Peaks, cliffs, & valleys: the peculiar incentives of teacher pensions

Ms. Baker is a hypothetical Ohio school teacher, age 49 with 24 years of service. She's had a good run, but is ready for a change; her heart's not in it anymore, and she wants to go out on a high note. But she has a dilemma regarding her pension. She and her school district have contributed $422,000 to Ohio's pension trust fund (with interest), yet her pension is worth only $315,000. If she hangs on for another six years, the pension picture changes dramatically: her pension will be worth close to $1 million, hundreds of thousands of dollars more than the contributions.

Ms. Brooks has the opposite dilemma. She's been teaching in Arkansas since age 25, and at age 53, in light of her exemplary career and continuing enthusiasm, she's just been chosen to be a mentor teacher. The problem is her pension. Every year of additional service reduces her pension wealth, despite the fact that she and her district continue to contribute 20 percent of her pay into the fund.

Welcome to the world of teacher pensions.

Pensions have long been an important part of compensation for teachers in public schools. However, the incentive structures of teacher pension systems are not widely understood, even though they can have powerful effects on the composition of our teaching force and on public finance.

In our research, we have found that teacher pension systems have two strong incentives--a pull and a push. Teachers typically earn relatively little in the way of pension benefits until they reach their early fifties, when much larger benefits start to accrue. The system therefore pulls teachers to "put in their time" until then, whether or not they are well suited to the profession. Beyond that point, the pension system quickly begins to punish teachers for staying on the job too long, pushing them out the door at a relatively young age, often in their mid-fifties, even if they are still effective teachers. These "pull-push" incentives are embedded in the patterns of pension wealth accumulation over teachers' careers, patterns that feature dramatic peaks, cliffs, and valleys that can greatly distort work decisions for no compelling public-policy purpose.

Teacher pension systems can also have important implications for recruitment. Pension benefits may seem distant and uncertain for prospective young teachers, who often change jobs. The costs, however, are incurred from the start in contributions from employer and employee that can exceed 20 percent of the teacher's pay. Many young teachers, who are paying off student loans, starting families, and buying homes, might prefer more of their compensation paid up front rather than diverted into a system from which they may well never benefit.

Finally, the teacher retirement benefit system has major effects on K-12 school finance. Teachers who retire in their mid-fifties are likely to draw pension benefits for at least as many years as they taught. This can be expensive. A teacher retiring at age 55 with a $50,000 inflation-indexed annual pension has received an annuity valued at...