Last week, the Fordham Institute released a study that erroneously claims teachers in Minnesota and in most states would be better off investing retirement contributions on their own rather than receiving a TRA defined-benefit (DB) pension after a career of teaching. The study used flawed calculations and methodologies to arrive at this conclusion by very significantly underestimating the value of a TRA pension and overestimating an individual’s ability to earn high investment returns.
The study’s calculation of future pensions used outdated life expectancy data that predict far shorter life expectancies than Minnesota teachers experience and made other erroneous assumptions about likely retirement ages. These miscalculations shortened the projected pension payout period by 10 years. The study’s numbers also inflate the potential earnings an individual is likely to earn from investing their own contributions. Below is a detailed description of the problems and miscalculations found in the study.
Pension Accumulation/Payouts: The study
underestimates the value of the MN pension benefit for several reasons:
1. The study uses Centers for Disease Control (CDC) 2007 life expectancy tables, which predict far shorter life expectancies than MN-specific teacher mortality tables predict. For example, CDC tables predict an age 60 female will live to age 84 while TRA’s mortality tables predict they will live to age 90.2. CDC tables predict an age 65 female will live to age 84.9 while TRA’s tables predict age 90.3. Due to life expectancy errors alone, the study’s calculations shorten the likely pension payout by between 5 and 6 years.
2. The study assumes a teacher retires at the plan’s statutory normal retirement age, which in TRA’s case is age 66. In reality, TRA’s average retirement age is about age 62. By assuming a beginning payout age of 66, the study shortens the payout period by another four years. These years are excluded in the pension wealth accumulation part of the equation.
3. The study’s combined use of an overly advanced retirement age of 66 and wrong mortality tables results in a predicted payout period of 18 years to 19 years whereas using TRA-specific data results in a payout of over 28 years, a very material difference of over 10 years.
4. There are no references in the study indicating that the authors incorporate COLAs in the calculation of pension payouts.
Accumulated contributions plus interest: The study greatly
overestimates the value of the teacher’s theoretical cumulative contributions plus investment earnings by assuming individuals can invest and earn as much as large institutional investors. This is very optimistic and unrealistic. Here are the study’s flawed assumptions regarding potential investment earnings.
1. The study assumes the individual is capable of earning a very aggressive compound annual return, net of investment fees, of 8.5% in each year of the teacher’s entire working career.
2. According to the National Institute on Retirement Security (NIRS), Morningstar advises individuals making retirement plans to use an expected return on their investments of 5%.
3. Previous studies show that individuals tend to earn 1% to 2% less per year than institutional investors due to high investment fees, less skill than institutional investors, and no access to certain high-performing investment sectors such as private equity and venture capital.
4. Individuals investing their own assets must reduce their risk as they approach retirement age and move more retirement assets into lower-performing bonds and other fixed income investments. This was not taken into account in the study which assumed an 8.5% return each and every year through the age 66 retirement age. The current investment market climate shows how retirees near retirement are struggling to eke out very low single digit returns on bonds and fixed income investments.
Teachers highly value retirement plans as an extremely important job feature. The DB pensions that cover the vast majority of teachers address an essential retirement security need –
‐ replacing income when one stops teaching. The DB pension adds value by assuring that teachers cannot exhaust their retirement savings and will not be hurt by investment losses and inflation. School systems use pensions to recruit, retain and manage the teaching workforce.
Defined contribution plans help teachers manage employment risk, making portability easier for teachers who leave. However, studies have shown that workers need to save more in a defined contribution plans to offset the lower returns in self-directed retirement accounts and make sure that retirement savings last for as long as a teacher will live. Teachers live much longer than average workers and, in TRA’s case are predominantly female. Three-fourths of TRA retirees are women.
Calculations for school districts conflict with results of more extensive analyses of alternative retirement plan designs done for teacher pension plans. Colorado Public Employees Retirement Association (COPERA) is an example of a system recently studied by the state’s auditor in an extensive 217-page analysis of typical teacher tenure patterns based on several plan design alternatives. In every situation, COPERA’s pension replaced a higher level of income than all of the alternative designs. For example, even a teacher who teaches for only three years would receive 40 percent more retirement income from COPERA than from investing the $6,700 refund and buying an annuity.
Courtesy of Communications Office
Teachers Retirement Association
Public Employees Retirement Association
Minnesota State Retirement System