The state should ensure that pension systems are neutral, uniformly increasing pension wealth with each additional year of work.
Tennessee'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.
Tennessee's pension plan is commended for utilizing a constant benefit multiplier of 1.0 percent. Teachers, however, may retire before standard retirement age based on years of service without a reduction in benefits. Vested teachers may retire at any age under the "Rule of 90", meaning that teachers reach retirement eligibility when their age plus number of years of service equal at least 90. Otherwise, vested teachers may not retire until age 65. Therefore, teachers who begin their careers at age 22 can retire by age 56 with 34 years of service, entitling them to 9 additional years of unreduced benefits than teachers who do not satisfy the Rule of 90 and must wait until age 65. These provisions, along with the state's early retirement with reduced benefits based on years of service, 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.
Tennessee Consolidated Retirement System. Hybrid Pension Plan for State Employees and Teachers, April 2014.
End retirement eligibility based on years of service.
Tennessee should change its practice of allowing teachers to retire at any age with full benefits under the Rule of 90. 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.
Tennessee allows all teachers to retire before conventional retirement age, some as young as 56. 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).
Tennessee was helpful in providing information that enhanced this analysis.