Reforming K-12 Educator Pensions: A Labor Market Perspective

February 2011

Retirement benefits represent a large and growing share of educator compensation. An important question is whether the current retirement benefit systems are an efficient or equitable way to structure educator compensation. An examination of the incentives built into typical state defined benefit plans suggests otherwise. Benefits are highly back-loaded, producing large peaks in pension wealth accrual followed by valleys of negative accrual. These have the effect of retaining teachers to a certain point (“pull”) and then pushing them into retirement beyond that point, a set of incentives that may be perverse, if teachers would otherwise optimally sort themselves into shorter or longer careers. The current systems offer little or nothing to those young teachers with a short tenure horizon, and also impose very large penalties for mobile educators, with no obvious efficiency rationale. The mobility penalties are likely to particularly distort the applicant pool for school administrators. This array of issues for current educator DB plans suggests that plans with more uniform lifecycle accrual and mobile benefits would likely provide a better fit for educator labor markets. The current crisis that many states face with public education pension funding provides an opportunity to reform retirement benefits along these lines. Unfortunately, thus far states are modifying existing systems (e.g. raising the retirement age for new hires), rather than reforming their basic structure. These reforms may improve actuarial balance but do little to improve incentives or equity and can, in some respects, make matters worse. It is theoretically possible to structure pension reforms in a way that manipulates conventional formulas to yield smooth accrual of benefits over an educator’s working career. However, it is much simpler and more transparent to do so directly, by tying benefits more closely to contributions, as in a cash balance plan or hybrid retirement plan. Equally important, codifying the principle of tying benefits to contributions would do much to prevent future funding crises arising from arbitrary enhancements of idiosyncratic pension rules.