Blog: Alternative Models

The research field of teacher pensions has been a relative backwater, but lately it just keeps getting more interesting. Yesterday, the Fordham Institute released a new paper from Marty West and Matt Chingos analyzing a 2002 policy change in Florida which allowed teachers to choose between a traditional defined benefit pension plan and a 401k-style defined contribution plan. The authors were able to track who chose which plan, what subject they taught, how effective they were in the classroom, how long they remained teaching, and whether the pension plan’s structure had any effect on retention.

Perhaps not surprisingly, they found that math and science teachers, teachers with advanced degrees, and charter school teachers were all more likely to opt for the portable defined contribution plan. These teachers may enter the profession not planning to stay for long or, in the case of charters, may anticipate switching to another school that’s not enrolled in the Florida defined benefit system (Florida charters have a choice on whether to participate or not).

Important, they did not find any differences in effectiveness between those who chose the defined benefit plan and those who chose the defined contribution plan, but they did find differences in attrition rates. Teachers who opted into the defined contribution plan were one percentage point more likely to leave before their second year and nine percentage points more likely to leave after their fifth year. This will give fodder to the crowd that claims that defined benefit plans do a better job of retaining employees than 401k-style defined contribution plans and support those seeking to preserve the status quo in most other states.

But wait, there’s more to this story. If you care at all about the thousands of teachers who will one day become ex-teachers, this paper puts numbers on just how many there are and how much money they’re losing. In the seven years of the study, Florida districts hired 92,000 first-time teachers. The authors found that roughly 40 percent of these beginning teachers stay less than six years, the amount of time Florida required a teacher to be employed before becoming eligible for pension benefits. By not meeting the vesting requirement, the authors estimate each of those ex-teachers will lose out on retirement savings of up to $27,784 in today’s dollars.

It was outside the scope of the study, but Florida recently lengthened the vesting period from six to eight years, meaning even more teachers are likely to become ex-teachers before qualifying for pension benefits, leaving even more money on the table. (See how Florida’s vesting requirements compare to other states here.)

Articles on retirement security, like this one from the NY Times, are good to read and know about. The short version is that few of us are saving enough for retirement, so we’re going to see more “retired” people working part-time, retiring later, or, worst case scenario, looking for a government fix. The situation is even worse for younger Americans.

One thing that’s particularly relevant for this blog is that defined benefit pension plans are more or less a thing of the past for most workers, and in the next five or ten years we’re going to have a whole class of workers becoming eligible for retirement age who’ve never had a DB plan in their entire working career.

To see why this matters, check out the chart below from a recent McKinsey report.  It’s divided by age and income, and it shows how much, or how little, workers have saved for retirement and what form that savings takes. At the bottom right-hand side are workers aged 60-65 who earn $20-50,000 a year. Sixty percent of their retirement income will come from Social Security, 22 percent will come from a defined benefit pension plan, only 1 percent will come from personal savings, and they’re facing a 17 percent shortfall between what they have saved and what they’re likely to need. Looking at the next youngest age bracket, workers aged 40-59 earning the same amount, they can expect 48 percent from Social Security, only 4 percent from a DB plan, an 6 percent from personal savings (including 401k plans and IRAs). They face a 42 percent shortfall.

These figures would be improved, although not erased, through a stock market boom. The awful truth is that Americans just aren’t saving enough for retirement.

In the midst of an excellent piece arguing unions aren’t winning negotiations on salaries–they’re winning negotiations on everything else–David Leonhardt makes a really important point:

Unfortunately, though, politicians do not have the same incentives to be tough negotiators on issues besides money. Why not? Because most government agencies are monopolies. They face no competition. Whether they perform beautifully or miserably, they cannot be run out of business. They also can’t be run out of business by pushing off costs until a future day. So they delay too many costs and don’t perform their jobs well enough.

The delaying of costs is obvious. Both politicians and union leaders have decided that generous future benefits offer the easiest way to hold down spending and still satisfy workers. The result is government pay that’s skewed too heavily toward pensions and health insurance.

Study after study has found that public-sector workers have traded lower salaries for better benefits, but there’s no particular reason that trend must continue. A smart governor would approach the public-sector unions in her state and ask to trade some of the expensive, unpredictable health care costs and back-loaded pension benefits for higher salaries**. This could even be a revenue-neutral trade that manages to make both sides better off.  The governor would be getting greater predictability in her budget, while union leaders would put more cash in the pockets of their members. A smart union leader would take the deal, because people tend to value cash more than they do in-kind contributions, so union members may even feel like they’re better off. Perhaps most importantly, it would help put public-sector worker compensation more in line with that of private employees.

**In many states, it’ll illegal to reduce the accrued retirement benefits of workers, but the courts have found such reductions acceptable if they’re accompanied by increases in compensation. 

This blog entry first appeared on The Quick and the Ed.

The Wall Street Journal featured a very good article this weekend on how poorly the 401k is functioning as the primary retirement savings account for millions of Americans. Launched in the 1980s to allow management-level employees to put away more money for their retirements, companies embraced 401ks as alternatives to costly defined benefit pension plans. The first group of workers relying solely on 401ks for their retirement are just now approaching retirement age, and the numbers do not look good:

Consider households headed by people aged 60 to 62, nearing retirement, with a 401(k)-type account at their jobs.

Such households had a median income of $87,700 in 2009, according to data from the Center for Retirement Research at Boston College, which derived this and other numbers by updating Fed survey data, at The Journal’s request. The 85% needed for retirement would be $74,545 a year.

Experts estimate Social Security will provide as much as 40% of pre-retirement income, or $35,080 a year for that median family. That leaves $39,465 needed from other sources. Most 401(k) accounts don’t come close to making up that gap.

The median 401(k) plan held $149,400, including plans from previous jobs, according to the Center for Retirement Research. To figure the annual income from that, analysts typically look at what the family would get from a fixed annuity.

That $149,400 would generate just $9,073 a year for a couple, according to New York Life Insurance Co., the leading provider of such annuities— less than one-quarter of the $39,465 needed.

Just 8% of households approaching retirement have the $636,673 or more in their 401(k)s that would be needed to generate $39,465 a year.

In other words, the vast majority of workers are going to be working more years, trying to find part-time jobs, and relying more heavily on their Social Security benefits. This is important context for the debate over public-worker retirement benefits, and it should be a cautionary tale to anyone who thinks 401k-style investment plans are the solution to our country’s impending retirement crisis.

This blog entry first appeared on The Quick and the Ed.

Ezra Klein has a good post laying out some of the issues around public-sector workers and their retirement benefits, but I want to amplify two of his points. The first is around some of the overblown rhetoric going around right now (epitomized by this David Brooks column that was Klein’s inspiration in the first place) suggesting that public-sector defined benefit pension plans are causing massive holes in state budgets. In our report on teacher pensions, we write:

A historical context is also useful. While the current funding ratios are less than ideal, they are not catastrophic. The most recent figures from the Public Fund Survey, a compilation of 101 state and municipal retirement plans, show that the aggregate funding ratio for these plans reached a high of 102 in 2001 at the end of the Internet-led bull market.Through a combination of poor investment returns and benefit enhancements, the ratio had fallen to 85 by July 2008, about where it was in 1994.

In other words, after the longest bull market in history followed by one of the worst decades for investment returns on record, we’re in roughly the same position we started in.  That doesn’t mean the financial problems with teacher pension plans are insignificant–and the political incentives to raise benefits during boom times skews things here–but it is useful to view them in an historical context (I might argue some of the non-financial problems are actually more important).

The second point worthy of amplification is when Klein writes:

And while states are facing serious pension problems because they still offer defined-benefit pensions, we’re also going to see the retirement of millions of private-sector workers who don’t have defined-benefit pensions, and either haven’t contributed enough to their 401(k)s or saw their wealth wiped out in the recent turmoil. We’re facing a pension crisis in the public sector, but we’re also looking at a retirement crisis in the private sector.

This is spot-on. As we get closer to the mass retirements of workers who’ve never had a defined benefit pension plan, something that will be upon us in the coming decades, we really have no idea what to expect. Preliminary research suggests it’ll be downright ugly: