Pension Flexibility: Michigan

2011 Retaining Effective Teachers Policy

Goal

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

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

Analysis of Michigan's policies

Michigan only offers a type of hybrid pension plan, known as pension plus, to teachers hired as of July 1, 2010, as their mandatory pension plan. A hybrid plan has elements of both defined benefit and defined contribution plans. Even though Michigan's plan is a hybrid, it is not fully portable, does not fully vest until year 10, and only provides minimal employer contribution for teachers who withdraw their accounts. It also limits flexibility by restricting the ability to purchase years of service.
  
Michigan teachers and employers contribute to both a defined benefit component and a defined contribution component. Contributions to the defined benefit component are mandatory, while contributions to the defined contribution component are optional. Teachers are automatically enrolled to contribute 2 percent of their salary to the defined contribution component with employers contributing a 50 percent match up to 1 percent of salary. 

Teachers may choose to increase or decrease their contribution levels. While the state is commended for offering a defined contribution component, it is optional and only contains a minimal employer contribution.

Teachers in Michigan also participate in Social Security, so they must contribute to the state's hybrid plan in addition to Social Security. Although retirement savings in addition to Social Security are good and necessary for most individuals, the state's policy results in mandated contributions to two inflexible plans, rather than permitting teachers options for their state-provided savings plans.

Vesting in the defined contribution component entitles teachers to permanent rights to their own contributions and any available employer contributions. Michigan teachers vest immediately in their own contributions to the defined contribution plan and after four years of service for the employer contributions.

Vesting in the defined benefit component 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. Michigan's vesting at 10 years of service is very late and limits the options of teachers who leave the system prior to this point.

Many teachers in Michigan will leave the system before they reach 10 years of service. Teachers in Michigan who choose to withdraw their contributions upon leaving only receive their own contributions and accrued interest. This means that those who withdraw their funds accrue no benefits beyond what they might have earned had they simply put their contributions in basic savings accounts. 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 from the defined contribution component.  

Michigan limits teachers' flexibility 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. Michigan's plan does not allow teachers to purchase time for previous teaching experience or for time while on approved leaves of absence. This provision is a severe disadvantage to teachers who move to Michigan with teaching experience and those teachers who need to take more than one year of leave, such as for maternity or paternity leave.

Citation

Recommendations for Michigan

Offer teachers a pension plan that is fully portable, flexible and fair.
Michigan 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 Michigan participate in Social Security, they are required to contribute to two mainly defined benefit-style plans. Although technically a hybrid plan, Michigan's pension plan is a very restrictive defined benefit plan with a small, optional portable defined benefit component.

Increase the portability of its defined benefit plan.
If Michigan maintains its defined benefit plan with a hybrid component, it should allow teachers that leave the system to withdraw employer contributions from the defined benefit component. The state should also allow teachers to purchase their full amount of previous teaching experience upon the first day of employment, allow for the purchase of at least one year for each approved personal leave and decrease the vesting requirement to year three. A lack of portability is a disincentive to an increasingly mobile teaching force.   

Offer a greater employer contribution to the defined contribution component.
While Michigan at least offers teachers the option of a defined contribution component, this option would be more meaningful if the state required employers also to contribute and if there were multiple investment options. 

State response to our analysis

Michigan stated that "NCTQ's report indicates that the teachers do not fully vest in the hybrid plan until year 10, and as such, the plan is not portable enough. Teachers are immediately vested in their own contributions to the defined contribution (DC) component; 50%, 75%, and 100% vested in employer contributions in the DC plan, respectively; and they vest in the defined benefit (DB) component after 10 years. The DB plan is portable for unvested members. Members contribute up to 6.4 percent of their pay toward the plan, and if they leave employment without vesting, they have the ability to get a refund of these contributions or roll them over into another qualified retirement plan. Members who do not vest, accordingly, can walk away from the plan with a sizeable retirement nest egg."

The state also maintained that while NCTQ's indication that the DC component is optional is technically true, employees are automatically enrolled in a 2 percent contribution, allowing them to receive the full employer match. Currently, the opt-out rate experienced by the plan is less than 2 percent.

Michigan also disagreed with the assertion that teachers don't have options for their "state-provided" savings plans. The DC component offers teachers the ability to contribute to a 457 plan. The 457 plan is not offered through many school employers directly and is not required to be coordinated with 403(b) limits, and it affords school employees an additional $16,500 worth of pre-tax contributions.

Finally, Michigan reiterated that school employees do have the ability to contribute additional monies into the 457. Rather than use their own funds to purchase service, teachers can use these funds to make additional contributions to the 457 plan, and if it makes them more comfortable to have additional guaranteed income, use these funds to purchase an annuity upon retirement.

Last word

NCTQ maintains that a pension plan that does not fully vest until year 10 is not fully portable. Prior to 10 years of service, a teacher can at most withdraw an employer contribution of 1 percent.  

While Michigan is commended for automatically enrolling its teachers in the optional defined contribution component, it is still technically optional and at the automatic rate of a combined 3 percent contribution, it is still only a minimal part of the full pension plan compared with a total of over 16 percent of salary contributed to the defined benefit system. The defined benefit component is mandatory and thus does not allow teachers options for their pension plan. After their mandatory contributions to the defined benefit component and Social Security, many teachers may not be able to contribute meaningfully to a 457 plan. And contributing extra funds will not move them closer to vesting in the defined benefit component, which is why purchasing time is important.

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).