Pension Neutrality: Washington
Pensions Policy
Analysis of Washington's policies
Washington's defined benefit pension plan (Plan 2) and the defined benefit component of its hybrid plan (Plan 3) are based on benefit formulas that are not quite 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 within a defined benefit structure 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.
Although Washington's defined benefit plans are not quite neutral, the state's policies are better than what is offered in most states. Its pension plans utilize a constant benefit multiplier of 2 percent in Plan 2 and 1 percent in Plan 3, but the state's retirement eligibility timetable is not fair to all teachers. In Plan 2, all vested teachers may retire with unreduced benefits at age 65. Early retirement with reduced benefits, however, is only available to teachers with 20 or more years of service, and the reduction varies greatly with years of service because teachers with at least 30 years of service have much less, or no, reduction in benefits. Teachers with 20 to 29 years of service who retire at age 55 will receive only 37 percent of their unreduced benefits, while teachers with 30 or more years of service who retire at age 55 will receive 70 percent of their unreduced benefits, or 80 percent of their unreduced benefits with stricter return-to-work rules. Therefore, teachers with 29 years of service have their early retirement benefits reduced almost 50 percent more than teachers with 30 years of service. Reducing benefits for early retirement is a fair practice because early retirees will receive benefits for a longer period of time, but the drastic differences in reductions based on years of service are not fair to all teachers.
In Plan 3, teachers may retire with unreduced benefits at age 65 with 10 years of service, or at age 65 with only five years of service, if one of those years was earned after age 44. As in Plan 2, early retirement benefits are tied to years of service, except that in Plan 3, the minimum service needed for early retirement is 10 years. Teachers in Plan 3 with 10 to 29 years of service must follow the same severe reduction schedule as those in Plan 2 with 20 to 29 years of service, and teachers with 30 years of service must follow Plan 2's respective schedule. Teachers with 10 to 29 years of service who retire at age 55 will receive only 37 percent of their unreduced benefits, while teachers with 30 or more years of service who retire at age 55 will receive 70 percent of their unreduced benefits. Therefore, teachers with 29 years of service have their early retirement benefits reduced almost 50 percent more than teachers with 30 years of service. Again, while reducing early retirement benefits based on age is fair, the reductions based on years of service are not.
These provisions may 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.
Plan 3's defined contribution component is neutral because teachers' pension wealth increases in a uniform way.
Recommendations for Washington
End early retirement eligibility based on years of service.
Washington should change its practice of only allowing teachers with certain years of service to retire early with reduced benefits. If retirement at an earlier age with reduced benefits is offered, it should be offered to all teachers regardless of years of service.
Utilize an actuarially determined rate of reduction for early retirement benefits.
Washington's current method to reduce benefits for early retirees does not treat each year of work equally.
State response to our analysis
Washington recognized the factual accuracy of this analysis.
-
Washington
Select another topic
Delivering Well Prepared Teachers
- Admission into Teacher Preparation
- Elementary Teacher Preparation
- Elementary Teacher Preparation in Reading Instruction
- Elementary Teacher Preparation in Mathematics
- Early Childhood
- Middle School Teacher Preparation
- Secondary Teacher Preparation
- Secondary Teacher Preparation in Science and Social Studies
- Special Education Teacher Preparation
- Special Education Preparation in Reading
- Assessing Professional Knowledge
- Student Teaching
- Teacher Preparation Program Accountability
Expanding the Pool of Teachers
Identifying Effective Teachers
- State Data Systems
- Evaluation of Effectiveness
- Frequency of Evaluations
- Tenure
- Licensure Advancement
- Equitable Distribution
Retaining Effective Teachers
Exiting Ineffective Teachers
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.