Pension Neutrality: Arizona

It is unfair to all teachers when pension wealth does not accumulate in a uniform way.

In addition to the ways defined benefit pension systems disadvantage teachers described in the goal on pension flexibility, the way pension wealth accumulates in some systems further compounds the inequity. Defined benefit pension systems use a multiplier to calculate the benefits an individual is entitled to receive based on salary levels and years of service. For example, a pension system may have a multiplier of 2.0. In such case, pension benefits are determined by multiplying average final annual salary by years of service and then multiplying the product by 2.0. Thus, someone working fewer years with a lower final salary would appropriately receive less in benefits than someone with more years of service and/or a higher final salary. However, the multiplier in many pension systems is not fixed; it increases as years of service increase. When a higher multiplier is used, teachers receive even more generous benefits.

Another way that pension benefits are awarded unfairly is through the common policy of setting retirement eligibility at different ages and years of service. For example, in a given state, a teacher with 30 years of service may retire at age 55, while teachers with fewer years of service may not retire until age 62. This means that a teacher who started teaching in this state at age 25 would reach 30 years of service at age 55 and receive seven additional years of full retirement benefits beyond what a teacher that started at age 32 and cannot retire with full benefits until age 62 would receive. A fair system would set a standard retirement age for all participants, without factoring in years of service.

Pension systems affect when teachers decide to retire as they look to maximize their pension wealth.

The year teachers reach retirement eligibility by age and/or years of service, their pension wealth peaks; pension wealth then declines for each year they work beyond retirement age. Plans that allow retirement based on years of service create unnecessary peaks, and plans that allow a low retirement age create an incentive to retire earlier in one's career than may be necessary. For every year teachers continue to work beyond their eligibility for unreduced retirement benefits, they lose that year of pension benefits, thus decreasing their overall pension wealth.

Although their yearly pension benefits would continue to rise as they earn additional service credit, it would only be at a small percentage per year, which would not make up for the loss of each year of benefits.

To try to balance this incentive to retire, some states have created DROP (Deferred Retirement Option Plan) programs. DROP programs allow participants to place their monthly pension benefits in a private investment account while still teaching and earning a salary, thus retaining those benefits. These teachers are, in effect, earning their pension and salary at the same time, and often at a relatively young age.

A DROP program is a band-aid on the problem; it does not fix what is structurally wrong: retirement at an early age without reduction of benefits. For example, the hypothetical teacher above decides to forgo retiring at age 47 in order to wait and qualify for her state's DROP program at age 55. She now has 33 years of service and has reached a pension equal to 66 percent of her salary. She remains in DROP for the maximum allowable five years. During that time, her five years of lost pension benefits plus her five years of mandatory employee pension contribution have been deposited in a private investment account. Upon retiring at age 60, she would receive the total of that private account plus a lifetime pension benefit annually of 66 percent of her final salary. With the lump-sum payment of her DROP account and monthly pension benefit, she will receive 100 percent of her final average salary for at least 10 years, and, depending on the state, she may also receive Social Security benefits. This generous guaranteed payout would be hard to find in any other profession.

DROP programs do create an incentive for some teachers to remain past their eligible retirement age, but at a high cost. DROP programs mean that districts still must find the funds to pay pension benefits to teachers at a relatively young age when those dollars could be more effectively spent.

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 R. Costrell and M. Podgursky. "Reforming K-12 Educator Pensions: A Labor Market Perspective." TIAA-CREF Institute, Policy Brief, February 2011.

For evidence that retirement incentives do have a statistically significant effect on retirement decisions, see J. Furgeson, R. Strauss, and W. Vogt. "The Effects of Defined Benefit Pension Incentives and Working Conditions on Teacher Retirement Decisions", Education Finance and Policy, Volume 1, No. 3, Summer 2006, pp. 316-348.

For examples of how teacher pension systems inhibit teacher mobility, see R. Costrell and M. Podgursky, "Golden Handcuffs," Education Next, Volume 10, No. 1, Winter 2010, pp. 60-66.

For additional information on state pension systems, see S. Loeb and L. Miller. "A Review of 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, December 2006; and J. 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, Inc., 2010.