The state should ensure that pension systems are neutral, uniformly increasing pension wealth with each additional year of work.
Ohio'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.
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.
Ohio's defined benefit plan does not utilize a constant benefit multiplier. Instead, the state's multiplier remains at 2.2 percent through 30 years of service but then increases for every subsequent year. The multiplier is 2.5 percent for year 31 and 2.6 percent for year 32 and continues to increase by one-tenth of a percent for every year thereafter until the benefit equals 100 percent of final average salary at 40 years of service. In addition, once teachers reach 35 years of service, the first 31 years are all calculated at 2.5 percent. This means that 35-year veteran teachers would receive benefits equal to 88.5 percent of their final average salaries, while 30-year veteran teachers would only have benefits equal to 66 percent of their final average salaries. If a 35-year teacher's benefit used the same multiplier as the 30-year teacher, the benefit would be only equal to 77 percent rather than 88.5 percent.
In addition, teachers may retire before standard retirement age based on years of service without a reduction in benefits. Teachers with 30 years of service may retire at any age with unreduced benefits, while teachers with less than 30 years may retire with unreduced benefits at age 65. Therefore, teachers who begin their careers at age 22 can reach 30 years of service by age 52, entitling them to 13 additional years of unreduced retirement benefits beyond what other teachers would receive who may not retire until age 65. Additionally, Ohio's early retirement with reduced benefits is also based on years of service. Teachers with 25 years of service may retire with reduced benefits at age 55, while other vested teachers with less than 25 years of service may not retire with reduced benefits until age 60. These provisions may encourage effective teachers to retire earlier than they may otherwise, and they fail to treat equally those teachers who enter the system at a later age and give the same amount of service.
Ohio's combined plan, however, is based on a neutral formula. It uses a constant multiplier of 1 percent. Vested teachers are eligible for monthly payments from their defined benefit accounts starting at age 60. However, this results in teachers being paid benefits by the state well before Social Security's retirement age.
The state's defined contribution plan is also based on a neutral formula because pension wealth accumulates in a uniform way. In both the combined plan and the defined contribution plan, retired teachers are always eligible to withdraw funds from their defined contribution accounts and at age 50, they may convert them to lifetime annuities if they choose.
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. Ohio's defined benefit plan should use a pension formula that treats each year of service equally.
End retirement eligibility based on years of service.
Ohio should change its practice of allowing teachers in its defined benefit plan with 30 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.
Ohio allows all teachers to retire before conventional retirement age, some as young as 52. 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).
Ohio was helpful in providing NCTQ with facts that enhanced this analysis.
The state noted that legislation is currently in the Senate (S.B. 3) and House (H.B. 69) to change the defined benefit plan. The legislation calls for a flat 2.2 percent multiplier, an actuarially neutral reduction for early retirements and later retirement eligibility. When fully phased in, the retirement eligibility will be age 60 with at least 35 years of service or age 65 with five years of service for unreduced retirement. Members can get an actuarially reduced retirement at age 55 with 30 years or age 60 with five years of service.
The proposed changes would improve the neutrality of the system; however, retirement based on years of service would still remain, leaving unnecessary spikes in retirement wealth.