The state should ensure that pension systems are neutral, uniformly increasing pension wealth with each additional year of work.
Pennsylvania'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.
Pennsylvania's pension plan is commended for utilizing a constant benefit multiplier of 2 or 2.5 percent, depending on the teacher's chosen class; however, teachers may retire before standard retirement age based on years of service without a reduction in benefits. Teachers may retire according to the "Rule of 92" with a minimum of 35 years of service, meaning that they can retire when age plus years of service equal at least 92, while other vested teachers may not retire with unreduced benefits until age 65. Therefore, teachers who begin their careers at age 22 can reach the "Rule of 92" with 35 years of service by age 57, entitling them to eight additional years of unreduced retirement benefits beyond what other teachers would receive who may not retire until age 65. Moreover, teachers with at least 25 years of service qualify for retirement beginning at age 55. 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, and they fail to treat equally those teachers who enter the system at a later age and give the same amount of service.
Commonwealth of Pennsylvania Public School Employees' Retirement System, Active Member Handbook, September 2012
End retirement eligibility based on years of service.
Pennsylvania should change its practice of allowing teachers whose age and years of service equal 92 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.
Pennsylvania 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).
Pennsylvania was helpful in providing information that enhanced this analysis. Pennsylvania asserted that benefits do accrue in a way that treats each year of work uniformly, as benefits accrue based on the member's annual benefit accrual rate, which is set forth in statute.
It is true that the multiplier used to determine benefits is fixed, but retirement eligibility rules treat certain years of service very differently.