Pension Flexibility: California

2011 Retaining Effective Teachers Policy

Goal

The state should ensure that pension systems are portable, flexible and fair to all teachers.

Meets in part
Suggested Citation:
National Council on Teacher Quality. (2011). Pension Flexibility: California results. State Teacher Policy Database. [Data set].
Retrieved from: https://www.nctq.org/yearbook/state/CA-Pension-Flexibility-9

Analysis of California's policies

California only offers a defined benefit pension plan (with a small cash balance component) to its teachers as their mandatory pension plan. This plan is not fully portable, does not vest until year five and does not provide any employer contribution for teachers who choose to withdraw their account balances when leaving the system.  However, California is commended for increasing flexibility by allowing the purchase of service and for offering a fully portable supplemental savings plan.

California's plan is technically a hybrid plan composed of a defined benefit component (DB) and a cash balance component, known as the Defined Benefit Supplement Program (DBS), which started in 2001. However, the state terminated the vast majority of funding to DBS as of January 1, 2011. From 2001 to 2010, California teachers' mandatory contribution rate of 8 percent was divided with 6 percent going to the DB plan and 2 percent going to DBS. Eight percent of any extra compensation (e.g. summer school, coaching) was also contributed to DBS. However, as of January 1, 2011, the full 8 percent of regular compensation will only fund the DB plan. Extra compensation contributions are the only funds that will continue to go to DBS.

Vesting in a defined benefit plan guarantees a teacher's eligibility to receive lifetime monthly benefit payments at retirement age. Nonvested teachers do not have a right to later retirement benefits; they may only withdraw the portion of their funds allowed by the plan. California's vesting at five years of service limits the options of teachers who leave the system prior to this point.

Teachers who withdraw their funds when they stop teaching in California only receive their own contributions plus interest. This means that teachers who withdraw their funds accrue no benefits beyond what they might have earned had they simply put their contributions in basic savings accounts. Therefore, teachers leaving the pension system would have saved only 8 percent of their salary plus interest (see Goal 4-H), which is significantly below the level conventionally recommended by retirement advisers for individuals not also contributing to Social Security.

While California's relatively low mandatory contribution rate allows for flexibility in teachers' retirement savings, it also means that California needs to educate teachers on what happens if they leave the system and encourage savings in other portable supplemental plans. Further, teachers who remain in the field of education but enter another pension plan (such as in another state) will find it difficult to purchase the time equivalent to their prior employment in the new system because they are not entitled to any employer contribution.

California increases the flexibility of its defined benefit plan with a generous policy to purchase years of service. The ability to purchase time is important because defined benefit plans' retirement eligibility and benefit payments are often tied to the number of years a teacher has worked. California's plan allows teachers to purchase time for all previous teaching experience.  The state's plan also allows teachers to purchase time for approved leaves of absence, including maternity and paternity leave for up to two years per leave, and for leave covered by the Family and Medical Leave Act, up to 12 weeks per leave.

California is commended for offering optional supplementary defined contribution plans, known as Pension2. Teachers may enroll in 403(b), 457 and Roth 403(b) plans. The state maintains an informational website to provide teachers with the choices that are available to them and allows them to compare products prior to participating in a particular plan. However, there is no employer contribution to these accounts.

Citation

Recommendations for California

Offer teachers a pension plan that is fully portable, flexible and fair.
California should offer teachers for their mandatory pension plan the option of either a defined contribution plan or a fully portable defined benefit plan, such as a cash balance plan. A well-structured defined benefit plan could be a suitable option among multiple plans. However, as the sole option, defined benefit plans severely disadvantage mobile teachers and those who enter the profession later in life. Because teachers in California do not participate in Social Security, they have no fully portable retirement benefits that would move with them in the event they leave the system. Its DBS component is similar to a defined contribution plan and could be fully portable if the state reinstituted meaningful funding to these accounts.

Increase the portability of its defined benefit plan.
If California maintains its defined benefit plan, it should reinstate funding the cash balance component and allow teachers that leave the system to withdraw employer matching contributions. The state should lower the vesting requirement to year three. A lack of portability is a disincentive to an increasingly mobile teaching force. 

Offer an employer contribution to the supplemental retirement savings plan.
While California at least offers teachers the option of a supplemental defined contribution savings plan, this option would be more meaningful if the state required employers also to contribute. 

State response to our analysis

California asserted that the CalSTRS defined benefit plan is portable and flexible. A CalSTRS member can move to any public school district or county office of education within California and continue to accrue benefits in the same system. As commended in this analysis, the state reiterated that CalSTRS allows members to purchase time and encourages participation in Pension2. Furthermore, CalSTRS educates members about the gap between their current monthly income and the income they can expect to receive from CalSTRS. CalSTRS teaches members various ways to fill this gap, which include purchasing service credit, investing in supplemental savings plans and working longer to reach benefit enhancements provided by CalSTRS.

The state also discussed its Cash Balance Program (CB Program) for part-time educators who are not members of the Defined Benefit program. The CB Program provides immediate vesting and a benefit based on the employee's contributions, employer contributions and the compounded interest on the participant's accumulated funds. A retiring participant may choose a lifetime annuity, a period-certain annuity or a lump-sum distribution.

Regarding the option of a lump-sum withdrawal, California reiterated that members may withdraw their contributions and interest, and the state maintained that vested members should not be encouraged to refund upon termination of employment since their contributions and interest are pooled and professionally invested by CalSTRS. Furthermore, by keeping their contributions and interest with CalSTRS, members are entitled to a lifetime monthly benefit upon retirement that cannot be outlived. The state contended that if CalSTRS also refunded the employer contributions, it would increase the cost of the retirement program and reward members who quit the profession at the expense of those who did not.

The state further noted that in contrast to a defined benefit plan, a defined contribution plan provides a benefit that is based only on the member's and employer's contributions and interest, must be managed by the member, and can easily leave the member with no retirement income later in life if the balance in her or his defined contribution account is insufficient. Defined contribution plans are not as reliable as a source of retirement income as defined benefit plans, were not designed to serve as a primary retirement benefit and are particularly inappropriate for our members, who do not participate in Social Security.
 

Last word

Although California's pension plan certainly has some commendable aspects, NCTQ maintains that the plan is not fully portable or flexible. Being able to continue membership within the state of California is valuable, but despite the size of the state, it still does not aid educators who move out of the state.

The Cash Balance Program is laudable but, unfortunately, is only offered to part-time educators, and thus is not included in this analysis.  The state should consider offering this program to all educators.

NCTQ contends that teachers should have the choice to withdraw employer contributions, regardless of vesting status, when terminating employment. Teachers can be educated about the potential benefits and disadvantages, but the decision should be left to the individual. Teachers may need the employer contribution to aid in purchasing time in another state's system or may be able to invest in other professionally managed accounts. While vested members cannot outlive monthly benefits, the monthly benefit to members who leave the system at a relatively young age may be of little value by the time they receive the benefit. However, California does currently have policies in place that guarantee future benefits that equal a minimum of 85 percent of initial purchasing power which decreases the losses due to inflation.

Defined contribution plans may not be as reliable at defined benefit plans, but they are more flexible, portable and fair to all members, and, therefore, teachers should at least have the option of such a plan. 

Teachers not covered by Social Security do have to be particularly thoughtful regarding their retirement savings plan; that does not mean they cannot benefit from a fully portable and flexible savings plan. In fact, teachers not covered by Social Security are in even more need of a portable plan because if they move out of state or to a different profession at an early stage in their career, they are left with little savings for retirement. 

Defined contribution plans can be structured to have many of the benefits of defined benefit plans, but they would also have the added benefits of portability and flexibility to attract new individuals to the profession and to treat all teachers fairly for each year of service, not to mention less stress to states' financial health (see Goal 4-H). Plans can be structured as cash balance plans that allow the employer to maintain the investment risk and to include benefits such as disability and survivor coverage. Increased participation in defined contribution plans may also result in lower fees more commensurate with defined benefit plans. Teachers' individual accounts can be invested in statewide, professionally managed funds to align their earnings and losses with other statewide plans, such as a defined benefit plan. Teachers must receive proper education on topics such as longevity risk, tax implications and annuity options. The state may also consider enrolling its teachers in Social Security to give them full portability.
Defined benefit plans do provide greater retirement security to long-time teachers but at a great cost both budgetary and in compensating and retaining teachers earlier in their careers. Finally, defined benefit plans' security places a great financial burden on the state and taxpayers, and their reliability is diminished if municipalities and states cannot afford to pay promised benefits.

How we graded

Anachronistic features of teacher pension plans disadvantage teachers early in their careers.

Nearly all states continue to provide teachers with a defined benefit pension system, an expensive and inflexible model that neither reflects the realities of the modern workforce nor provides equitable benefits to all teachers. To achieve the maximum benefits from such a plan, a teacher must begin and end his or her career in the same pension system. Teachers who leave before vesting—which is as much as 10 years in some states—are generally entitled to nothing more than their own contributions plus some interest. This approach may well serve as a retention strategy for some, but on a larger scale it fails to reflect the realities of the current workforce. At present, the United States is experiencing an explosion in school-age populations in some states, while other states are experiencing a decline. The nation's workforce needs to be able to respond to these changes. The current workforce is increasingly mobile, with most entering the workforce expecting to change jobs many times. All workers, including teachers, may move to jobs in other states with no intention of changing careers. To younger teachers in particular, a defined benefit plan may seem like a meaningless part of the compensation package and thus fail to attract young talent to the profession. A pension plan that cannot move across state lines and that requires a long-term commitment may not seem like much of a benefit at all.

There are alternatives. Defined contribution plans are fair to all teachers at all points in their careers. These plans are more equitable because each teacher's benefits are funded by his or her own contributions plus contributions from the employer specifically on the individual employee's behalf. This is fundamentally more equitable than defined benefit plans, which are generally structured to require new teachers to fund the benefits of retirees. Moreover, defined contribution plans are inherently portable and give employees flexibility and control over their retirement savings. It must also be noted that defined benefit plans can be portable and fair, if structured as cash balance plans or plans that permit the withdrawal of employer contributions.

Research rationale

NCTQ's analysis of the financial sustainability of state pension system is based on actuarial benchmarks promulgated by government and private accounting standards boards. For more information see U.S. Government Accountability Office, 2007, 30 and Government Accounting Standards Board Statement No. 25.

For an overview of the current state of teacher pensions, the various incentives they create, and suggested solutions, see Robert Costrell and Michael Podgursky. "Reforming K-12 Educator Pensions: A Labor Market Perspective." TIAA-CREF Institute (2011).

For evidence that retirement incentives do have a statistically significant effect on retirement decisions, see Joshua Furgeson, Robert P. Strauss, and William B. Vogt. "The Effects of Defined Benefit Pension Incentives and Working Conditions on Teacher Retirement Decisions", Education Finance and Policy (Summer, 2006).

For examples of how teacher pension systems inhibit teacher mobility, see Robert Costrell and Michael Podgursky, "Golden Handcuffs," Education Next, (Winter, 2010).

For additional information on state pension systems, see Susanna Loeb, and Luke Miller. "State Teacher Policies: What Are They, What Are Their Effects, and What Are Their Implications for School Finance?" Stanford University: Institute for Research on Education Policy and Practice (2006); and Janet Hansen, "Teacher Pensions: A Background Paper", published through the Committee for Economic Development (May, 2008).

For further evidence supporting NCTQ's teacher pension standards, see "Public Employees' Retirement System of the State of Nevada: Analysis and Comparison of Defined Benefit and Defined Contribution Retirement Plans." The Segal Group (2010).