The state should ensure that pension systems are neutral, uniformly increasing pension wealth with each additional year of work.
Kentucky'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.
Kentucky's pension plan does not utilize a constant benefit multiplier. Instead, the state uses a multiplier of 1.7 percent for years of service 1-10, 2 percent for years 10.1-20, 2.3 percent for years 20.1-26, 2.5 percent for years 26.1-30, and 3 percent for years over 30. Further, if teachers are at least 55 years old with at least have 27 years of service, their final average salary is based on their highest three years of service, rather than the highest five years for all other teachers. These rules arbitrarily value certain career points more favorably than others.
In addition, teachers may retire before standard retirement age based on years of service without a reduction in benefits. Teachers with 27 years of service may retire at any age, while other vested teachers may not retire until age 60. Therefore, teachers who begin their careers at age 22 can reach 27 years of service by age 49, entitling them to 11 additional years of unreduced retirement benefits beyond what other teachers would receive who may not retire until age 60. Thus, these teachers are paid benefits by the state well before Social Security's retirement age. These provisions, along with the state's early retirement with reduced benefits based on years of service, 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.
Kentucky Teachers' Retirement System, Comprehensive Annual Financial Report as of June 30, 2015.
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. Kentucky should use a pension formula that treats each year of service equally.
Calculate "final average salary" consistently for all teachers.
The final average salary can greatly affect a teacher's pension wealth. Kentucky should use the same number of years to calculate the average, regardless of teachers' years of service.
End retirement eligibility based on years of service.
Kentucky should change its practice of allowing teachers with 27 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.
Kentucky allows all teachers to retire before conventional retirement age, some as young as 49. 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).
Kentucky did not respond to repeated requests to review this analysis.