Pension Neutrality: California

2011 Retaining Effective Teachers Policy

Goal

The state should ensure that pension systems are neutral, uniformly increasing pension wealth with each additional year of work.

Does not meet
Suggested Citation:
National Council on Teacher Quality. (2011). Pension Neutrality: California results. State Teacher Policy Database. [Data set].
Retrieved from: https://www.nctq.org/yearbook/state/CA-Pension-Neutrality-9

Analysis of California's policies

California'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.

California's pension policy contains many provisions that benefit older and more experienced teachers. The plan's multiplier is 2 percent at age 60, increasing thereafter to a maximum of 2.4 percent. Teachers increase their benefit by .033 for each quarter of a year they teach beyond age 60, reaching the maximum at age 63; however, teachers with at least 30 years of service may add an additional 0.2 percent up to the maximum of 2.4 percent (reaching their maximum at 61-1/2 years) and also receive a monthly longevity bonus of $200 for 30 years, $300 for 31 years and $400 for 32 or more years of service (these bonuses only apply to teachers who earn 30 years of service by January 1, 2011).

Additionally, teachers who retire with 25 or more years of service are entitled to have their benefits calculated based on their final year's salary, rather than averaging the last three years as retirees with less experience must do. Also, while all teachers are eligible for unreduced retirement at the same time, early retirement with reduced benefits is dependent on years of service. For example, a teacher with 30 years of service may retire with reduced benefits at age 50, while other vested teachers with less than 30 years of service may not retire early with reduced benefits until age 55.

Citation

Recommendations for California

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. California should use a pension formula that treats each year of service equally. 

End early retirement eligibility based on years of service.
California should change its practice of allowing teachers with 25 or 30 years of service to retire earlier than other members. If retirement at an earlier age is offered, it should be offered to all vested members, and 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.
California allows teachers to retire before conventional retirement age. 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).

State response to our analysis

California was helpful in providing NCTQ with facts that enhanced this analysis. 

In addition, the state maintained that NCTQ's analysis does not address the reason for these benefit enhancements for teachers with greater years of service—retention. These benefit enhancements encourage educators to continue to teach in California, allow public school districts to retain qualified teachers and address teacher shortages.

Last word

While these benefits may retain teachers at a certain period in their careers, they do not take into account each teacher's effectiveness nor do they attract or retain teachers earlier in their career or teachers who know they may be more mobile.  Defined benefit plans' benefits are so back loaded and tied to longevity, that the dollars spent on retirement are often not valued because they are not seen by potential employees.  Many individuals may never enter the profession if they know they may not be able to dedicate 25 or more years within one system because they can receive more balanced compensation in a different sector. Teachers who move between states, while still dedicating their life to teaching, receive far less in retirement benefits even though they educated just as many students for just as long. Further, our systems need to attract highly effective teachers who can produce great results, especially in high-needs schools, whether or not they are prepared to make a career-long commitment or to teach only for shorter periods of time.  A defined benefit pension system does not grant shorter-term teachers the same pension wealth per year of teaching as a teacher who was able to teach longer in a different assignment. These policies may give a teacher an incentive to remain in the field from year 24 to year 25, but they may not encourage a fifth-year teacher to stay for the sixth year.

How we graded

It is unfair to all teachers when pension wealth does not accumulate in a uniform way.

In addition to the ways defined benefit pension systems disadvantage teachers described in Goal 4-G, the way pension wealth accumulates in some systems further compounds the inequity. All pension systems use a multiplier to calculate the benefits an individual is entitled to receive based on salary levels and years of service. For example, a pension system may have a multiplier of 2.0. In such case, pension benefits are determined by multiplying average final annual salary by years of service and then multiplying the product by 2.0. Thus, someone working fewer years with a lower final salary would appropriately receive less in benefits than someone with more years of service and/or a higher final salary. However, the multiplier in many pension systems is not fixed; it increases as years of service increase. When a higher multiplier is used, teachers receive even more generous benefits.

Another way that pension benefits are awarded unfairly is through the common policy of setting retirement eligibility at different ages and years of service. For example, in a given state, a teacher with 30 years of service may retire at age 55, while teachers with fewer years of service may not retire until age 62. This means that a teacher who started teaching in this state at age 25 would reach 30 years of service at age 55 and receive seven additional years of full retirement benefits beyond what a teacher that started at age 32 and cannot retire with full benefits until age 62 would receive. A fair system would set a standard retirement age for all participants, without factoring in years of service.

Pension systems affect when teachers decide to retire as they look to maximize their pension wealth.

The year teachers reach retirement eligibility by age and/or years of service, their pension wealth peaks; pension wealth then declines for each year they work beyond retirement age. Plans that allow retirement based on years of service create unnecessary peaks, and plans that allow a low retirement age create an incentive to retire earlier in one's career than may be necessary. For every year teachers continue to work beyond their eligibility for unreduced retirement benefits, they lose that year of pension benefits, thus decreasing their overall pension wealth.
Although their yearly pension benefits would continue to rise as they earn additional service credit, it would only be at a small percentage per year, which would not make up for the loss of each year of benefits.

To try to balance this incentive to retire, some states have created DROP (Deferred Retirement Option Plan) programs. DROP programs allow participants to place their monthly pension benefits in a private investment account while still teaching and earning a salary, thus retaining those benefits. These teachers are, in effect, earning their pension and salary at the same time, and often at a relatively young age.

A DROP program is a band-aid on the problem; it does not fix what is structurally wrong: retirement at an early age without reduction of benefits. For example, the hypothetical teacher above decides to forgo retiring at age 47 in order to wait and qualify for her state's DROP program at age 55. She now has 33 years of service and has reached a pension equal to 66 percent of her salary. She remains in DROP for the maximum allowable five years. During that time, her five years of lost pension benefits plus her five years of mandatory employee pension contribution have been deposited in a private investment account. Upon retiring at age 60, she would receive the total of that private account plus a lifetime pension benefit annually of 66 percent of her final salary. With the lump-sum payment of her DROP account and monthly pension benefit, she will receive 100 percent of her final average salary for at least 10 years, and, depending on the state, she may also receive Social Security benefits. This generous guaranteed payout would be hard to find in any other profession.

DROP programs do create an incentive for some teachers to remain past their eligible retirement age, but at a high cost. DROP programs mean that districts still must find the funds to pay pension benefits to teachers at a relatively young age when those dollars could be more effectively spent.

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).