars?  

They can't.

The system depends on substantial additional support from school districts and from the state.

For decades, California's STRS account benefitted from some enormous advantages and a tremendous run of good luck.

The most basic advantage has been long term population growth. As California added new public school teachers to keep up with growth in enrollment, the number of teachers and school districts paying into the system grew faster than the number of retired teachers served by it. Also, like all banks and funds, STRS benefitted hugely from falling interest rates and sustained growth in the stock market.

For decades, teachers in California were required to contribute just six percent of their wages toward their retirement system. In the dot-com boom of the late 1990s, California's public pension systems appeared to be overfunded, so the legislature changed the math, permanently lowering retirement age requirements and raising benefits.

As if on cue, the boom went bust. The pension crisis was born.

What Goes Up...

Jeff's Mom

The stock market collapse of 2008 added to pressures that had been building over time. California's enrollment growth had slowed. Interest rates had reached levels so low they could no longer fall. Retired teachers were living longer than the models expected, drawing pensions for more years.

In 2013, California's legislature committed to a set of gradual measures to put the system on a path toward stability, a journey that is projected to take thirty years. Under this plan, more money will be withheld from teachers' paychecks. The employee contribution increases to 10.25%, higher than Social Security's 6.2% but less than the rate in other states like Louisiana, where the withholding rate exceeds 20%.

The state budget commits a rising share, too; its contribution rate will double from 5.2% to more than 10%. But the plan places the biggest share of the burden on school districts.

Higher state and local contributions can improve the financial health of the teacher pension system, but the money isn't coming from a magic well — it's mostly coming from school district budgets.

The legislature broke the teacher pension system in the dot-com era

If you hear that the state budget is going up, but your school is making cuts, now you know a big part of the reason why: the legislature broke the teacher pension system in the dot-com era, didn't fix it for ages, and now the bill is past due.

Would a "Defined Contribution" system work better?

Just as many non-teachers use an IRA account or 401k to save for retirement, on top of their Social Security benefits, many teachers set aside savings, if they can, in a "defined contribution" account. These accounts have different names than those for private-sector employees: 403(b), 457(b), Roth 403(b) and Roth 457(b).

Some argue that the best "fix" for the teacher pension system would be to abandon it in favor of a "defined contribution" system that treats new teachers and full career teachers more equally. For an example of this argument, see this analysis by the Fordham Foundation of the pension system in Los Angeles Unified. For the opposite view, read the analysis of the Berkeley Labor Center.

What if teachers also earn Social Security wages?

A person who works part of a career in STRS employment and part of a career in "regular" employment, contributing to Social Security, may qualify for retirement benefits from both systems. There's a wrinkle. As described above, the STRS system is set up to strongly reward high end-of-career earnings. The Social Security system is set up in a roughly opposite way; it is progressively indexed to support those with low total earnings. This has a practical impact: If you pay in only a small amount to Social Security, the system assumes that you need more support.

To prevent abuse of this progressive indexing, Social Security discounts STRS receipts. The interaction of these systems is complex, and some argue that the Social Security rules amount to a "hero's penalty" that discourages work.

Most criticism of STRS is similar to criticism of other defined benefit pension systems. The following video explains some of the oddities that have crept into many states' systems, making them vulnerable to issues like "spiking."

Are Teachers' Pensions Safe?

California's public pension systems, including STRS, are out of whack, but the fixes begun in 2013 are serious. Public pension funds in some states are in even worse shape. Over time, the plan will eventually balance the system unless something goes very wrong. Even if the plan works, though, it is going to hurt. It will require diverting a significant and rising amount of money away from the classroom for a long time. There isn't much of a choice, unless taxpayers decide they want to add more money to the system.

The Silent Recession

Even if you see headlines that say a budget provides “more money” for the school system, remember: the pension system has left a big hole to fill. The cost of providing special education is also expanding, along with health care costs and deferred maintenance costs for aging school buildings. A 2018 analysis by WestEd argues that the combination of these factors amounts to a Silent Recession. More money in "the budget" doesn't necessarily mean more money to invest in programs and services at your school.

This post concludes the "Teachers" section of Ed100. The overall structure of Ed100 is "Education is Students and Teachers spending Time in Places for Learning with the Right Stuff in a System with Resources for Success. So Now What?"

In the next chapter, we tackle the educational implications of life's most precious resource: Time.

Sources: Ed100 pension model, CalSTRS Retirement Calculator, CalSTRS Member Handbook.

Extensively revised July 2018

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Questions & Comments

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user avatar
June 20, 2018 at 5:42 am
Though the article's focus is California pensions it is important to note the differences in the state to state differences- closed versus open retirement systems. As a Florida retired teacher, we pay into and are set up to receive Social Security, unlike the scenario in the article; however, consider too that it is stated a "years 32-37 teachers receive pension commitments virtually equivalent to their full salary". While many California teachers may not qualify for Social Security, the "closed system" benefits them substantially. Florida teachers hired before 7/1/2011 working 32-37 years earn up to a maximum of 55% of their 5 highest averaged salaries and, unless they started teaching at 25+, will have to wait before seeing any Social Security. Thirty years puts many waiting 10 years or so living on 48-55% of their average or $22-$24K a year for years BEFORE S.S. kicks in.
user avatar
Jeff Camp June 20, 2018 at 11:39 am
Thanks for this comparison with Florida. The BIG point here is that pension systems can differ a lot, and teachers don't necessarily figure it all out until they are decades into it. Teacher unions spend quite a bit of energy helping their members understand what they have. California has recently made significant changes, and this post is under review for update.
user avatar
Carol Kocivar May 28, 2018 at 10:41 am
Why More Than A Million Teachers Can't Use Social Security from All things Considered on NPR:

Read the
user avatar
Carol Kocivar May 28, 2018 at 10:42 am
user avatar
Jeff Camp - Founder April 15, 2018 at 5:24 pm
California teachers are not alone in relying on pension promises as a key part of their total compensation. For The74, Chad Aldeman writes that retirement commitments are rising part of the "total package" for teachers all over America. https://www.the74million.org/article/aldeman-teachers-have-the-nations-highest-retirement-costs-but-theyll-never-see-the-benefits/
user avatar
MaryGW April 3, 2018 at 9:55 am
Excellent explanation of a complex topic. Trying to get 30 years of middle income work to support 80 years of life is a difficult proposition without rethinking how we finance baseline life costs, like funding getting kids from birth to the job market and managing everyone's health. Esp. as we come to terms with the delta between population growth projections and reality.
user avatar
Jeff Camp - Founder July 31, 2017 at 2:20 pm
Figure 26 in this 2017 LAO report summarizes the planned changes in pension contributions that will affect school districts in California: http://www.lao.ca.gov/Publications/Report/3549#Pension_Costs
user avatar
Jeff Camp February 3, 2017 at 2:31 pm
In early 2017 the STRS board voted to lower the state's assumptions about future investment returns in the STRS fund from 7.5% to 7%. This is one of those dull decisions that matters a lot. On the plus side, getting real is a good thing. Budgeting on the basis of an assumption that the fund will kill it in the market every single year just isn't smart. It's good news that the board is moving closer to reality-based budgeting. On the minus side, OUCH. Getting real means that more money needs to be added to the STRS fund, and that will have to come from two sources: bigger deductions from teachers' paychecks and bigger set-asides from the state budget. (School districts are already digesting their share of a big increase agreed to in 2013.) Read more on EdSource: State, new teachers to pay more to shore up state teachers pension fund
user avatar
Albert Stroberg May 1, 2016 at 6:58 pm
My office examined retirement plans for all of our workers. Even in 1985 we saw the traditional Defined Benefit plan was not workable- none of us could afford it. Yet, the state legislators went ahead with this idea that the market investments would magically make everything easy & there would be no need to raise taxes or contributions. They were and are wrong. We need to get used to pay as we go rather than always hoping for manna.
user avatar
Manuel-Romero June 27, 2015 at 12:09 pm
"As employers, districts previously contributed the equivalent of 8.25% of teacher salaries to STRA, but under the new law that will eventually rise to 19.1%." That is a HUGE increase!
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