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

Teacher pay is better than it looks

A teacher's total pay is better than it looks. Unless something goes terribly wrong. It might.

Comparing a pension (defined benefit) to a retirement plan (defined contribution) is an apples-and-oranges problem. People considering teaching often underestimate the real value of the pension they will receive. Comparing a pension (defined benefit) to a retirement plan (defined contribution) is an apples-and-oranges problem. People considering teaching often underestimate the real value of the pension they are promised.

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. Few jobs in the private sector offer a pension in this manner anymore. In the private sector, employees commit a portion of their pay into personal retirement savings accounts such as an IRA or 401(k) account. This approach is known as a "defined contribution" model.

The difference in approach creates an apples-and-oranges problem. It is difficult to accurately compare teacher pay with private sector pay, and in a simple comparison teacher salaries seem worse than they are. Private-sector workers' retirement dollars flow through paycheck deductions and build up in a way that is easy to count. They show up on a monthly statement and accumulate in an account.

Teacher pensions, by contrast, don't accumulate, they just exist. Like a life insurance contract, teacher pensions are a promise of future payments that will vary depending in large part on how long an individual lives.

It's like Social Security, but less secure

California public school teachers do not pay Social Security taxes or earn Social Security benefits.

California public school teachers do not pay Social Security taxes or earn Social Security benefits. Instead, they participate in the California State Teachers’ Retirement System (STRS). Retirement benefits are a very important and significant element of teacher compensation.

California teachers pay into their STRS system through an 8.15% withholding on gross wages (a rate higher than Social Security's 6.2% but less than STRS rates in other states; in Louisiana the withholding rate exceeds 20%). In return, in an average retirement lifetime of thirty years, CalSTRS has historically paid back about five or six times what teachers have put in, adjusted for inflation. Pension benefit calculations are complicated, and few teachers fully understand them.

The graph below expresses the total financial compensation a hypothetical teacher in Oakland receives each year, including each year’s increase in promised lifetime STRS pension benefits. This example is based on the Oakland salary schedule in 2006, a suitably representative example.

3-11-1-Pensions

The chart requires a bit of explanation. In year ten, for example, the teacher receives gross pay of about $59,000, from which 8% (about $4,700) is withheld for contribution to the California STRS system. (In the graph, this is the very small negative portion below each column.) The school district matches this contribution, plus an extra 0.25%. The plan includes a few specific anomalies: A teacher qualifies for no pension at all unless he or she works at least five years. There is a very significant pension incentive to stay for a thirtieth year. And in years 32-37 teachers receive pension commitments virtually equivalent to their full salary.

Examining a sample year for a sample teacher can help you understand how it works. For completing his or her 10th year in the system, the teacher’s defined monthly pension check upon retirement increases by about $100. You can think of this as an upgrade in the value of the teacher’s pension which will benefit him or her each month, upon retirement. This small monthly increase, granted in year ten, will add up to about $36,000 (in 2006 dollars) over the course of an average 30-year retirement. (Of course the "increase in value" shown here is an estimate based on a typical 30-year retirement. The actual value of these bumps will vary, depending on how long a teacher lives in retirement.)

A person who works part of a career in STRS employment and part of a career in Social Security employment receives retirement benefits from both systems, but Social Security benefits, which are progressively indexed to favor initial earnings, are reduced by STRS receipts, which are indexed to favor end-of-career earnings. The complexity and interaction of these systems creates barriers to entry and exit from the teaching profession.

Most criticism of STRS is similar to criticism of other defined benefit pension systems. For example, it's pretty clear that $36,000 is a very strong risk-free inflation-adjusted return on a $4,700 contribution. This payout ratio worked fine until about 2008, thanks to strong stock market performance and steady growth in the number of teachers paying into the fund.

Concerns About STRS in the Long Term

What the market gives it can also take away. Over the long term, STRS benefitted greatly from steady increases in California public school enrollment, which added to the number of teachers paying into the system faster than the growth in the number of retired teachers served by it.

As enrollment has flattened and investment returns have swooned, teachers and analysts began to express concerns about whether these pensions were safe. 

O give me a pension
that I can trust
O please don't mention
the risk of a bust

In 2008 the Pew Center on the States raised eyebrows by estimating California’s unfunded current public liabilities at more than $60 billion, much of it from STRS. By 2013, even after two years of strong growth in fund assets, the unfunded liabilities of the STRS system alone were reckoned to be nearly $167 billion - equivalent to hundreds of thousands of dollars per teacher.

The Legislative Analyst Office (LAO), charged with providing impartial analysis to the state legislature, reported in its sober style that unfunded teacher pensions could be California's "most difficult fiscal challenge." David Crane, president of the nonpartisan advocacy organization Govern for California, compared the pension obligation to being on the wrong end of a giant zero-coupon bond. He said that the state needed to quickly begin setting aside significant funding each year to pay down this debt, or the interest would swell into an unfunded "$600 billion dollar sinkhole." How much funding is "significant"? The LAO analysis suggested that the problem could be stabilized with a steady investment of $4.6 billion per year.

Source: LAO, 2016 Source: LAO, 2016

The legislature responded to these concerns in June 2014. Over a period of seven years, AB1469 began phasing in changes to the amounts that teachers, school districts (which employ teachers) and the state each pay into the STRS system. The bulk of the changes fall on school districts. As employers, districts previously contributed the equivalent of 8.25% of teacher salaries to STRS, but under the new law that will eventually rise to 19.1%.

Could be Worse!

All pension systems are complex, and teacher pension systems vary enormously from state to state. Overall, comparisons with other states tend to show California's system as fairer and more stable than most. Because of the difficulty in comparing the personal value of a defined benefit system with that of a defined contribution system, teachers and prospective teachers in California tend to underestimate the substantial value of the pension benefits they are earning. In the long run, California teacher pay is better than it looks on a pay stub.

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.

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Which of the following statements about California teacher pensions is FALSE?

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Questions & Comments

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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 R 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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