When More Years Working Means Fewer Retirement Dollars: Time to Do Away with the 'Magic Year'
In this Wednesday, Oct. 26, 2011 photo, Police officers, teachers, caregivers and other rank-and-file public servants join Illinois AFL-CIO members to protest the state's pension situation and Illinois Gov. Pat Quinn's opposition to arbitrators ruling on AFSCME pay raises and closing facilities, at the Illinois State Capitol in Springfield, Ill.(AP Photo/Seth Perlman)
The longer you work at a company, the more you would expect to be paid in retirement, right? But that’s not the case for teachers. For teachers and many other government workers, too many years working might actually mean a lot less money later.
Advocates for traditional pensions often cite the “3 Rs” of teacher pension plans: recruitment, retention, and retirement. Under this argument, pensions offer secure and attractive benefits that not only recruit talent, but retain them for a career until retirement.
Most late-career teachers know they have a “magic year” they need to reach in order to receive optimal retirement benefits. In the magic year, a teacher reaches peak lifetime retirement benefits. This usually happens between ages 55 to 60, or after 30 plus years in the classroom, depending on the plan and when the teacher began teaching. Many states have specials rules to figure out when to retire.
But once teachers hit that special year, they know they need to get out. Otherwise, every year they don’t is a year they give up in retirement benefits. Even though staying beyond the set retirement year oftentimes means a bigger retirement check, because pensions are guaranteed over a lifetime, working when you could be retired means less checks to collect over a lifetime. And so working longer than needed still means giving up a substantial amount of money.
If you’re confused by these backward incentives, you’re right: this makes no sense. Unlike most other retirement savings plans, pension benefits are not directly tied to an employee’s contributions, or for that matter, the employer contribution. Instead, traditional pensions are based on formulas and eligibility rules that unevenly ramp up benefits at the end of a teacher’s career, only to suddenly drop off after peaking.
In Illinois, a teacher hired at age 25 with 35 years of service gives up $49,000 if she works an additional five years according to a recent Urban Institute report. Benefits quickly accrue and reach a peak when an Illinois teacher reaches 35 years of service. But once she reaches this peak, her overall lifetime benefits go downwards for every year that she stays in the classroom.
Lifetime Pension Benefits for an Illinois Teacher
Source: Richard W. Johnson, "Reforming Government Pensions to Better Distribute Benefits: What Are the Options?", Urban Institute, December 2014. Graph for an Illinois public school teacher hired before 2011 at age 25.
The origins behind setting this pension “sweet spot” at the 30 or 35 year mark comes, in part, from a history of mandatory retirement. In many states, mandatory retirement was normal practice for making sure that older teachers -- seen as feeble and no longer effective workers—were no longer in the workforce. Other reasons, similarly blunt, were economic. In the 1970s, France and Germany set incentives for early retirement as a way to create more jobs for younger workers. The logic at the time was that removing older workers from the labor force meant more available jobs for younger workers.
But this has become antiquated: Economies aren’t fixed, and this theory has been empirically debunked in recent studies in Europe and the U.S. More older workers in the labor force doesn’t push out jobs for younger workers. But despite growing life expectancies, many public sector plans continue to set retirement at relatively the same ages as in the past.
Rather than discouraging work at older ages, states could enact policies that encourage workers to continue working for longer. Social Security sets a normal retirement age but also uses financial incentives to induce workers to stay longer. Other types of retirement plans, such as cash balance plans, accrue benefits evenly and are directly tied to employee contributions, allowing workers who wish to stay beyond retirement to continue increasing benefits without penalty.
An effective teacher who reaches her “magic year” of retirement doesn’t suddenly become ineffective upon reaching that year. Teachers who perform well and want to teach beyond the prescribed plan retirement age shouldn’t be punished. The teaching workforce could greatly benefit from the insights of veteran teachers, or second-career teachers who switched to teaching at relatively older ages.
And given poor savings habits, most Americans will need to work for longer. Switching to an alternative plan, like a cash balance, would allow individuals to continue accruing benefits for however long they decide to work for, no matter their age.