Teaching in Michigan is about to become a lot more attractive. Recently enacted legislation will improve retirement choices for future teachers, increase compensation for some recently hired teachers, and ensure the state will pay every dollar of pensions promised to teachers.
Costs of paying off the state’s rising teacher pension debt are scheduled to skyrocket and consume any future resources that could otherwise be used to increase teacher pay or get money into the classrooms. Absent reform, this debt growth would have been unconstrained and posed a threat to the retirement of teachers across the state.
Retirement security and good compensation for teachers are important issues to us. Professionally, we work on a national project that aims to ensure pension plan solvency and retirement security for public sector workers. Personally, we both have close family who are active or retired teachers in Michigan.
We firmly believe that states need to keep 100 percent of their pension promises, and Michigan’s new reform legislation does that. First, all new teachers will have a real choice of retirement plans upon hiring and can pick the option that works best for them and their families. The default is a “defined contribution” retirement plan similar to the 401(k)s offered in the private sector, but with a big difference — teachers do not have to pick their own investments or make strategic allocation of assets if they do not want to.
Teachers could simply set their preferred retirement date — say 35 years in the future — and let professionally designed “target date funds” reallocate their assets over time in a way that creates minimal risk and maximizes return. And they can choose to purchase annuities if they’d like their benefits distributed just like a traditional pension check.
The other option is a “Pension Plus” plan with the same defined benefit pension currently offered to teachers, but with its own big difference — the state will be more honestly accounting for the cost of providing this new benefit than they are now. Ensuring that pension benefits are accurately priced by actuaries to avoid pension debt is what makes Michigan’s new retirement legislation so strong. Plus, where teachers currently pay two-thirds of the costs of the pension plan, under the new design they will pay 50 percent of costs.
Second, 20 percent of teachers hired since 2012 have chosen an optional—but weak—401(k)-style benefit over a pension, where if they put in 6 percent, their employer matches an additional (and skimpy) 3 percent. The reform upgrades this benefit to match the new defined contribution plan, where new teachers will only have to put in 3 percent of their salary and to get 7 percent from their employer.
Last, for retirees or teachers who have already earned pensions, the adopted legislation creates a viable path to solvency for their beleaguered pension fund $29 billion in debt. Absent changes, Michigan was on track to see pension debt payments effectively double by the 2030s, requiring billions in annual debt payments for teacher pensions coming out of the state’s School Aid fund (instead of going into the classroom or enabling teacher pay increases).
Unfortunately, the state has currently saved less than 60percent of the money it needs to pay promised pension benefits. This dismal fiscal position is mostly because actuarial assumptions used to determine annual contributions for the pension fund have been consistently inaccurate. For example, the state has consistently underperformed its expected rate of return on invested assets for the past 20 years. As a result, Michigan had over $2 billion in required pension debt payments last year — more than 25 percent of the amount paid in salary to teachers.
Fortunately, the Legislature and governor are embracing more realistic assumptions about the cost of funding pensions and planning to chip in more money every year down the road to get pension debt paid off. While there is still more room to adopt better assumptions, this year’s state budget allocates an additional down payment towards the debt of over $200 million.
Teachers themselves should welcome the new reforms. Not a single dollar of pension benefits was cut. Teachers currently in a weak retirement plan are getting a sweetened benefit in the process. Future teachers will have a real choice between generous defined contribution plan or a pension (with a similar benefit as today’s teachers). And the Legislature is depositing hundreds of millions more into the pension fund. All together, the reform package will ensure retirement security for every teacher in Michigan.
Anthony Randazzo and Len Gilroy are managing directors of the Pension Integrity Project at Reason Foundation.