«5• 2007 working paper april Teacher Pensions and Retirement Behavior: How Teacher Pension Rules Affect Behavior, Mobility, and Retirement Michael ...»
How Teacher Pension Rules
Affect Behavior, Mobility,
Mi c h a e l Po d g u r s k y
Ma r k eh l e r t
working paper april
Teacher Pensions and Retirement Behavior:
How Teacher Pension Rules Affect Behavior,
Mobility, and Retirement
Michael Podgursky and Mark Ehlert
University of Missouri–Columbia
This paper examines late career mobility and retirement decisions for a cohort of mid-career Missouri public school teachers. Specifically, the paper follows a cohort of teachers whose combined age and experience totaled 45 or more years in fall 1991 through the 2005-06 school year. Like many public employee pensions, Missouri has a system that permits teachers to receive full benefits if the sum of their age and experience is at least 80 (“rule of 80”). Thus, the sum of age and experience for most of the teachers in this cohort will hit 80—full retirement eligibility—in the 16-year window studied. Traditional benefit (DB) pension systems provide teachers with a large annuity value on retirement. The accrual of this annuity value occurs over the teacher’s entire work life; however, the rate of accrual is highly nonlinear and back-loaded with most of the gain occurring in the final years prior to retirement. In addition, these pension systems have various rules that introduce kinks or discontinuities in the rate of accrual after 30 years. This paper explores the effect of these pension rules on retirement patterns, as well as general descriptive data on retirement patterns. Like many states, Missouri permits teachers to continue teaching part-time while collecting benefits (e.g., DROP plans).
Teachers can also retire from one pension system and begin teaching in another. The paper examines both types of behavior. The primary source of data for this study is administrative teacher records maintained by the Missouri Department of Elementary and Secondary Education. These records include data on teacher experience, demographics, teaching field, compensation, retirement, and workforce exit, as well as the employing school and district. The paper also compares teacher retirement data from the Missouri administrative records with data from the 2000-01 Teacher Follow-up Survey.
*This paper was prepared for the Teacher Supply and Demand Symposium for the National Center for Education Statistics, and with support from the National Center for Education Statistics and the American Institutes for Research. This research is also part of the activities of the National Center for the Analysis of Longitudinal Data in Education Research (CALDER).
CALDER is supported by Grant R305A060018 to the Urban Institute from the Institute of Education Sciences, U.S.
Department of Education. CALDER working papers have not gone through final formal review and should be cited as working papers. They are intended to encourage discussion and suggestions for revision before final publication. Any opinions, findings, and conclusions expressed in these papers are those of the authors and do not necessarily reflect the views of the Urban Institute, the Institute of Education Sciences, the U.S. Department of Education, or any other sponsors of the research.
Background SECTION I Teacher pensions and retiree health insurance represent a large and growing cost for public school districts. A recent study estimated the unfunded liabilities of state and local employee pension systems (including teachers) to be as large as $1.4 trillion in the aggregate (Edwards and Gokhale 2006). Much of these unfunded liabilities arise from pay-as-you-go retiree health insurance benefits about which researchers have limited data.
However, even the teacher pension systems, which are expected to be fully funded, have large unfunded liabilities in many states. Examples include California ($20.3 billion), Ohio ($19.4 billion), Missouri ($5.2 billion), and West Virginia ($5.0 billion). 1 Aside from their fiscal impacts, teacher pensions potentially have important labor supply effects. Substantial literature in labor economics has identified the effect of incentives in pension systems on the timing of retirement decisions, labor turnover, and workforce quality (Asch, Haider, and Aissimopoulos 2005;
Friedburg and Webb 2005; Ippolito 1997; Stock and Wise 1990). Unfortunately, little of this literature pertains to teachers. While there have been many studies of the effect of current compensation on teacher turnover (e.g., Hanushek, Kain, and Rivkin 2004; Murnane and Olsen 1990; Podgursky, Monroe, and Watson 2004; Stinebrickner 2001), the econometric literature on teacher pensions is very slender. The only published econometric study to date of which the authors are aware is Furgeson et al. (2006), who found that Pennsylvania teachers’ retirement decisions were highly responsive to changes in administrative rules on changes in experience levels for full retirement benefits. 2 In spite of the growing visibility of the problems faced by states and districts in the area of pensions and retiree benefits, even simple descriptive data are lacking. This paper focuses on teacher pension data, briefly reviewing the character of teacher pension plans and noting the key parameters used in determining contributions and benefits.
The paper also analyzes data from a unique administrative data file for Missouri public school teachers that tracks a cohort of mid- to late-career teachers from 1990-91 through 2005-06, and it compare the findings from the Missouri data with the 2001 and 2005 Schools and Staffing Teacher Follow-up Surveys (TFS).
Review of Literature: Basic Features of Teacher Pensions SECTION II Public school teachers are almost universally covered by traditional “defined benefit” (DB) pension systems. 3 “Traditional” types of plans were the norm in both the public and private sector until recent decades.
However, this is no longer the case in the private sector, which has largely shifted to defined contribution (DC) systems. In a DB system, the employer has an obligation to provide a regular retirement check to employees upon their retirement. The plans are collective in the sense that employee and employer contributions go into a fund that is supposed to be actuarially sound.
Typically, a DB teacher pension plan requires that both teachers and employers make a contribution each year.
For example, Maryland is a state in which public school teachers are covered by Social Security. During the 2005-06 school year, employees contributed 2 percent of their gross salary and school districts paid 9.35 From National Association of State Retirement Systems annual survey. Retrieved from 1 http://www.publicfundsurvey.org/publicfundsurvey/actuarialfundinglevels.asp.
2 See also Brown (2006), who examines the effect of an early retirement incentive program in California.
3 Data collected by the U.S. Department of Labor show that, unlike the public sector, defined contribution (DC) plans now predominate in the private sector (Employee Benefits Research Institute 2006). DC plans are particularly attractive for professionals who tend to exhibit high rates of mobility between employers (or who go into self employment and back). Two states (Ohio and Florida) have introduced limited defined contribution options for new teachers.
Teacher Pensions and Retirement Behavior Podgurksy & Ehlert 1 percent for a combined total of 11.35 percent. This is in addition to the 12.4 percent combined employer and employee contribution to the Social Security system. In Ohio, teachers are not part of the Social Security system; they contribute 10 percent, and their employers contribute 13.5 percent for a combined total of 23.5 percent. In the Missouri state plan, also outside of the Social Security system, teachers and districts both contribute 11.5 percent.
Teachers become eligible for a full pension based on a combination of age or service. In both Maryland and Pennsylvania, teachers are eligible for full pension if they reach the age of 62 or have 35 years of service at any age. In Missouri, qualification for full benefits is based on a “rule of 80”– the sum of age plus experience must total at least 80. This is an important difference between state teacher pension systems and the Social Security system. In the latter, employees face reduced payments if they retire before age 65, regardless of years of covered employment. However, under nearly all state teacher pension systems, teachers can retire at much younger ages—many in their mid-fifties—if they have put in the requisite years of service (usually 30 to 35).
Benefits at retirement are usually determined by a formula of the following sort:
Annual Benefit = (years of service) x (final average salary) x M where final average salary is the average of the last (or highest) several years of salary and M is a proportion.
In Missouri, teachers earn 2.5 percent for each year of teaching service up to 30 years. 4 Thus, a teacher with 30 years experience and a final average salary (average of last three years) of $60,000 would receive Annual Benefit =.025 x 30 x $60,000 = $45,000 The traditional DB system described above may be contrasted with a defined contribution (DC) plan. In a DC plan, the employer merely agrees to contribute a fixed amount annually to a retirement account for an employee. For example, a common arrangement in the private sector is for the employer to contribute 5 percent of an employee’s salary and match employee contributions up to an additional 5 percent. These contributions go into a retirement account associated with that employee. If the employee quits, the fund goes with him or her. The employer is under no obligation to provide a given payment to the employee at the time of retirement.
Sources of Data on Teacher Pension Plans SECTION III Even simple descriptive data on state and district teacher pension plans and teacher retirement behavior are limited. The National Compensation Survey (NCS) is the flagship Bureau of Labor Statistics survey on pay and benefit comparability. It is the foundation for detailed reports on the cost and nature of employee fringe benefits, including pensions. Unfortunately, due to sample size restrictions, the data released on public school teachers are very limited. In fact, tabulations for public school teachers do not break out pension costs separately from other benefits. In addition, use of these data is complicated because many public school teachers are not covered by Social Security. 5 Currently, the multiplier for teachers with 31 or more years of service is 2.55. Thus, teachers who are near 30 years of 4 experience have a strong incentive to wait until 31 years. However, this was only introduced in 2001 and is scheduled to be phased out in 2008.
5 Whether or not teachers in a given state or district are covered by Social Security is important in assessing the adequacy of their retirement income systems. State and local employees were originally excluded from the Social Security system when it was set up in 1935. Congress amended the Act in 1950 to permit states to arrange voluntary entry of some or all state and local employees to enroll in the system. Some states and districts chose to do so and some did not. (Mitchell et al. 2001). The result is a complicated mosaic: there are 14 states in which most or all of the public school teachers are not covered by the federal Social Security system. For example, in Missouri, the teachers in the Kansas City and St. Louis school districts are in the Social Security system and have their own separate pension funds. Teachers in the remaining Teacher Pensions and Retirement Behavior Podgurksy & Ehlert 2 Every 2 years, the National Education Association (NEA 2004) releases a report on large public education pension plans that provides a detailed table on the various features of the pension plans (e.g., employer and employee contribution rates, benefit multiplier, COL adjustments, years to vesting, etc.). Similar data are also collected annually by the National Association of State Retirement Administrators (2006) although on fewer teacher pension funds. Both of these studies provide useful data on the “parts” of the retirement pension system; however, they do not provide an overall assessment of the generosity of the benefits nor the labor market effects. A recent study by Loeb and Miller (2006) takes a useful step in this direction. This is a comprehensive paper that attempts to catalog a wide range of state policies concerning teacher labor markets.
They provide a set of summary tables on pension plan parameters similar to those described above. In addition, they provide summary estimates of the overall replacement rates of these pension systems for teachers with various years of seniority for states in and out of the Social Security system.
For the next section, a more disaggregated microeconomic analysis of the retirement incentives built into the Missouri system is examined. Unfortunately, such an analysis cannot be taken “off the shelf,” so instead the authors have built one for a representative teacher.
The Structure of Missouri Pension Benefits SECTION IV Data on the parameters of teacher pension plans can be used to generate estimates of the magnitude of pension benefits using the concept of present value. When an individual retires under a DB plan, he or she is entitled to a stream of payments that has a lump sum value that can be readily determined using standard actuarial methods. Indeed, such methods form the basis for the pricing of annuities that are regularly bought and sold in the marketplace.