Author: Leslie Kan

This post was originally published at TeacherPensions.org

By Leslie Kan

The Louisiana Legislature last year agreed to a 1.5 percent cost-of-living adjustment (COLA), meaning that retirees will see a small boost in their pension payments.* In Louisiana, like most other states, cost-of-living adjustments are a way for state pension plans to offer retiree benefits that are adjusted for inflation and are usually determined by the state legislature. Louisiana previously linked their pension plan’s COLAs to just changes in the Consumer Price Index (CPI), but now also tie COLAs to investment gains so the amount they adjust for is subject to change according to the plan’s funding levels. COLAs, like pension benefits themselves, are entangled in the political process, and so retirees must rely on the legislature to get their benefits.

While the formulas used to determine public sector pensions have ironclad legal protections—protecting past and sometimes even future benefit accruals—COLAs face less scrutiny. The Center for Retirement Research reports that 17 states reduced, suspended, or eliminated their COLAs from 2010 to 2014. While most of the cuts were challenged, the courts upheld 10 of the 12 cuts (except in Illinois and New Jersey, where the case is still pending in a lower court but a COLA freeze remains).

But compared to the uncertainty around public pension COLAs, Social Security benefits automatically adjust for inflation. While debates rage on what measure of the CPI to use, the fact is that Social Security benefits are automatically adjusted each year. Unlike in state pension plans, workers don’t need to worry about the value of their Social Security benefits eroding over time. Today, six teacher pension plans offer COLAs less than the change in CPI (when it’s positive) or have eliminated COLAs altogether. Another 12 teacher pension plans are left to the ad hoc decision-making of their state legislatures or are based on investment returns.

This is bad news for public workers who don’t participate in Social Security. Teachers in Louisiana may get a temporary win with their new COLA, but overall, they lose out because Louisiana teachers and other public sector workers aren’t covered by Social Security. Instead, they’ll have to hope that investment gains improve in order to see any further increases. Similarly, states with ad hoc increases will have to depend upon their legislatures to approve adequate adjustments from year to year. States without coverage historically banked on their pension systems to Social Security, but that wager carries more risk.

*Update: Governor Bobby Jindal vetoed the COLA bill, so Louisiana’s retirees will not receive an increase to their pensions.  Instead, the 1.5 boost will go into effect next year, unless other legislative changes are made and/or funding levels and investment gains change.  

In terms of retirement benefits, now is the worst time in at least three decades to become a teacher. After years of expansion, a number of states enacted legislation cutting benefits for workers in response to financial pressures. The cuts fall hardest on new and future teachers, particularly for teachers hired after the recession who do not plan to teach in the same state for 30 or more years.

This brief uses a unique historical data set to analyze how states changed teacher retirement benefits from 1982 to 2012. Specifically, states use various pension variables to boost teacher benefits during good times or cut them during harder times. While benefit increases tend to apply to all workers, benefit decreases typically only affect new workers. As a result, two teachers with the same career length would experience significant differences in benefits simply based upon when they were hired.

Moreover, pension benefits are already inherently unequal for teachers with varying career lengths. Shifting the benefit parameters to create lower benefits for new workers only magnifies these structural inequities. The following report analyzes the changes states have made over time, and how those changes impact the retirement security for our nation’s public school teachers.

To avoid further cuts that harm the teaching profession, states must fully fund the promises they’ve already made, while also balancing the needs of the present and future teaching workforce and providing sustainable benefits for all teachers.

After spotting a deal that looked too good to pass up, you discover a flaw and end up returning and getting a refund on your purchase. It may sound shocking and counter-intuitive, but in many cases, teachers may actually be in a similar situation with their pension plans. They might be better off taking a refund on their contributions rather than waiting around to receive a pension.

How is this possible? Teachers qualify for very little in the way of retirement benefits during the first half of their career because pension benefits don’t accrue evenly. A mid-career teacher therefore is faced with a choice: she qualifies for some pension and can receive lifelong payments upon retirement, or she can forfeit her rights and get a refund on her contributions.

New research from the Urban Institute compares the value of a teacher’s contributions to a teacher’s overall pension wealth. Using the pension plan’s own interest assumptions (often 8 percent), in half of states teachers need to stay in a single system for at least 24 years to simply break even on their contributions plus interest. Even using a more conservative 5 percent interest rate, a teacher would need to stay for at least 15 years in order to break even in the median state. This means that an individual teacher could work for over a decade, diligently contributing to the system, and qualify for a pension that’s worth less than the value of her own contributions plus interest. She may actually lose money to the state pension system.

The graph below shows the differences in the value of a newly hired, 25-year-old California teacher’s lifetime pension benefits, her contributions using the plan’s interest assumptions (7.5 percent interest), and her contributions if the teacher requested a refund. Although California assumes it can earn 7.5 percent interest every year on the plan’s assets, the state plan only gives teachers 4.5 percent interest on refunded contributions. For a new California teacher, even the limited refund policy would be worth more than her actual lifetime pension benefits for the first 22 years of her career. She would be better off getting a refund and giving up the pension if she teaches for anything less than 22 years.

Refunding and rolling over her contributions to a tax-sheltered savings vehicle would actually allow that teacher to grow and invest her contributions, rather than giving it up to the state and waiting the years before she can actually collect a retirement pension, whereupon its value has eroded over time. Most state pension formulas, including California’s, don’t adjust salary figures for inflation when calculating benefits. A teacher, of course, has to weigh the risks and her own savings habits; if she is prone to high spending or making risky purchases where she burns through all her contribution money rather than saving, otherwise known as “leakage,” then keeping it locked away with the state in exchange for a small pension down the road may be a better decision.

On the surface, a lifelong annuity sounds like a great deal. In California, the plan assumes that less than a quarter of teachers with 15 years of experience will take a refund. In other words, the plan assumes that most teachers who qualify for a pension usually take it. But not all pensions are equal, and for many teachers, pensions likely carry a flaw that demands a refund. The reality is that pensions vary vastly depending on how many years of service a teacher has and when she can actually retire and collect. Just because a teacher has the option to get a pension at some point down the road doesn’t necessarily mean she should take it.

*This is post is based on research on California’s teacher retirement plan. It is not personal or institutional investment advice. Please consult a qualified financial professional before making consequential financial decisions.

Photo by cybrarian77 via Flickr CC License