The Three R’s of Teacher Pension Funding: Redistribution, Return, and Risk

Abstract

How are teacher pension benefits funded? Under traditional plans, the full cost of career teachers’ benefits far exceeds the contributions designated for them. The gap between the two has three pieces, which may (with some license) be mnemonically tagged the three R’s of pension funding: redistribution, return, and risk. First, some contributions made for the benefits of short-term teachers are redistributed to fund the benefits of career teachers. Second, pension plans assume rosy returns on their investments, which push costs onto future teachers and taxpayers. Finally, the risk inherent in providing guaranteed pensions carries other costs, tangible and intangible, notably including the nontrivial risk of insolvency, which would dramatically raise mandated contributions and endanger future teacher benefits. I quantify these three components of the gap between benefits and contributions using the same metric as annual contributions. Illustrating with the California plan, I find the full cost of a career teacher’s annual accumulation of benefits can be as high as 46.6% of earnings, nearly triple the corresponding contributions of 17.5%. To understand this gap, which fiscally affects all areas of education policy, researchers and practitioners may find it helpful to think of the three R’s of pension funding: redistribution, return, and risk.