Pension Neutrality: South Dakota

Analysis of South Dakota's policies

South Dakota'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). 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.

South Dakota's pension plan is commended for utilizing a constant benefit multiplier of 1.7 percent for years of service earned prior to 2008 and 1.55 percent for years after. Teachers may also calculate their benefit with a 2.25 percent multiplier and then subtract 80 percent of their total benefit. Teachers are entitled to whichever calculation is greater. While the multiplier changes, it is not advantageous or disadvantageous to anyone, as it is not dependent on a teacher's total number of years of service; however, teachers may retire before standard retirement age based on years of service without a reduction in benefits. Teachers may retire according to the "Rule of 85," meaning that age plus years of service equal 85, once they reach the age of 55, while other vested teachers may not retire with unreduced benefits until age 65.

Therefore, teachers who begin their careers at age 24 can reach the "Rule of 85" with 31 years of service by age 55, entitling them to 10 additional years of unreduced retirement benefits beyond what other teachers would receive who may not retire until age 65. Not only are teachers being paid benefits by the state well before Social Security's retirement age, but these provisions may also encourage effective teachers to retire earlier than they may otherwise, and they fail to treat equally those teachers who enter the system at a later age and give the same amount of service.

Citation

South Dakota Retirement System, Income for Your Retirement, Class A http://www.sdrs.sd.gov/publications/documents/ClassA2010_000.pdf

Recommendations for South Dakota

End retirement eligibility based on years of service.
South Dakota should change its practice of allowing teachers whose age and years of service equal 85 to retire at age 55 with full 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.

Align eligibility for retirement with unreduced benefits with Social Security retirement age.
South Dakota allows all teachers to retire before conventional retirement age, some as young as 55. 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 Goal 4-H).

State response to our analysis

South Dakota recognized the factual accuracy of this analysis. The state further noted that it does not necessarily concur with the recommendations.