IP-9-2008 (December 2008)
Author: Micheal Mannino
The debate about defined benefit pensions in K-12 education has focused on unfunded liabilities rather than appropriate levels of retirement compensation. Public K-12 employees typically retire at much younger ages with more replacement income and better inflation protection than private sector counterparts. School districts use contribution rates derived from uncertain assumptions about pension plan returns as substitutes for estimating realistic retirement compensation levels. The contribution rates ignore the considerable value of risk assumption that public employee pension plans provide to career employees. In addition, the large amounts of deferred retirement compensation have negative impacts on employee motivation and high, uncertain taxpayer costs.
To improve understanding of public K-12 retirement compensation, this Issue Paper provides historical estimates using a substantial sample of retiree characteristics and salary histories. The sample contains 846 retirees from the Denver Public Schools Retirement System (DPSRS) who retired between 2001 and 2006. While most Colorado K-12 employees receive benefits through the Public Employee Retirement Association (PERA), DPS employees participate in DPSRS. The sample supports reliable estimation of deferred retirement compensation without simplifying assumptions about salary growth and retiree characteristics.
DPSRS is a hybrid defined benefit plan with the following characteristics:
This Issue Paper defines deferred retirement compensation from a hybrid defined benefit plan as the difference between an employee’s estimated retirement account balance and the greater pension value she expects to receive. To account for risk, deferred compensation calculations use a private sector standard, the Single Premium Immediate Annuity, and low-risk investment returns. Deferred retirement compensation is divided into two parts.
First, extra value represents benefits that exceed the amount a retiree could expect from low-risk investment of employer and employee retirement contributions. Second, withheld value keeps an employee’s account balance artificially low to subsidize career retirees’ benefits and limits pension portability.
When accounting for K-12 employee compensation, large amounts of deferred compensation should be included. For the 846 DPS retirees in the sample, average lump sum deferred compensation (LSDC) is $627,570, broken down as follows:
The findings strongly indicate that K-12 public employee compensation is poorly structured:
Pay for teachers and administrators is heavily backloaded, penalizing non-career employees.
The current economic situation provides strong motivation for policy makers to enact reform soon to avoid reductions in K-12 service levels. As a first step, K-12 administrators should be moved into a defined contribution plan. In addition, pensions for teachers and non-professional employees should be reformed as follows, to reduce negative economic impacts: