The state should ensure that pension systems are neutral, uniformly increasing pension wealth with each additional year of work.
Colorado'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 percent). 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.
When teachers in Colorado retire, their benefits are calculated using both the traditional formula and the money purchase method; teachers are entitled to receive whichever calculation is higher. The traditional formula multiplies teachers' years of service by their final average salary and a benefit multiplier. The money purchase method is an actuarial calculation that equals the total value of one's account at the time of retirement (employee contributions and assigned interest earnings, currently 3 percent compounded), plus a 100 percent employer match, and 7.50 percent credit on investments. At retirement age, a teacher can either withdraw the total value or receive monthly lifetime benefits by multiplying the total value by a life expectancy factor.
Colorado's pension plan is commended for utilizing a constant benefit multiplier of 2.5 percent; teachers, however, may retire before standard retirement age based on years of service without a reduction in benefits. For teachers hired on or after January 1, 2011, the state allows teachers with 35 years of service to retire at any age, and teachers with 30 years of service can retire at age 58. Teachers with between 25 and 30 years of service may retire according to the "Rule of 88" in which they may collect unreduced benefits provided the sum of their age and service equals 88. Teachers with less than 25 years of service must wait until age 65. Therefore, teachers who begin their careers at age 22 can reach 35 years of service by age 57, entitling them to eight years of additional retirement benefits beyond what other teachers with less than 25 years of service would receive who may not retire until age 65. Not only are teachers being paid benefits by the state well before Social Security's retirement age, but these provisions, along with the state's early retirement with reduced benefits based on years of service, may also encourage effective teachers to retire earlier than they may otherwise. They also fail to treat equally those teachers who enter the system at a later age and give the same amount of service.
The money purchase method is a neutral formula because each year of work accrues wealth in a uniform way. Although the same eligibility timetable is used allowing teachers to retire early with unreduced benefits based on years of service, teachers' pension wealth does not decline after they reach eligibility because their pension wealth is tied directly to the balance of their personal accounts, rather than calculated by a traditional formula. Similar to a defined contribution plan, teachers' contributions fund their own individual accounts, and their contribution and the employer match remain constant for each year of service. The state is commended for offering this neutral calculation method.
Colorado Public Employees' Retirement System. Your PERA Benefits: A Summary of the Colorado Pera Defined Benefit Plan, revised April 2015.
End retirement eligibility based on years of service.
Colorado should change its practice of allowing teachers with 35 years of service to retire at any age and teachers with 30 years of service to retire at age 58, both 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.
Colorado allows all teachers to retire before conventional retirement age, some as young as 57. 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 pension sustainability goal).
Colorado pointed out that anyone with one month of service credit can retire at age 65.