The state should ensure that pension systems are neutral, uniformly increasing pension wealth with each additional year of work.
Arizona'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.
Arizona's pension plan does not utilize a constant benefit multiplier. Instead, the plan's multiplier is 2.1 percent for up to 19 years of service, 2.15 percent for 20 to 24 years of service, 2.2 percent for 25 to 29 years of service and 2.3 percent for 30 or more years of service.
In addition, teachers may retire before standard retirement age based on years of service without a reduction in benefits. All teachers with 10 years of service may retire at age 62, while other vested teachers with less than 10 years of service may not retire until age 65. Teachers hired prior to July 1, 2011, may also retire according to the "Rule of 80," which means that teachers may retire when their age plus years of service equal 80. Therefore, teachers who begin their careers at age 22 can reach the "Rule of 80" with 29 years of service by age 51, entitling them to more than 14 additional years of unreduced retirement benefits beyond what other teachers would receive who may not retire until age 65. Teachers hired on or after July 1, 2011, may retire at age 55 with 30 years of service, at age 60 with 25 years of service, at age 62 with 10 years of service or age 65. Not only are teachers being paid benefits by the state before Social Security's retirement age, but these provisions may also 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.
Arizona State Retirement System, Member Handbook, 2011 https://www.azasrs.gov/content/pdf/Mem_Handbook_2011.pdf Arizona State Retirement System, 2011 Legislation Summary https://www.azasrs.gov/content/pdf/2011_legislation_summary.pdf
Utilize a constant benefit multiplier to calculate retirement benefits for all teachers, regardless of years of service.
Each year of service should accrue equal pension wealth. Arizona should use a pension formula that treats each year of service equally.
End retirement eligibility based on years of service.
Arizona should change its practice of allowing teachers with 10 years of service and teachers whose age and service equal 85 to retire before other teachers. 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.
Arizona allows all teachers to retire before conventional retirement age, some as young as 51. 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).
Arizona was helpful in providing NCTQ with facts that enhanced this analysis.
Arizona noted that the ASRS defined benefit plan calculates benefits based on service and salary, which rewards career employees and is consistent with the overall statutory purpose of the defined benefit plan to attract and retain public employees. The design of the ASRS plan is generally consistent with the design of most teacher pension plans. If the ASRS were to change its plan design in the manner suggested, it has the potential to negatively affect schools trying to attract employees.
NCTQ is not suggesting that years of service be excluded from the benefit formula; it is an important component that represents how many years teachers have contributed to the system. The point is that it should not be included in the eligibility requirements, as it creates unnecessary peaks in pension wealth.