---

Beyond the basics

In Three Reasons to Hug Your Pension, I covered the basics of educator pensions and encouraged you to create a user account for your pension(s) so you can better understand both your current state and future benefits you might receive for your hard-earned pay.

In this post, I’m going to dive deeper to build your financial intelligence and help you understand how your pension can be a powerful tool for financial independence and your future retirement.

Because pension programs vary from state to state and plan to plan, this will cover some general features of pensions. Your continued homework will be to research your own program and plan to apply what you’re learned here to your own retirement planning.

Working for my ‘free’ lunch

When I worked at Skyview High School, I was a volunteer lunch dude. I was part of a small group of educator colleagues who helped manage the rush of hungry students. With a student body hovering around 2000, efficiency and speed were the name of the game. In exchange for about 15 minutes of slinging salads and soup, I got a free lunch.

Since we know that there’s really no such thing as a free lunch, the catch was that about half of my short lunch period was consumed serving lunch to students. But as a teacher librarian, if I wasn’t teaching a class after lunch, I could flex a bit of extra time when the bell rang. On most days, I didn’t have to scarf my lunch in 15 minutes or less.

It was a win-win, despite my penchant for passing up healthy salads in favor of cheeseburgers and some of the best french fries EVER served in an American high school. Oh, and in the early days (before K-12 Carbonated Prohibition), we even had serve-yourself soft drinks. I’m not making this up. I’ll probably write a future post featuring my colleagues who volunteered as the ‘Pop Police.’

In many ways, pensions are very much like a free lunch. Or at least they used to be.

How do educator pensions work?

Defined benefit plans are funded by payroll contributions that are paid directly by your educational organization and/or you. In some cases, this contribution is in addition to your normal payroll compensation, but more often is deducted as a portion of your pay. The employer contribution is usually a percentage which may be defined by statute or locally bargained. If applicable, your personal contribution is also based on a defined percentage. 

In most cases, pensions are not managed by your school district or educational service organization. Instead, public employee retirement programs are state government agencies which provide pension and retirement services to qualified workers. Pension programs are funded through multiple sources including:

• Employer contributions,
• Employee contributions, and
• State allocations.

As a governmental agency, pension programs invest and manage these contributions to provide defined benefits at retirement to qualifying individuals defined by legislation and administrative code. 

Educator pension systems are often similar or equivalent to pension programs for other public service employees (fire fighters, law enforcement, judges, government workers, etc.).

In many cases, the same retirement agency will oversee and manage multiple programs. Here are some examples from the Pacific Northwest. 

• Washington State – Department of Retirement Services (DRS) 
• Oregon State – Public Employees Retirement Services (PERS)
• Idaho – Public Employee Retirement System of Idaho (PERSI)

Why doesn’t every worker have a pension?

Ah, the good old days. 

Pension programs are expensive for the organizations which offer them. They are funded through payroll deductions and employer contributions, but are dependent on the retirement program effectively investing and managing those monies. And like personal investments in the stock and bond markets, pensions are subject to the same forces which impact your personal portfolio. When economies and markets are healthy, pensions are likely to hum along fine. But if markets suffer like they did in the Great Recession, pension programs can feel the same financial pain that individual investors experience. Private-sector pensions can also be impacted by the financial health of the parent company.

Pensions are also like life insurance — based on actuarial calculations. Actuaries (it’s a real job) generate odds on how long people will live and how much will be needed to pay them during their lifetimes. Based on those odds, retirement investment teams invest and manage the pooled contributions from employees to ensure everyone gets the money they are due when they retire. It’s like Vegas, but not as exciting.

Poor management, soaring costs, bad investment decisions, or economic forces can cause pension programs to fail or become unsustainable. As part of cost cutting or bankruptcy, some corporations simply stopped funding their pensions. This is what happened to many pension programs in the 1980s and 90s, particularly those offered by private corporations. 

Public pension programs face the same challenges, but as governmental agencies they are different in two key ways. First, they are not beholden to shareholders or a corporate bottom line. Second, as governmental entities, their operations are often protected by statute and when necessary, may be supported by additional funding through legislative action. While public pensions may be underfunded in the same ways as Social Security, they have historically been supported by public opinion, unions, legislatures, and the courts. 

Despite this support, pension programs have had to evolve and change to meet existing and future obligations. Over time, states have created new plans for newer employees which are less generous when it comes to guaranteed benefits.

By ‘cost sharing,’ (shifting some risk and responsibility onto individual investors), pension programs have been able to remain solvent and continue to provide the guaranteed defined benefits which are so valuable. But for those educators hired over the last several decades, your pension is now likely a combination of guaranteed income (defined benefit) and personally-defined investments (defined contribution) which are subject to market forces. Let’s examine how the guaranteed defined benefit aspect of pensions works. 

What is a ‘defined benefit’ plan?

Defined benefit plans are ‘classic’ pensions in which contributions from an employer and/or employee are collected over time and invested in order to provide future retirement benefits for qualified participants. In the last century, this was pretty much the only kind of pension that existed. Social Security is a type of defined benefit plan.

Contributions flow into a large investment pool and remain there until you retire or separate from covered service. Your retirement program manages and invests the money from all the covered employees until the day you qualify to receive benefits. 

Upon retirement, you received benefits defined by the pension program guidelines. Get it?

How are defined benefits calculated?

Pension programs use formulas to calculate your defined benefit, usually based on three basic variables

Years of service
x
Average compensation
x
Multiplier

The first two are pretty straightforward. Generally, the longer you work and the more you get paid, the larger your benefit will be at retirement.

Your years of service are based on qualified work for a position and employer which is covered under the pension program. If you worked full-time, you will get full credit for that time. If you work part time, you will get credit based on your fractional contract. For example, if you have a .5 contract or position, you’ll get .5 credit in for years of service for each month you worked.

Depending on the type of position and contract, you may get credit for work in the summer even if you are on vacation. This is often the case for teachers and administrators.

Your average compensation is usually based on a set number of months of highest pay, often consecutive. For many educators, this will be the last several years of employment because they are often the years of highest pay. But in my case, I moved to part time employment before resigning and my consecutive months will not include my last years of employment. 

The multiplier variable depends on several factors, most importantly what plan you are in. Most pension programs have multiple plans with different multipliers. As discussed above, your plan likely depends on your date of hire.

Because I started working in Washington State before my spouse did, I am in a different plan. In her plan, that multiplier is smaller. This means that even if she had the same years of service and average compensation, she would receive less than I would.

However she also taught in Oregon before she started working in Washington and was enrolled in a pension plan that is no longer available to new hires. Even though she hasn’t worked there for years, she is vested and kept her earnings in that program. As a result, she will have a higher multiplier than more recent hires when she retires. 

Another multiplier that affects your benefit is your retirement age. Each plan defines a normal retirement age, often 65. If your plan allows it, you can retire earlier than that. But because you will receive benefits for a longer period of time (and because the actuaries don’t like complications in their oddsmaking), your benefit is reduced.

Each plan and service has different early retirement formulas and policies which can get quite complicated. In some cases, you can delay your retirement and wait to claim benefits in order to receive an increased benefit. Social Security offers this option.

Defined benefit meets defined contribution

Most educators hired over the last several decades have pensions which combine the guaranteed income of defined benefits with an employee-defined contribution portion. As explained above, these hybrid pension programs were designed to ensure the stability of the programs themselves by ‘cost sharing’ with employees. 

In addition to contributions to the defined benefit portion of the pension, educators in these programs can usually select a defined percentage of their income to be invested by the retirement agency on their behalf.

Like other defined contribution retirement programs, these investments are considered tax-deferred. Contributions to these programs are deducted from your paycheck before taxes, providing you with a tax break in the year in which they were made. 

Educators can also select how the contributions are invested, usually from a small menu of managed funds offered by the retirement program. While not as diverse as offerings from major investment companies, pension programs will include fund options including conservative bonds, aggressive growth, and more recently, retirement date funds. In many cases, these funds feature far lower fees and costs compared to other investments offered to the public.

What happens if I leave my job or the education field?

If you leave your job and resign before qualifying for and claiming retirement benefits, it’s called separation from service. If there have been contributions to a pension program, you often have several options. If you have met a minimum number of years of service (vesting), you usually have a choice of either leaving the money in the pension or withdrawing your contributions at their present value.

In most cases, you cannot withdraw any employer contributions made on your behalf. You can only take out what you have contributed on your own. Your withdrawal can either be taken out as regular income or rolled over into another defined contribution plan like a 403b or 457.

If you separate from service before being vested, you are entitled to any employee contributions, but forfeit any employer contributions. You can either take the money as a lump-sum or roll it over into another retirement account. But if you take the money out of a retirement account, you will be on the hook for taxes and possible penalties for early withdrawal.

Filling the hourglass

When I began my first job in an elementary school, I had no idea that 30+ years later, I would look back on a rich career as an educator. I also could not have imagined that the pension which began accumulating months, years, and then decades of service credit would become a keystone to my future financial independence and retirement security.

IMHO, pensions are a gift and privilege for educators. It may not be a free lunch, but it’s an invaluable tool to build financial independence and retirement security. There are few working adults who wouldn’t jump at the chance of having guaranteed income in retirement, which is what pensions can offer.

The power of investing comes from saving consistently over time. Pensions are no different. Thankfully, you don’t have to actively manage your pension like you do with other investments. That said, most educator pensions allow you to tweak the defined contribution portion. In most cases you need to make decisions about how much you wish to contribute and how you want to invest your contributions.

If you are young or new educator, your pension is not usually top- of-mind as you are settling into a job working in schools. But knowing your pension plan, what options you have, and what you might receive in the future is a centerpiece of your financial intelligence and independence.

If you are ready to move to Pensions 301, click on the link below to learn even more about strategies for maximizing your contributions and benefits.

You. Can. Do. This.

Now

1. Find out what pension program you are currently in and locate their website.
2. Create a user account for your current pension program and navigate to your personal profile.
3. Review the personal information and check the following:
   1. Is your personal information correct?
   2. Are you vested in this program (usually after 3-5 years)?
   3. Is your earning history and years of service accurate?
4. If anything looks incorrect, contact your pension program and/or your payroll department to address any questions or issues.

Next

1. If you have worked in other states or qualified for other pensions, follow the same steps listed above.
2. Your pension website likely offers a benefit calculator that will allow you to model different retirement scenarios to identify how much you would receive in the future. Play around with this tool to determine what you would receive if you continue working until retirement age.