Value of Teacher Benefits Part 4B – Retirement Plans

Retirement plans are an important part of total compensation for UCF teachers.  In today’s post we will look at the pension benefit teachers can earn during the career.  For certain teachers, it can be a huge wealth creator.  

Retirement Plan Divorce

In today’s post, we will look at the incentives PSERS creates for teachers.    For long-service teachers, PSERS can be a major wealth creator and an important element of retirement planning.  For short-term teachers and those who move to other states prior to vesting, PSERS provides much less value.  For late-in-career teachers, base pay increases become extra valuable, as those increases will be multiplied into retirement by the PSERS benefit formula.

From my post on PSERS benefits, we learned that the retirement benefit earned by a teacher is given by the following formula:

PSERS Formula

To understand how the value of the pension benefit changes near the end of a teacher’s career, let’s look at the change in value for a female teacher, age 62, with 40 years of service earning $100,000 in year 40 (and 39 and 38), and who will earn $100,000 again in year 41.  And let’s assume the single salary schedule is stagnant with no grid increases during the next 3 years.

The annual benefit earned, at year 40 =      $100,000  x  40  x 2.5% = $100,000
annuity value @ age 65 = $1,217,000
The annual benefit earned, at year 41 =      $100,000  x  41  x  2.5% =  $102,500
annuity value @ age 65 = $1,247,425
The annual benefit earned, at year 42 =      $100,000  x  42  x 2.5% = $105,000
annuity value @ age 65 = $1,277,850
The annual benefit earned, at year 43 =      $100,000  x  43  x  2.5% =  $107,500
annuity value @ age 65 = $1,308,275

Two observations:

  1. A teacher with 40 years of service can replace 100% of her pre-retirement income by retiring.  After the 40th year of service (for those in plans with the 2.5% multiplier) retirement income will exceed pre-retirement income.  Or stated differently, a long-service teacher will more income in retirement than in her final years of employment.
  2. By deferring retirement and working for an additional year, the hypothetical teacher increases her annual retirement income from PSERS by an additional  $2,500.   And, using actuarial tables, we can see that the  extra $2,500 annuity is worth about $30,425.   So by working one additional year, a long-service teacher generates about $30,000 in extra paper wealth for themselves (deferred into retirement).

What incentives are at play here?

  • PSERS generous benefit formula creates an incentive to retire:  our hypothetical teacher could retire at Year 40 and replace 100% of her income (ignoring taxes and benefits).  So if a teacher is ready to move on the next phase of life, the PSERS benefit creates a great path to do that.  That is in part why PSERS was created (though the formula did not always have the present higher multiplier)
  • PSERS also creates an incentive to keep working, because in return for working another year, the teacher can accrue that next PSERS annual increment, which is worth $30,000.

If instead our example teacher received a 1% raise in each year, the new annual benefit stream looks like this instead:

The annual benefit earned, at year 40 =      $100,000  x  40  x 2.5% = $100,000
annuity value @ age 65 = $1,217,000
The annual benefit earned, at year 41 =      $100,333  x  41  x  2.5% =  $102,841
annuity value @ age 65 = $1,251,574
The annual benefit earned, at year 42 =      $101,000  x  42  x 2.5% = $106,050
annuity value @ age 65 = $1,290,628
The annual benefit earned, at year 43 =      $102,000  x  43  x  2.5% =  $109,650
annuity value @ age 65 = $1,334,444

So teachers that are close to retirement can derive material benefit from late-in-career increases to base salary.  In this example, the 1% raise creates $23,000 in extra PSERS value over a three year period, vs. the no-salary-increase scenario.  So teachers who are close to retirement and who are maxed out on steps and lanes would really like to see grid increases in the last few years to boost PSERS values.

And in some ways school districts have an incentive to go along with raises for near-retirement teachers.   In our example, the raise given to a teacher who gets a 1% salary increase each year for years 41 through 43 costs the school district only $6,000 in extra base pay in total over those three years.  But that local decision commits the PSERS system to payout an incremental $23,000 dollars.  So school districts foot only about one fifth of bill for the the incremental cash that will flow to to soon-to-retire teacher.  The rest of the benefit comes from PSERS (which is funded, ultimately, by all PA taxpayers.)

Although giving raises to late in career teachers could be a viable strategy to both retain or reward long-service teachers (since 80% of the costs are shifted to PSERS) I don’t think I could advocate a policy that is good for the District but bad for the greater community (in this case, all residents of Pennsylvania).  And given the financial stress PSERS is already under, it makes this logical but perverse path even less attractive.  If all districts enacted such policies (and I am sure some school boards do make this calculus today) then PSERS underfunding would only get worse.

Key Takeaways:

  •  Retirement benefits is not a differentiator for UCF — all teachers in Pennsylvania are covered by the same plans
  • However, the fact that UCF pays teachers at the 90th percentile does mean that PSERS benefits in retirement for UCF teachers are better than those for almost all other teachers, since the benefit is calculated using highest salaries achieved
  • PSERS (like all pension plans) rapidly builds value in later years of employment
  • For teachers who leave the state or only teach for a few years before changing careers, PSERS is not a good system because benefits are not portable, and employer contributions are not refundable to the departing employee