The state should ensure that pension systems are neutral, uniformly increasing pension wealth with each additional year of work.
Alabama's pension system is based on a benefit formula that is not neutral, meaning that each year of work does not accrue pension wealth in a uniform way until teachers reach conventional retirement age, such as that associated with Social Security.
Teachers' retirement wealth is determined by their monthly payments and the length of time they expect to receive those payments. Monthly payments are usually calculated as final average salary multiplied by years of service multiplied by a set multiplier (such as 1.5). Higher salary, more years of service or a greater multiplier increases monthly payments and results in greater pension wealth. Earlier retirement eligibility with unreduced benefits also increases pension wealth, because more payments will be received.
To qualify as neutral, a pension formula must utilize a constant benefit multiplier and an eligibility timetable based solely on age, rather than years of service. Basing eligibility for retirement on years of service creates unnecessary and often unfair peaks in pension wealth, while allowing unreduced retirement at a young age creates incentives to retire early. Plans that change their multipliers for various years of service do not value each year of teaching equally. Therefore, plans with a constant multiplier and that base retirement on an age in line with Social Security are likely to create the most uniform accrual of wealth.
Alabama's pension plan is commended for utilizing a constant benefit multiplier of 2.0125 percent; however, teachers may retire before standard retirement age based on years of service without a reduction in benefits. The state allows teachers with 25 years of service to retire at any age, while other vested teachers with less than 25 years of service may not retire until age 60. Therefore, teachers who begin their careers at age 22 can reach 25 years of service by age 47, entitling them to 13 years of additional retirement benefits beyond what other teachers would receive who may not retire until age 60. Not only are teachers being paid benefits by the state well before Social Security's retirement age, but these provisions also may encourage effective teachers to retire early, and they fail to treat equally those teachers who enter the system at a later age and give the same amount of service.
End retirement eligibility based on years of service.
Alabama should change its practice of allowing teachers with 25 years of service to retire at any age with full benefits. If retirement at an earlier age is offered to some teachers, benefits should be reduced accordingly to compensate for the longer duration they will be awarded.
Align eligibility for retirement with unreduced benefits with Social Security retirement age.
Alabama allows all teachers to retire before conventional retirement age, some as young as 47. As life expectancies continue to increase, teachers may draw out of the system for many more years than they contributed. This is not compatible with a financially sustainable system (see Goal 4-H).
Alabama stated that it provides an incentive for teachers to continue to work after 25 years of service (Service Premium Component) and until age 65 (Age Premium Component and Subsidy Premium Component) by reducing the teacher retiree health insurance premium through the Public Employee Health Insurance Plan.
The legislation cited by Alabama states that the employer contribution to retiree health insurance premium will be decreased by 4 percent for each year of service less than 25 years and increased by 2 percent for each year past 25 years of service. In addition, the contribution will decrease by 1 percent for each year that a teacher retires before Medicare eligibility age. While this may encourage longer employment, it does not negate or compensate for the early retirement eligibility provided in the pension plan.