Teacher Pension Solvency

A fairly typical pension plan for a public school teacher in California is as follows – if they retire at age 55, they receive 1.4% of the average of what they were paid during their three consecutive years of highest pay. If they retire at are 60, the multiplier increases to 2.0%, and if they retire at age 63, it will be 2.4%. Also fairly typical are the following rates of contribution into the pension fund – the employee contributes 8.0% in the form of payroll withholding, and the employer contributes an additional 8.25%. This post is to examine what rate of return on the pension fund is necessary in order to maintain solvency under these terms.

If you check the Actuarial Life Table courtesy of the U.S. Social Security Administration, you will see that the average 63 year old American male has a life expectancy of another 18 years, and the average American female at age 63 has a life expectancy of 21 years. To be conservative, assume the pension fund will need to retain a positive balance for 18 years after retirement – taking the average would require a higher rate of return, but in the interests of always using conservative assumptions, we’ll go with 18 years.

Following this text are three tables that show the results of a baseline case and two what-ifs. In the baseline case, the teacher commences work at age 26, works for 38 years, then enjoys 18 years of retirement. During their career, their real income (after inflation; all figures used are after inflation) doubles between when they are hired and when they retire, increasing at an even rate over the 38 years. In combination with their employer, each year a sum equivalent to 16.25% of their earnings are contributed into their retirement pension fund, where it is invested. The fund earns a real rate of return (after adjusting downwards for inflation) of 4.75%. This is the official real rate of return currently used by California’s major public employee pension funds in their projections.

As table #1 indicates, using these assumptions, the pension fund will remain solvent for 18 years, earning 4.75% on a declining balance, which doesn’t dip into negative territory until the 19th year after retirement. But what happens if the long-term rate of return dips below 4.75%?

For reasons explored in great depth in other posts, it is important to consider the possibility that the real rate of return on a gigantic pension fund, managing hundreds of billions in assets, may not be able to sustain a real rate of return of greater than 3.0%. The point of this post isn’t to explore that question – although that question is THE question that urgently needs to be explored – but to illustrate how dramatically the contributions to this pension fund will need to be increased, if the long-term rate of return to the fund is decreased.

In table #2, the same assumptions are considered with one exception: Instead of earning 4.75% after inflation, the rate of return is 3.0%. And by making this change, the fund becomes insolvent in 9 years instead of 18. Reducing the real rate of return by 1.75%, in this model, cuts the period of positive fund balance in retirement by half.

In table #3, the same assumptions used in table #2 are repeated, that is, the real rate of return is lowered to 3.0%, but the annual contribution is increased to an amount sufficient to render the fund solvent for 18 years. In order to accomplish this, instead of contributing 16.25% per year, the teacher and employer will need to contribute 26.5% per year, an increase of 63%. Put another way, if California’s approximately 770,000 teachers, on average, made $60,000 per year (which is the mid-career average used in our example), and they all were under the pension plan shown here, then the pension fund contribution for all of California’s teachers would increase from $7.5 billion per year to $12.4 billion per year.

Worth mentioning is the fact that return on investment is only one major element in the debate. Less discussed, but equally relevant is why public employee pension funds are investing in the private market at all? Why aren’t they purchasing low-risk treasury bills and staying out of the markets? Why are we seeing America’s public employee pension funds invest $250 billion (or more) per year into Wall Street investments, at the same time as their marketing departments and political consultants bombard naive voters with entreaties to “spare public employees the volatility of 401K funds and greedy Wall Street brokers”? Is there no irony here? No hypocrisy? Why are public employee pension funds pouring money into Wall Street investments in a desperate attempt to get high enough rates of return to preserve solvency, when doing so completely distorts our markets and destroys sustainable investment opportunities for everyone? And if we’re going to ruin our markets with too many passive funds chasing too few active investment opportunities – why isn’t the social security fund also investing into the market? Would that make it too obvious what’s going on? Why are public sector pension funds – our government workers – allowed to buy up and control huge portfolios of private assets? (ref. The Axis of Wall Street and Unions, or Pensions: Giant 401K Plans).

Getting back to our typical California schoolteacher, it is fair to wonder: Why is someone entitled to retire after 38 years and collect, for life, with cost-of-living adjustments, a pension equivalent to 91.2% of the highest salary they ever made, and more to the point, how can anyone possibly think such generosity is financially sustainable? In the real world, a private sector taxpayer who contributes – a 50/50 split with their employer – a combined 12.4% into the social security fund, who makes $85K when they retire at age 63, will receive $17,000 per year from social security for the rest of their life (ref. Social Security Calculator). A public school teacher who makes about this – our example used $80K per year – when they retire at age 63, will get $72,960 for the rest of their life. The public servant, contributing marginally more into their retirement fund, 8.0% vs. 6.2%, or combined with their employer – since that is true compensation, 16.25% vs. 12.5% – collects 4.3x more in retirement benefits. Market returns cannot and will not sustain this differential.

Facts like this make the antics, the agenda, and the ideology of public employee unions very hard to contemplate with equanimity.

11 replies
  1. Keen Observer says:

    In previous posts, I neglected to mention the state’s contribution in California STRS financing. The details may be found at:


    From 1990-1998, the state’s contribution was 4.3% of payroll. This was reduced to 3.102% in 1999 and then to its current rate, 2.017%, in 2000.

    So the current combined contribution (employee + employer + state) is 18.267%.

    Presumably this would affect your calculations.

  2. Tough Love says:

    Keen Observer,

    You are a teacher on track to get a pension using just the formula outlined in this article. Can you explain WHY you feel it’s “fair” (to taxpayers) that, as this article points out, your pension will be …………. “…. 4.3x more in retirement benefits” than a comparably paid Private sector taxpayer ?

  3. Fake SkippingDog says:

    CalSTRS pensions are not as good as CalTurds, but still light years ahead of the private sector.

  4. Keen Observer says:

    I’m no expert on private sector pensions, though I call reading about companies that failed to fund their pension plans and did everything possible to shed their obligations, leaving longtime workers in the lurch. I assume that you’re not suggesting that government pension funds do the same.

    I have an Ivy League BA and could have done almost anything I wanted to do – law, business, medicine – except I didn’t want to go into those fields, even if they offered substantially higher salaries and potential to accumulate wealth.

    My father was a teacher who never lost his enthusiasm for either his subject or for encouraging urban children to become the first in their families to attend and graduate from college. As I surveyed my options, I sort of fell into the family business, as it were. It offered a modest salary compared to banking, but I loved the contribution I made to the community.

    Teaching, like being a police officer or firefighter, requires tremendous stamina. Even if the heart and mind are willing, it’s not a job one can effectively perform into one’s 70s or 80s. It’s too much for many after 60.

    Entering teaching, I knew that I would not get rich, but part of my compensation would be deferred into a pension plan, so that after a long career I would at least have an income so that I could pay my rent and put food on the table. On a teacher’s salary, I was never able to afford to buy a home in Los Angeles, so that vision of the American Dream that involves a paid-off mortgage in one’s golden years was never in the cards.

    The anti-pension folks often sound as though the only rational choice a person could make would be to go into high income jobs in the private sector. If everyone’s an investment banker, who’s going to teach the children or respond to the calls to 911? Besides, the greed-driven antics of the bankers, with their mortgage-backed securities and credit default swaps may have downgraded the economy (and pension funds) permanently.

    Should teachers, cops and firefighters be expected to live as paupers after decades of service?

    CALSTRS does not allow the abuses (spiking, overtime, etc.) like some pension plans, including CALPERS. My pension is based on my base salary, and extra work (summer school, etc.) does not factor into the equation. The average CALSTRS pension is 62% of final salary, which probably comes to a little over $40,000. Not bad, but not exactly gold-plated. Remember, I won’t receive Social Security, unlike some workers with pensions, and school districts don’t provide a match for 403(b) deferrals.

    I’m not sure if that answers your question, but it’s late and was a long day at school. Budget cuts are taking their toll, increasing the stress on everyone, including the students.

  5. Charles says:

    Keen Observer
    December 8, 2010 at 2:12 am
    If I read you right, you are mistaken about Calpers, at least as it applies to California State Employees. No spiking. Nada.

  6. Charles says:

    Tough Love
    December 7, 2010 at 5:27 pm
    Keen Observer,

    You are a teacher on track to get a pension using just the formula outlined in this article. Can you explain WHY you feel it’s “fair” (to taxpayers) that, as this article points out, your pension will be …………. “…. 4.3x more in retirement benefits” than a comparably paid Private sector taxpayer ?

    Because for 37.5 years out of the last 40 we were paid about 65% of private enterprise engineers. Don’t tell me otherwise. I have sat across the table from many Contractor’s Superintendents who were making 2 and a half times my salary and had perks and a retirement on top of it. You are mudraking the last two or three years when private wages have dropped. Who are you kidding? Not me.

  7. Editor says:

    Charles – you have stated the private sector engineers were frequently required to work overtime without extra compensation. You certainly also know that these jobs in the private sector were far more volatile and often one of your private sector colleagues would find themselves looking for more work. You also may wish to calculate what all the extra paid time off would be worth in your public sector job vs. the private sector jobs. Moreover, I doubt the pay differential was only eliminated in the last three years of your forty year career – the pay gap started to narrow and was probably crossed in most of these professions over ten years ago. Finally, while the trade-off, lower pay in exchange for greater benefits including a pension, is an equitable exchange that we all agree with in principal, just how much pension do you think is appropriate? It is nearly impossible for a private sector worker to save enough to retire – even after 40 years – on 90% of their highest salary. It not only isn’t possible barring unusual circumstances, but it isn’t really what retirement is supposed to mean. When you make 90% of your final highest salary, that means you are actually making MORE than you made during the heart of your career. Who are we kidding? Planning for retirement means getting your children through college, paying off your mortgage, and slowing down a bit. It isn’t supposed to mean you make more discretionary income than you ever did. The very idea is ridiculous.

  8. Charles says:

    Sorry Ed

    I totally disagree. The day I went to work for the State on June 12, 1969 at the age of 18 I knew if I worked until 63 I would get 104% of salary. I retired at 59 and accepted 90%. So there is no big surprise here.

    And you are completely wrong about salary increases. They did not start 10 or more years ago. Try five years ago. And that doesn’t change being paid 35% less for 35 years.
    If I had been paid the additional 35% for 35 years I would have half a million dollars in principle alone.
    You are certainly entitled to your opinion about the purpose of retirement. I lived in average houses, hardly ever could take a vacation and lived on the lower salary.
    Private enterprise used to have defined benefit pensions. So where did all that money go? Into the pockets of CEOs of large corporations and their stockholders who get bailouts from the Federal Government. In short, YOUR money Mr. Ring.

  9. oz says:


    “You are a teacher on track to get a pension using just the formula outlined in this article. Can you explain WHY you feel it’s “fair” (to taxpayers) that, as this article points out, your pension will be …………. “…. 4.3x more in retirement benefits” than a comparably paid Private sector taxpayer ?”

    You and Ed are deliberately using examples which minimize the SS benefit in order to make your case. SS is much more generous than you give it credit for. SS has real COLA’s, non-working spouse benefits, free survivor benefits, and with this new proposal might even only require a 4% employee contribution. It furthermore has the backing of what is essentially the largest union in the country (AARP), and is by far the largest lobbying group in the country… way bigger than any California union you two spend so much time attacking.

    And there’s plenty of 80k/85k earners who are getting a whole lot more than 17k/yr from SS. Please stop cherrypicking hypotheticals which exaggerate your case.

  10. Editor says:

    Oz: Regarding social security, I think no matter how generous you are with your assumptions, you are going to get staggering multiples. If I wanted to cherry-pick, I’d use the example of the public safety employee who works 33 years, then spikes their pension, and ends up getting 100% of a (spiked) final salary of $175K, i.e., a pension of $175K per year. It happens all the time. And if you are generous with a social security equivalency, you would still have the maximum benefit of $31K, only supplemented (if the wife didn’t work, and most wives do work these days) by another $15.5K in spousal benefit. As you know, the spousal benefit only kicks in if the spouse’s own earnings don’t qualify them for an amount greater than 50% of the primary benefit. That, given the progressive nature of the social security benefit, is not very likely unless the spouse doesn’t work.

    So what am I missing? Social security has COLAs, so do pensions. Social security has survivor benefits, so do pensions, albeit in return for a somewhat reduced pension. None of this materially alters the equation. And remember that at age 63 (which qualifies you for the MAXIMUM pension tier as a retiring public school teacher) you are only qualifying for the MINIMUM tier as a social security recipient. Check these tables yourself – you will get $17K per year – and I guess, another 50% for the spousal benefit, IF your spouse is also over age 63 and has no work experience sufficient to qualify them for an $8.5K+ per year additional benefit. There is still absolutely no comparison.

    As for the proposed reduction in the employee contribution rate to 4% for social security, don’t expect my endorsement. That is a ridiculous and irresponsible proposal. For social security to remain solvent, the contribution will need to go up to about 20%, presumably split equally between employer and employee (ref. https://civicfinance.org/2010/05/22/funding-social-security-vs-public-pensions/ ). Keeping public sector pensions solvent will require far, far more dramatic changes. Wall Street generated investment returns are not going to be able to bail out public sector pensions, despite what their public relations professionals who work at the pension funds would have you believe.

  11. gail says:

    For those who don’t know–most of us who are retired teachers get no social security pension. We were not allowed to put into it and instead were forced to pay into the Cal. Teachers State Retirement System. I put into the system, which was (and still is) mandated, for 34.5 years. I would much rather have taken that money each month and invested it as I saw fit, but the law didn’t allow me to.

    During his term as governor, Reagan used what he called “borrowing” from the STRS fund to balance the state’s budget so the taypayer, in all fairness, has to realize money taken from my paycheck fir STRS was used to bail out many state programs over the years.

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