Pensions: They Ain’t What They Used To Be

coins-1523383_1920This is the latest part of a series by Ryan Frailich discussing financial planning for teachers. For more from Ryan, you can sign up for his monthly newsletter here

For the majority of young teachers today, the chances of retiring and earning a secure payday from their pension is slim to none. Most state pension systems are severely underfunded, meaning that they are projected to be unable to pay out what’s been promised.

Even if current promises are kept, the benefits paid out from teacher pensions are often less than the amounts contributed since the current contributions are going to fund people already in retirement. Bellwether Education suggests that over half of teachers entering the workforce today won’t qualify for retirement benefits in their state. If you are someone who isn’t absolutely certain that you’ll work 20-30 years as a teacher in the same state, you’re likely on the wrong side of this equation. Add it all up, and it means that most teachers should be making plans for retirement that don’t rely solely on a teacher pension.

How Does a Pension Work?

Pensions are a defined benefit plan. This means that if you meet certain specific terms, you’ll have a very clearly defined benefit. A fixed percentage of your paycheck goes to the fund, and your employer has to contribute a fixed percentage as well. In Louisiana, teachers are currently contributing 8% while employers (school districts) are contributing 25.5% of each teacher salary to the fund. The idea is that between current contributions from teachers and from school districts, and investment earnings on those contributions, the fund will pay out a set amount per person, provided that that person works for a certain number of years.  

For example, let’s look at Louisiana’s formula for teachers who started after July 1999 but before January 2011:

Years of Service x Final Average Compensation (FAC) x 2.5% benefit factor

*Final Average Compensation is the average of your 3 highest earning years in the system.

Example:

Andrew has worked as a teacher in Louisiana for 30 years. At peak earning, he earned an average of $57,000 annually.  

30 x 57,000 x 2.5% = $42,750  

This means Andrew would receive this amount (adjusted annually for inflation) for the rest of his life. Lucky him!  This sounds great, but there are many questions accompanying the likelihood of a pension like Andrew’s. What about someone who works somewhere for a few years and then moves to a new state? What about parents who quit teaching to care for their own children, and then don’t come back into the same system? Or teachers who leave the traditional public system to teach at schools – charter or private – that don’t feed into the same pension system?

Is A Pension for You?

A study by the Urban Institute graded the state of Louisiana an F for Rewarding Younger Workers & Promoting a Dynamic Workforce. This is because they found that it would take a worker 10 years of work before they break even on their pension in Louisiana – or 10 years to get back the money that they themselves contributed. This means that anyone who leaves the profession prior to 10 years would not recover their contributions to the pension system. This is a common dynamic among state pension funds, where the benefits for workers who put in 30+ years are great, but that benefit is at the hands of all the people who contribute more than they actually get back out. In fact, the average annual benefit for a retired teacher in Louisiana is much lower than Andrew’s – only $23,828. (For information about your state, see here.)

To add another layer, 15 states prohibit teachers who participate in the state pension system from paying social security taxes; 40% of teachers nationwide aren’t covered by social security. If you’re a teacher who works 15 years in one state, then moves and spends another 15 years teaching in the new state, it’s possible you won’t qualify for a full pension in either state, and you may also have dramatically lower (or no) social security earnings. To learn more about this, Dave Grant over at Finance for Teachers has a great piece explaining the interplay between social security and a teacher pension. You can also start by getting your own social security statement from the Social Security Administration, so you know where you stand today.

All this is to say: if you worked somewhere for a few years and paid into a pension, you should claim what’s yours. In most states, you can claim a refund for the amount you personally contributed, but you won’t get the amount contributed by the district on your behalf. In Louisiana, teachers pay 8% of their paycheck to the fund, so that’s what they would be able to get back. The simplest thing to do would be to roll it to an IRA, which you’ll maintain control of. You still have decisions to make on the type of investments within the IRA, but that’s a whole other topic.

On the other hand, if you can say with near-certainty that you’re going to remain in your current state and in a teaching role for your entire career, a pension can be a great tool in your plans. A pension won’t cover your entire retirement income, so I’d still strongly recommend saving into another retirement vehicle, such as an IRA, 403b, or 457 plan, depending on what you’re eligible for. I’ll write more on these options and what may make sense for you in two weeks.  

I want to be clear as day that I’m not saying teachers don’t deserve better than this. They do, and it’s in no way the fault of teachers that this system is where it is. It’s the fault of short-sighted politicians, unreasonable projections for investment earnings, and the challenge of “guaranteeing” anything when there are so many variables.  But we are where we are, and I want to make sure that you’re able to make decisions with your eyes wide open. What are you going to do to make sure your own financial future is planned for?

*For this post, I relied heavily on the research at www.teacherpensions.org, which is a great resource to dive into these issues.

(c) Ryan Frailich

Ryan Frailich is the founder of Deliberate Finances, a registered investment adviser in the state of Louisiana.  Information presented is for educational purposes only and should not be relied on for investment or other financial decisions.  Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. 

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