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Risking Teacher Nest Eggs

Financially-troubled pension systems require change.

The U.S. teacher pension system is in major financial trouble, with almost $390 billion in unfunded liabilities, according to a recent report from the National Council on Teacher Quality (NCTQ). And funding shortfalls grew in all but seven states between 2009 and 2012, the nonprofit research and policy group found.

Though the current economic downturn is a factor, America’s public pension systems—which offer retirement benefits to public service employees, largely composed of teachers, administrators and school staff—were earlier showing signs of weakness. The combination of states not keeping up with funding, unrealistic assumptions about investment returns, and increasing retiree lifespans has weakened the system, says Sandi Jacobs, NCTQ state policy director. As primary author of the report “No One Benefits: How teacher pension systems are failing both teachers and taxpayers,” Jacobs states further that these factors have led states to implement a number of changes that are costly to districts, teachers, and taxpayers.

“The policy changes states have been making are, for the most part, chipping away at the benefits teachers receive,” Jacobs says. “Few places are thinking about comprehensive reforms, but are putting the squeeze on districts and teachers to try to compensate for these huge liabilities.”

Only 10 states have pension systems that are adequately funded, the report states (see map on p. 52). The chronic underfunding nationwide represents legislator hesitancy to take major reform actions, according to Frederick Hess, director of education policy studies at the American Enterprise Institute, a nonpartisan think tank.

The problem is Americans “like getting stuff, and don’t like paying for stuff,” Hess says. “It’s the same problem we see with the deficit in Washington. Everybody thinks the government should balance its books, but no one wants to pay more taxes or cut programs.”

With the hands of most administrators tied and increasingly tight state and district budgets, America’s pension problems will require decisive state action to solve.

Defined Benefit vs. Defined Contribution Plans

Teacher retirement systems nationwide primarily use a defined benefit plan, ensuring retirees of a guaranteed income. However, the vast majority of American businesses have switched to 401(k)-style defined contribution plans, where pension payments can vary with market fluctuation and other factors. Many analysts believe that it is time for teacher pension benefits to be based on defined contribution rather than defined benefit plans, to create more pension portability and lessen the financial burden on school districts and taxpayers.

Underfunded Districts

Though pension costs increase each year, the amount of money in retirement systems is shrinking, and legislators in many states continue to divert their discretionary share to other budget priorities. For example, in Illinois between 1970 and 2014, the state will have redirected $30 billion from the Teachers’ Retirement System (TRS) to other areas, including public safety and health care, according to Dave Urbanek, TRS director of communications. In fact, the Chicago Public Schools are projecting a deficit of over $1 billion by 2014, due in part to pension costs. TRS is Illinois’ biggest pension fund, and has nearly $53 billion in unfunded liabilities, Urbanek says.

“The financial trouble stems from the fact that the state of Illinois has never paid the complete amount in any given year to the fund to pay for the annual cost of pensions,” Urbanek says.

For the coming year, the state owes $4.38 billion, but will only pay $3.4 billion. “We can pay pensions for the next 20 years—that’s not a problem,” he adds. “But after that point, the amount of money we have on hand and the cost of  ensions will meet, and we will become insolvent.  We won’t be able to pay pensions without money from some other source.”

The National Picture

Costs to districts and teachers are on the rise nationally—since 2008, when 40 states raised employer contribution rates at an average cost of $1,200 more per teacher per year, the NCTQ report states.

Over the same time period, 27 states raised teacher contributions, with the average teacher paying $500 more per year toward retirement. “Very often, districts are at the mercy of the state system,” Jacobs says.“The district’s contribution is decidedly separate from the fiscal realities in the district,” leading districts to draw funds away from other areas to make up for the shortfall.

Defined benefit plans, she adds, limit district leaders who want to be more flexible and innovative with their compensation packages. “When districts think about the proportion of the budget that goes toward teacher compensation, and things they want to do, like performance pay, incentivizing teachers to work in the most challenging schools, or differential pay for shortage subject areas, their ability to do that becomes harder when a significant percentage of the compensation is not within their control,” Jacobs says.

And though starting salaries for teachers have risen in the last decade, teachers still receive small raises, Jacobs says, and the path from new hire to experienced, higher-paid employee tends to take much longer than in other fields. If administrators did not have to worry about funding pension shortfalls, they may be able to provide higher raises to help with recruitment and retention, she adds.

Rising district contributions also consume funds that could otherwise be spent on teaching materials for students, Hess says. “And the trajectory is pretty frightening,” he adds. “Especially as we look at a tight fiscal environment, a bigger and bigger chunk of dollars will be spent mailing checks to retired educators rather than instructional faculty or serving kids.”

Unions remain in favor of defined benefit pension plans, arguing that retired educators should not be held responsible for the states’ lack of payments. “It costs the government less and the taxpayers less when you have in place a solid pension plan that’s funded as it should be—modestly by employer and employee, and let the investment earnings take care of the vast majority of the funding,” says Carolyn York, director of collective bargaining and member advocacy at the National Education Association.

The following are two major retirement program issues that need to be resolved, according to the NCTQ report.

Vesting and Portability

Some states are addressing pension problems by increasing vesting periods, with 25 states now requiring teachers to stay in the state pension plan for at least five years before pension eligibility, and 15 states requiring teachers to stay 10 years. The average vesting period in 2009 was 5.7 years; in 2012, it rose to 6.5 years, the report states.

Pensions are not portable to other states before a teacher is vested. So if teachers spend eight years in a district that requires 10 years to vest, and then move out of state or leave the profession, they are typically entitled to only the money they contributed and not to guaranteed pension benefits.

Retirement Ages

Retirement age poses another fiscal problem, since people are living longer, and retirement eligibility ages and years of service generally haven’t changed. In 38 states, retirement eligibility is based on years of service rather than age, allowing many teachers to retire well before the traditional age of 65. “In most states, a teacher is more likely to get paid out of the system for more years than she put in,” Jacobs says.

For example, in Kentucky, a teacher can retire with 27 years of service (many states require 30  ears for full benefits) at age 49, the report found, and the amount of pension money the average teacher receives between ages 49 and 65 (during which, in another career, they would still be working) is almost $800,000 per teacher. The 10 states that no longer allow teachers to begin collecting their defined benefit pension before traditional retirement age now save an average of $450,000 per teacher, according to the NCTQ report.

Policy Recommendations

State leaders need to consider moving to other types of plans to keep the public pension system sustainable, Jacobs says, though they will likely meet resistance. For the most part, these types of systemic changes can only be implemented for new teachers, she adds, but states can offer them to all teachers, especially those early in their careers, even if they are not mandated to change.

Six states provide teachers with the choice to enroll in a defined benefit or defined contribution plan, (see map on p. 48.) And in those states, most teachers are sticking with the traditional defined benefit plan. For example, in Florida, about 80 percent opt for this plan, according to Scott Clark, risk and benefits offcer atMiami Dade Public Schools. However, new teachers are increasingly choosing defined contribution plans, to ensure portability and control where their contributions are invested. “There was a real push to get more people into the defined contribution method, and there very well may be bills filed for the 2013 legislative session to look at only offering defined contribution options for new employees,” he adds. “But it’s very controversial,” as it would require teachers to contribute more and select their own investments.

States should adopt a defined contribution plan, the report states, or one of many “hybrid” plan options, such as cash balance plans, in which teachers have individual retirement accounts similar to 401(k) plans funded by contributions from states or districts and teachers, but members are also guaranteed a minimum rate of return by the state rather than being subject to market fluctuations. These plans are portable, and will help prevent future liabilities and lower costs over time, the report states, as employers don’t have to pay for shortfalls.

“It’s not going to be pretty for anyone,” Urbanek from Illinois says of pension reform. “The potential exists for people to lose out, and that’s created a lot of angst. But what we’re seeing is that more and more people are recognizing that to keep us financially secure into the future, some changes will have to be made.”

Alison DeNisco is staff writer.