Are California Teachers Better off with a Pension or a 401(k)?
- Many Teacher Pension Plans Get Failing Grade: New Report
August 31, 2021 - Money
- If someone tells you your kid’s teacher would be better off with a 401(k) than a pension, don’t believe it
July 18, 2017 - Commentary by Nari Rhee in Los Angeles Times
RELATED BLOG POST: Most California Teachers Working Today Are Here for the Long Haul — and Better Off with a DB Pension
Pensions form a significant part of public school teacher compensation, and provide the primary source of retirement security for teachers, many of whom are not included in Social Security. While most private sector employers have shifted the retirement benefit costs and risks to employees by switching to 401(k) style plans, most public school teachers are still covered by defined benefit pensions that provide guaranteed retirement income and reward long service. While 401(k) plans have the advantage of portability for a mobile workforce, defined benefit pensions provide greater retirement income security and reduce turnover. Given the role of retirement benefits in meeting both employer goals for workforce retention and employee goals for retirement income security, this study examines the suitability of defined benefit pensions for California teachers compared to alternative retirement benefits.
Recent studies have questioned the adequacy and fairness of defined benefit pensions—including the pension provided by the California State Teachers’ Retirement System (CalSTRS)—based on the fact that a large percentage of new-hire teachers drop out early, and thus do not stay long enough to collect full pension benefits (Johnson and Southgate 2015; McGee and Winters 2013). These studies conclude that an account-based system would be fairer, whether that be a defined contribution plan such as a 401(k) or a cash balance plan. However, while early career turnover is a serious concern with respect to lost investment in training, analyses based primarily on new-hire attrition rates ignore the fact that most classroom teaching positions are not occupied by those who leave after a few years, but by those who stay long term.
This study compares CalSTRS pension benefits for California public school teachers to alternative retirement benefits, focusing on the currently active teaching workforce. We first analyze teacher turnover patterns and project the final tenure—years of service at retirement or separation—for the current teaching workforce using CalSTRS’ actuarial assumptions. We then model benefits under alternative plan designs—an idealized 401(k) plan and a generous cash balance plan that guarantees 7% interest on contributions—and compare them to the current CalSTRS pension for teachers hired since 2013. Finally, we analyze benefit outcomes for the three plans in the context of our tenure analysis findings in order to estimate the share of active teachers who are better off in the current defined benefit plan versus alternative retirement plans, and vice versa.
Overall, the CalSTRS pension benefit structure—which is designed to reward teachers who stay until at least early retirement age—is better matched to the needs of the active teaching workforce than 401(k) or cash balance plans. Although early career turnover is high, most of the teachers that a student will have during their K–12 education journey in California will have served 20 to 30 years or more before they leave public education in the state. Thus, the vast majority of the educators currently serving in California public schools can expect to collect pension benefits under CalSTRS that are superior in value and security to what they could receive under an ideal 401(k)-style plan. The CalSTRS pension system also offers significantly higher benefits compared to a generously modeled cash balance plan for a large majority of active teachers. Ultimately, switching to an account-based retirement system—such as a 401(k) or cash balance plan—would sharply reduce the retirement income security of teachers who account for a large majority of educational labor in California.
KEY FINDINGS ARE AS FOLLOWS:
1.Most classroom teaching in California is performed by long-career teachers who are well-positioned to benefit from a traditional pension.
- The typical teacher in the classroom today can expect to leave at age 61, and half of teachers (49%) will retire with 30 or more years of service.
- Three-quarters of classroom teaching is performed by teachers who will have been covered by CalSTRS for at least 20 years by the time they depart.
- The typical new hire in California schools is significantly older than the 25-year-old illustrated in recent studies. The current median age for new hires is 29, and the mean is 33.
2. For the vast majority of California teachers (six out of seven), the CalSTRS defined benefit pension provides greater, more secure retirement income compared to a 401(k)-style plan.
- The CalSTRS defined benefit pension becomes more valuable than an idealized 401(k) at age 51 for vested teachers hired before age 35, and earlier for those hired at older ages. The vast majority of active teachers (86%) in the state will stay in California schools until at least age 51.
- Our model assumes that everyone receives the reduced benefit formula implemented for new hires since 2012—2% of final average salary replaced at age 62. This is a conservative assumption because in reality, most current teachers fall under the older, more generous pension formula—2% at age 60.
- In addition, four out of five active teachers (79%) will stay until at least age 56, when the CalSTRS pension exceeds the value of a generously structured cash balance plan.
3. Conversely, only one out of seven teachers currently teaching in California schools will accrue less benefit under the CalSTRS defined benefit plan than they would if contributions were deposited into a defined contribution, 401(k)-type plan—assuming average investment returns.
- Only 14% of active teachers will receive less benefit from the CalSTRS defined benefit plan than a hypothetical defined contribution plan. This includes 6% comprised by recent hires who will leave before vesting, i.e., with less than five years of service, and 8% comprised by teachers who will vest, but leave before age 51, when the defined benefit benefit starts to exceed the defined contribution benefit for younger hires.
- Another 7% will vest, but leave between ages 52 and 56, when the defined benefit pension becomes more valuable than a hypothetical cash balance plan with generous benefits. Thus only one out of five active teachers (21%) would accrue higher benefits under a generous cash balance plan compared to the CalSTRS pension.
- The biggest reason why the CalSTRS pension provides a lower benefit than the idealized defined contribution plan for the 8% of teachers who vest but leave before age 51 is that the final salary used to calculate benefits loses value over time if the separation date occurs before retirement age. Indexing the final average salary to inflation during this period would mitigate this loss, but require a slightly higher contribution rate.
4. Focusing on new-hire attrition rates is misleading.
- While 40% of new hires leave before vesting, these leavers represent just 6% of teaching positions. The vast majority of public school teaching in California is performed by educators who have remained, or will remain, beyond the initial highattrition years and are very likely to stay long term.
- While some active teachers who terminate prior to retirement eligibility may receive higher benefits under an idealized account-based retirement plan, this advantage is dwarfed by the larger benefits that the vast majority of active teachers will receive under the DB plan compared to alternative plans.
- From a public education policy perspective, it makes little sense to restructure retirement benefits to advantage those who leave, in a manner that dramatically reduces benefits for those who conduct the vast majority of teaching work.
5. 401(k) and cash balance plans generate their own risks and inequalities in retirement income, decreasing the incentive for early and mid-career teachers to stay, and making it harder for older teachers to retire.
- Account-based retirement plans reward those who leave early with proportionally greater retirement benefit than those who stay. For instance, contributions for a 25-year-old yields lifetime retirement income worth more than 3% of that year’s pay in inflation-adjusted terms, compared to less than 1% for someone on the cusp of retirement.
- 401(k) plans create stark, arbitrary inequalities between retirement cohorts because retirement income varies wildly with financial market conditions. Roughly half of teachers will either have income that exceeds the expected benefit by one-third or more, or have income that falls short by one-third or more.
- Given the lack of deferred compensation in defined contribution and cash balance plans, and the lower benefits compared to defined benefit pension for those who stay until retirement age, account-based retirement benefits would increase the incentive for early and mid-career teachers to leave, and also decrease the ability of older teachers to retire.