California Teacher Retirement Benefits Are Hardly Modest--But CalSTRS Doesn't Want You To Know That

The average full-career California teacher receives a pension benefit equal to 105% of their final earnings. CalSTRS CEO says the plan isn't generous enough.

The Chief Executive Officer of the California State Teacher Retirement System (CalSTRS) believes the state’s public school teacher pension plan is too stingy. As Ed Ring of the California Policy Center points out, in December 2014 CEO Jack Ehnes wrote: “The median CalSTRS pension replaced less than 60% of final salary for the members who retired last year. CalSTRS recommends income replacement of 80% to 90% to maintain a similar lifestyle in retirement.” But Ehnes’ statements are doubly misleading: he both overstates what counts as an adequate retirement income and undercounts the benefits CalSTRS provides.

For a start, an 80 to 90% recommended “replacement rate” of pre-retirement earnings is higher than most financial planners recommend. For instance, the Social Security Administration states that “Most financial advisors say you'll need about 70% of your pre-retirement earnings to comfortably maintain your pre-retirement standard of living.” Retirees don’t have work-related costs such as commuting; they have often paid off their mortgages and stopped saving for retirement. Their children, who the federal government estimates cost nearly a quarter million dollars each to raise through high school graduation, have usually left home. For these reasons, academic research has found that a replacement rate of 60% of pre-retirement earnings is often perfectly adequate for a retiree to maintain their standard of living. CalSTRS is raising the bar on what counts as a decent retirement income to make the plan seem less generous.

Moreover, Ehnes’ figures that compare CalSTRS retirement benefits to pre-retirement earnings are misleading, for a very simple reason: Ehnes’ figures represent individuals who only worked a partial career under CalSTRS.

In 2013-2014, the average new CalSTRS beneficiary retired at age 62.7 after 23.8 years of service. In other words, the benefit figures Ehnes cites were referencing a person who, on average, didn’t start working under CalSTRS until age 39. Should we expect CalSTRS to pay a full benefit after what may be, for many Americans these days, barely more than half a full working career?

For a true full-career employee, CalSTRS benefits are plenty generous. According to CalSTRS data, employees who worked a full career – from age 23 to age 65 – received an average annual benefit of $110,364, equal to 105% of the employee’s final salary. Almost any financial planner would call this an excessively high replacement rate, meaning that a rational employee would prefer to receive more of their compensation as salary during their working years and less in the form of a retirement package.

If so, why does this happen? Economists Edward Glaeser of Harvard and Giacomo Ponzetto of the Center for International Economic Research in Barcelona call public employee defined benefit pension plans “shrouded,” meaning that “public-sector workers better understand their value than ordinary taxpayers.” Since higher public sector salaries would meet resistance from voters, public employee unions instead push for a compensation package that is heavy on hard-to-understand retirement benefits.

This is why reforms that shift public sector employees to 401(k)-style “defined contribution” retirement plans could be so helpful. As the Manhattan Institue's Josh McGee shows, a properly designed DC pension can provide perfectly adequate retirement benefits at reasonable cost, while adding portability of benefits that most public sector DB pensions lack. But DC retirement plans are also far more transparent: the employer contribution to employee’s retirement accounts is easily understood and easily compared to the employer match that private sector workers receive in their 401(k) plans.

The full annual CalSTRS employer contribution – something, admittedly, that is rarely actually paid – would equal 31% of employee payroll, according to the plan’s most recent actuarial valuation. By contrast, the typical private sector employee receives an employer match to their 401(k) plans of just 3% of their wages. In other words, pension costs for CalSTRS-covered employees are roughly 10 times higher than the typical private sector 401(k).

Anyone who thinks such pension plans don’t need significant reforms is either unable to understand the issues or doesn’t want you to understand them.