The state should ensure that pension systems are neutral, uniformly increasing pension wealth with each additional year of work.
Washington's defined benefit pension plan (Plan 2) and the defined benefit component of its hybrid plan (Plan 3) are based on benefit formulas that are not quite 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 within a defined benefit structure 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.
Although Washington's defined benefit plans are not quite neutral, the state's policies are better than what is offered in most states. Its pension plans utilize a constant benefit multiplier of 2 percent in Plan 2 and 1 percent in Plan 3, but the state's retirement eligibility timetable is not fair to all teachers. In Plan 2, all vested teachers may retire with unreduced benefits at age 65. Early retirement with reduced benefits, however, is only available to teachers with 20 or more years of service, and the reduction varies greatly with years of service because teachers with at least 30 years of service have much less, or no, reduction in benefits. Teachers with 20 to 29 years of service who retire at age 55 will receive only 37 percent of their unreduced benefits, while teachers with 30 or more years of service who retire at age 55 will receive 70 percent of their unreduced benefits, or 80 percent of their unreduced benefits with stricter return-to-work rules. Therefore, teachers with 29 years of service have their early retirement benefits reduced almost 50 percent more than teachers with 30 years of service. Reducing benefits for early retirement is a fair practice because early retirees will receive benefits for a longer period of time, but the drastic differences in reductions based on years of service are not fair to all teachers.
In Plan 3, teachers may retire with unreduced benefits at age 65 with 10 years of service, or at age 65 with only five years of service, if one of those years was earned after age 44. As in Plan 2, early retirement benefits are tied to years of service, except that in Plan 3, the minimum service needed for early retirement is 10 years. Teachers in Plan 3 with 10 to 29 years of service must follow the same severe reduction schedule as those in Plan 2 with 20 to 29 years of service, and teachers with 30 years of service must follow Plan 2's respective schedule. Teachers with 10 to 29 years of service who retire at age 55 will receive only 37 percent of their unreduced benefits, while teachers with 30 or more years of service who retire at age 55 will receive 70 percent of their unreduced benefits. Therefore, teachers with 29 years of service have their early retirement benefits reduced almost 50 percent more than teachers with 30 years of service. Again, while reducing early retirement benefits based on age is fair, the reductions based on years of service are not.
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.
Plan 3's defined contribution component is neutral because teachers' pension wealth increases in a uniform way.
Washington State Teachers' Retirement System Plan 3 Member Handbook, updated October 2015. Washington State Teachers' Retirement System Plan 2 Member Handbook, updated October 2015.
End early retirement eligibility based on years of service.
Washington should change its practice of only allowing teachers with certain years of service to retire early with reduced benefits. If retirement at an earlier age with reduced benefits is offered, it should be offered to all teachers regardless of years of service.
Utilize an actuarially determined rate of reduction for early retirement benefits.
Washington's current method to reduce benefits for early retirees does not treat each year of work equally.
Washington recognized the factual accuracy of this analysis.