Pension Neutrality: Wisconsin
Pensions Policy
Analysis of Wisconsin's policies
Wisconsin's pension system offers two ways to calculate benefits; a traditional formula system and a money purchase method. While the money purchase method is neutral, the traditional formula is not, 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.
When teachers in Wisconsin retire, their benefits are calculated using both the traditional formula and the money purchase method, and they are entitled to receive whichever value is higher. The value of the money purchase benefit is based on the balance of a member's WRS account, which includes their contributions and the employer's required matching contributions, plus investment earnings. This account is actuarially converted into a monthly benefit, or the money purchase benefit. The money purchase method is a neutral formula because each year of work accrues wealth in a uniform way.
Teachers' retirement wealth under the traditional formula 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 (despite a lower monthly annuity), 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.
Within its traditional formula, Wisconsin's pension plan is commended for utilizing a constant benefit multiplier of 1.6 percent. Teachers, however, may retire before standard retirement age based on years of service without a reduction in benefits. Those with 30 years of service may retire at age 57 while other vested teachers with less than 30 years of service may not retire with unreduced benefits until age 65. Therefore, teachers who begin their careers at age 27 can reach 30 years of service by age 57, entitling them to eight additional years of unreduced retirement benefits beyond what other teachers with fewer years of service would receive who may not retire until age 65. Also, all teachers may retire with reduced benefits at age 55, but the reductions vary by years of service. 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.
Although the same eligibility timetable is in use and allows teachers to retire early with unreduced benefits based on years of service, teachers' pension wealth does not decline after they reach eligibility because their pension wealth is tied directly to the balance of their personal accounts, rather than calculated by a traditional formula. Teachers must be 55 years old to calculate their benefits according to the money purchase method. Similar to a defined contribution plan, teachers' contributions fund their own individual accounts, and their contribution and the employer match remain constant for each year of service.
Recommendations for Wisconsin
End retirement eligibility based on years of service.
Wisconsin should change its practice of allowing teachers with 30 years of service to retire at age 57 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.
Wisconsin allows all teachers to retire before conventional retirement age, some as young as 57 without reduced 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
Wisconsin did not respond to repeated requests to review this analysis.
Updated: December 2017
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Research rationale
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.[2] 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. Although their yearly pension benefits would continue to rise as they earn additional service credit, it would only be at a small percentage per year, which would not make up for the loss of each year of benefits.
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.[3] These teachers are, in effect, earning their pension and salary at the same time, and often at a relatively young age.
A DROP program is a band-aid on the problem; it does not fix what is structurally wrong: retirement at an early age without reduction of benefits. For example, the hypothetical teacher above decides to forgo retiring at age 47 in order to wait and qualify for her state's DROP program at age 55. She now has 33 years of service and has reached a pension equal to 66 percent of her salary. She remains in DROP for the maximum allowable five years. During that time, her five years of lost pension benefits plus her five years of mandatory employee pension contribution have been deposited in a private investment account. Upon retiring at age 60, she would receive the total of that private account plus a lifetime pension benefit annually of 66 percent of her final salary. With the lump-sum payment of her DROP account and monthly pension benefit, she will receive 100 percent of her final average salary for at least 10 years, and, depending on the state, she may also receive Social Security benefits. This generous guaranteed payout would be hard to find in any other profession.
DROP programs do create an incentive for some teachers to remain past their eligible retirement age, but at a high cost. DROP programs mean that districts still must find the funds to pay pension benefits to teachers at a relatively young age when those dollars could be more effectively spent.[4]
[1] For an overview of the current state of teacher pensions, the various incentives they create, and suggested solutions, see: Costrell, R. M., & Podgursky, M. (2011, February). Reforming k-12 educator pensions: A labor market perspective. New York, NY: TIAA-CREF Institute. Retrieved from https://www.tiaainstitute.org/public/institute/research/briefs/institute_pb_reforming_K-12_educator_pensions.html
[2] For evidence that retirement incentives do have a statistically significant effect on retirement decisions, see: Furgeson, J., Strauss, R. P., & Vogt, W. B. (2005). The effects of defined benefit pension incentives and working conditions on teacher retirement decisions. Education Finance and Policy. Retrieved from http://www.andrew.cmu.edu/user/rs9f/aefa_journal_12_31_05.pdf
[3] For additional information on state pension systems, see: Loeb, S. & Miller, L. (2006). State teacher policies: What are they, what are their effects, and what are their implications for school finance? Stanford University: Institute for Research on Education Policy and Practice. Retrieved from http://web.stanford.edu/~sloeb/papers/Loeb_Miller.pdf; and Hansen, J. (2008, May). Teacher pensions: A background paper. Committee for Economic Development. Retrieved from http://eric.ed.gov/?id=ED502293
[4] For further evidence supporting NCTQ teacher pension standards, see: The Segal Group, Inc. (2010). Public employees' retirement system of the state of Nevada: Analysis and comparison of defined benefit and defined contribution retirement plans. Retrieved from https://www.nvpers.org/public/executiveOfficer/2010-DB-DC%20Study%20By%20Segal.pdf