Pension Neutrality: Massachusetts
Pensions Policy
Analysis of Massachusetts's policies
Massachusetts's pension system is based on a benefit formula that is not 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 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.
Massachusetts's pension plan does not utilize a constant benefit multiplier and bases retirement eligibility on years of service. Teachers with 10 years of service qualify for standard retirement at age 60. The multiplier is 2.5 percent for those who retire at age 67, and then it is reduced one-fifteenth of a percentage point for each year below 67 (e.g., 1.45 percent multiplier at age 60, 1.60 percent at age 61, and so on) if creditable service is less than 30 years. It is reduced 0.125 percentage points per year for teachers with 30 or more years of service (e.g. 1.625 percent multiplier at age 60, 1.750 percent at age 61, and so on). Reducing benefits for younger retirees is appropriate because they will on average receive benefits longer, but the state should use an actuarial reduction instead because, depending on a teacher's years of service, a fixed percent reduction in the multiplier may only have a minimal impact on benefits.
Teachers who establish membership after April 1, 2012 automatically participate in the RetirementPlus formula. Under RetirementPlus, teachers who reach 30 years of creditable service receive an additional 14 percent of final average salary plus an additional 2 percent for each year thereafter, not to exceed the maximum benefit amount of 80 percent of final average salary. Therefore, teachers who begin their careers at age 22 can reach their maximum pension benefit by age 57 with 35 years of experience.
The net effect of RetirementPlus is that teachers who retire with 29 years of service at age 60 will have benefits equivalent to 42.05 percent of their final average salaries, while teachers who retire with 30 years of service at age 60 will have benefits equivalent to 62.75 percent, a substantial increase for one additional year of service. Some of these provisions may encourage effective teachers to retire early, and they fail to treat equally those teachers who enter the system at a later age and give the same amount of service.
Recommendations for Massachusetts
Utilize a constant benefit multiplier to calculate retirement benefits for all teachers, regardless of years of service.
Each year of service should accrue equal pension wealth. Massachusetts should end its substantial increase in benefits for teachers with at least 30 years of service, and the state should use a pension formula that treats each year of service equally.
End retirement eligibility based on years of service.
Massachusetts should change its practice of allowing teachers with 20 years of service to retire at any age with standard benefits. If retirement at an earlier age is offered to some teachers, benefits should be reduced accordingly to compensate for the longer duration they will be awarded. The state's current policy of reducing the multiplier for each year a teacher retires before age 60 does not achieve this purpose because the reduction is a standard one-tenth rather than an actuarially determined amount.
Align eligibility for retirement with unreduced benefits with Social Security retirement age.
Massachusetts allows all teachers to retire before conventional retirement age, some as young as 57 with maximum benefits. As life expectancies continue to increase, teachers may draw out of the system for many more years than they contributed. This is not compatible with a financially sustainable system (see pension sustainability goal).
State response to our analysis
Massachusetts did not respond to repeated requests to review this analysis.
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Pensions
Research rationale
In addition to the ways defined benefit pension systems disadvantage teachers described in Goal 4-G, the way pension wealth accumulates in some systems further compounds the inequity. All 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.
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.
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.