Pension Flexibility: Minnesota

Analysis of Minnesota's policies

Minnesota only offers a defined benefit pension plan to its teachers as their mandatory pension plan. This plan is not fully portable and does not provide any employer contribution for teachers who choose to withdraw their account balances when leaving the system. It also limits flexibility by restricting the ability to purchase years of service. However, the state is commended for allowing teachers to vest at year three and for a provision that improves portability for teachers who defer their pensions.

Teachers in Minnesota also participate in Social Security, so they must contribute to the state's defined benefit plan in addition to Social Security. Although retirement savings in addition to Social Security are good and necessary for most individuals, the state's policy results in mandated contributions to two inflexible plans, rather than permitting teachers options for their state-provided savings plans.

Vesting in a defined benefit plan guarantees a teacher's eligibility to receive lifetime monthly benefit payments at retirement age. Nonvested teachers do not have a right to later retirement benefits; they may only withdraw the portion of their funds allowed by the plan. Minnesota's vesting at three years of service offers flexibility to most of its teachers.

Teachers in Minnesota who choose to withdraw their contributions upon leaving only receive their own contributions plus interest. This means that those who withdraw their funds accrue no benefits beyond what they might have earned had they simply put their contributions in basic savings accounts. Further, teachers who remain in the field of education but enter another pension plan (such as in another state) will find it difficult to purchase the time equivalent to their prior employment in the new system because they are not entitled to any employer contribution.

However, the state does offer a portability feature for vested teachers who exit the system but leave their funds in until a later retirement date, known as the portable deferred pension provision. The deferred provision calculates the benefit when a teacher leaves employment, and the benefit is then increased annually at a compounded rate of 2 percent to 5 percent per year (depending upon the member's date of hire) until the member retires. This provision reduces or eliminates pension wealth loss due to inflation.

Minnesota limits teachers' flexibility to purchase years of service. The ability to purchase time is important because defined benefit plans' retirement eligibility and benefit payments are often tied to the number of years a teacher has worked. Minnesota's plan does not allow teachers to purchase time for previous teaching experience, which is a severe disadvantage to teachers who move to Minnesota with teaching experience. However, the state's plan does allow teachers to purchase one year of time per approved parental leaves of absence and up to five years for extended leaves of any reason.

Citation

Minnesota Teachers Retirement Association, 2011 Handbook of Benefits and Services https://www.minnesotatra.org/IMAGES/PDF/handbook07-11.pdf

Recommendations for Minnesota

Offer teachers a pension plan that is fully portable, flexible and fair.
Minnesota should offer teachers for their mandatory pension plan the option of either a defined contribution plan or a fully portable defined benefit plan, such as a cash balance plan. A well-structured defined benefit plan could be a suitable option among multiple plans. However, as the sole option, defined benefit plans severely disadvantage mobile teachers and those who enter the profession later in life. Because teachers in Minnesota participate in Social Security, they are required to contribute to two defined benefit-style plans.

Increase the portability of its defined benefit plan.
If Minnesota maintains its defined benefit plan, it should allow teachers that leave the system to withdraw employer contributions. The state should also allow teachers to purchase their full amount of previous teaching experience. A lack of portability is a disincentive to an increasingly mobile teaching force.   

Offer a fully portable supplemental retirement savings plan.
If Minnesota maintains its defined benefit plan, the state should at least offer teachers the option of a fully portable supplemental defined contribution savings plan, with employers matching a percentage of teachers' contributions.

State response to our analysis

Minnesota was helpful in providing NCTQ with facts that enhanced this analysis.

Minnesota contended that the statement that TRA "does not offer a fully portable pension plan" is incorrect. The state maintained that TRA offers pension portability in two important ways.

First, state statute provides the portable deferred pension provision, as explained in the analysis. The state explained that this provision is unique among teacher pension systems nationwide and provides excellent portability. This provision not only maintains the value of the pension benefit, but also for older, mid-career teachers it matches or exceeds the annuity value of the benefit that a defined contribution account would generate. This deferred provision is particularly valuable to a teacher who enters teaching later in life. It is much more valuable than a defined contribution (DC) annuity for an older worker because a DC account requires a longer investment horizon in order to accumulate value; an older teacher does not have as long an investment horizon as a younger teacher. A sample calculation demonstrates the value of the deferred annuity: A teacher teaches for 10 years, terminates at age 50 with a salary at termination of $60,000. The TRA benefit calculated upon termination is $11,200 per year. If the terminated teacher begins collecting this benefit 15 years later upon reaching age 65, the benefit will have escalated automatically by 22% to a level of $13,895 a year. That is a lifetime benefit increase due to the deferral period that is equivalent to approximately $54,000. 

Second, members who terminate teaching employment and withdraw their contributions are paid 6 percent interest compounded annually from the year the funds were contributed to July 1, 2010, and 4 percent thereafter. This high rate of interest assures that contributions grow at a rate that is more than competitive with savings accounts and, for many periods, more than competitive with defined contribution accounts invested in a moderate to low-risk manner. Minnesota asserted that the NCTQ analysis tries to equate the TRA refund benefit to a basic savings or defined contribution account, which is not an appropriate comparison, as very few savings/certificate of deposit investments or defined contribution programs provide consistent, reliable interest rates of 4 to 6 percent. Members taking refunds of their accounts also have the ability to transfer their account balances to another qualified retirement plan without triggering a taxable distribution.

Both of these portability provisions described above (TRA's deferred pension and interest on refunds) are important and financially valuable elements of TRA's plan. 

Finally, Minnesota asserted that NCTQ's analysis seems to miss three important points in analyzing the value of defined contribution (DC) plans in comparison with defined benefit (DB) plans. First, experience in other states (Florida, Ohio, South Carolina, West Virginia) shows that when teachers are provided the option to elect between a DB or a DC plan, they overwhelmingly select defined benefit protection. This is strong, real-world evidence that DB protection is preferred and is an important recruitment and retention tool for teachers. Second, recent research backs up this claim, showing that employees with DB coverage report higher levels of job commitment than those with only DC coverage, and that this commitment is strongest among younger workers. Third, DB plans are more efficient and cost-effective than DC plans in delivering lifetime retirement benefits. Recent research quantifies that, because of their professional investment management and higher returns and because of their group insurance elements that spread mortality risk, a DB plan can provide the same level of target retirement income at almost half (46 percent) of the cost of a DC plan. This is particularly important since taxpayer dollars partially fund teacher pensions.

Last word

Minnesota's deferred pension provision, while commendable, still does not erase all pension wealth loss due to mobility. For example, teachers who vest in two different pension systems calculate their benefits on the final average salary at the time they left each system. So, a teacher who taught for 30 years in one system would have a much higher benefit than a teacher who taught for 15 years in two systems and had to have one of his or her benefits based on the salary at the mid-point in the total career.

The state does credit interest at a higher rate than current basic savings plans. This is a valuable aspect of the system for any teachers who choose to withdraw their contributions. The former 6 percent rate is similar to offering an employer match. However, as interest rates nationwide start to increase, the value of this credit as a "match" will erode, and the state can easily further decrease the interest rate credited to accounts. Providing a policy of a guaranteed employer match of contributions would offer more security for teachers who withdraw their funds.

When offered the choice, more public employees are enrolled in a defined benefit plan. However, the reality is that most members never actually "choose" a plan; the defined benefit system is the default plan. For example, in 2010 in Ohio 79 percent of members defaulted into the defined benefit plan while in Florida 53 percent entered by default. Interestingly, in Florida, not including the "defaulted" employees, more new employees actually chose the defined contribution plan; 25 percent enrolled in the defined contribution plan while 22 percent actively chose the defined benefit plan. In South Carolina 18 percent enrolled in the defined contribution plan, which is impressively high considering that new teachers only have 30 days to make their choice. Despite the defined benefit plan being the default plan, at least a certain percentage of teachers actively choose a defined contribution plan.

As for West Virginia, in 2008, 78 percent of teachers in the state's defined contribution plan elected to switch into the states newly reopened defined benefit plan. The vast majority of teachers had only invested in low-risk, low-yield portfolios, and the switch offered them no penalty to reinstate all their years of service (relative to the lower contribution rates they paid to the defined contribution plan). The percent of teachers that chose to stay in West Virginia's defined contribution plan and those in other states that elected a defined contribution plan show that certain teachers prefer a defined contribution plan, and that the option of a defined contribution plan is an attractive recruitment tool for some professionals.

Defined contribution plans can be structured to have many of the benefits of defined benefit plans but with the added benefits of portability and flexibility to attract new individuals to the profession and to treat all teachers fairly for each year of service, not to mention less stress to states' financial health (see Goal 4-H). Plans can be structured as cash balance plans that allow the employer to maintain the investment risk and to include benefits such as disability and survivor coverage. Increased participation in defined contribution plans may also result in lower fees more commensurate with defined benefit plans. Teachers' individual accounts can be invested in statewide, professionally managed funds to align their earnings and losses with other statewide plans, such as a defined benefit plan. Teachers must receive proper education on topics such as longevity risk, tax implications and annuity options.