Teachers' $500 Billion (and Growing) Pension Problem

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Teacher pensions may not sound like a sexy or even high-profile issue, but keep reading: they're threatening the fiscal health of many states and could cost you — yes, you — thousands of dollars. And, like the savings-and-loan crisis at the end of the 1980s or the current housing-market mess, insiders see big trouble ahead in the next few years and are starting to sound warnings.

Today there is an almost $500 billion shortfall for funding teacher pensions, and that gap is growing. Why should you care? Because ultimately taxpayers are on the hook for that money. But the problem doesn't just end there. The way teacher pensions operate is badly suited to today's teacher workforce, where 30-year careers are no longer the norm. The current setup penalizes teachers who move between states, switch to private or public-charter schools that do not participate in the pension system or leave teaching altogether. Meanwhile, it becomes financial suicide for teachers to change careers after a certain point, even if they no longer want to teach or are not good at it.

But first, let's talk about the money. Teacher pensions are part of a larger set of benefits that states and cities offer public employees, including health care and pension programs for cops, garbage men and other public employees. The Pew Center on the States puts the total shortfall for these benefits at $1 trillion. You read that right: trillion with a t. Obviously, these are important benefits to offer, but the costs are out of hand.

Although three states (New York, Florida and Washington) are currently enjoying funding surpluses for their teacher pensions, the rest have unfunded liabilities, meaning less money on hand than obligations. In New Jersey, Illinois and Connecticut, for example, these unfunded liabilities — that are just for teacher pensions — amount to more than $3,000 per state resident. Many experts see a state or city default as a real possibility in the next few years.

It would be easy to blame these shortfalls on the recent upheaval on Wall Street amid the Great Recession. But in practice, the liabilities stem from lousy incentives and bad decisions by state officials. In Pennsylvania, for instance, a 2002 surplus inspired state policymakers to increase benefits for teachers while decreasing the state's contribution to the pension fund. It was a move that made sense politically but was horrendous fiscally — Pennsylvania's $7 billion surplus by this year had turned into a $10 billion deficit.

Keep in mind that these pension systems are binding contracts, so in practice this means that as more teachers retire, state taxpayers will have to make up the difference through higher taxes, fewer services or both. And unlike Social Security, which relies on a nationwide base of people paying into the system, states and cities aren't propped up by an endless supply of new teachers; in places where enrollment is declining, fewer and fewer workers are being brought into the system. And unlike private-sector companies, states and cities can't go out of business, but that doesn't mean they can perpetually run enormous deficits either — particularly if newly elected GOP governors and Republican-majority statehouses are serious about imposing fiscal discipline.

Perverse incentives abound. Under traditional pensions, teachers and their state or city pay into a retirement fund that doles out a fixed amount to teachers when they retire. But only teachers who taught for 25 or 30 years reap the full benefits. (And since in some states these longtime teachers can be paid as much each year as they were making in their last few years of teaching, boomers who retire in their 50s or 60s and live for 30 more years can end up earning more from their pension than they did cumulatively during their three decades in the classroom.) Everyone else gets less, often much less than they would receive if the money were simply invested in a mutual fund. In other words, the system creates a small number of big winners at the expense of many losers.

There's also the sneaky little practice of cost shifting. In many states, for example, a school district can raise the salaries of teachers in their golden years knowing that the state, not local taxpayers, will bear the cost for the remainder of the teachers' lives after they retire. In some states, teachers can also "retire" and start collecting benefits but return to the same jobs, leaving taxpayers to pay extra for the same teachers.

Yes, a lot of insanity has been built into the current system, but we don't have to keep doing things the way we've been doing them. And the choice is not between anemic benefits for teachers or sticking with the status quo. States can structure sustainable retirement systems that are aligned with the goal of attracting great teachers.

How to do that? For starters, as my colleague Chad Aldeman and I urged in a paper published in August, policymakers need to update the 20th century pension schemes for today's more mobile workforce; 401(k)-style plans are not the only option, but genuine portability is essential. Benefits must be spread more evenly across a teacher's career, not just concentrated in the last few years. Reforms should lead us to a system in which new teachers are not financing the retirement of veterans, but rather saving for their own retirement — and they should be able to take their savings with them if they change jobs. Meanwhile, states and cities should be required to make realistic assumptions about how much their pension funds will earn on Wall Street and to budget accordingly.

Reforms could also shine a light on teacher behavior and pensions. Economists Robert Costrell and Michael Podgursky, two of the leading researchers on teacher pensions, point out that despite the development of sophisticated state databases for K-12 education, these are still in no way linked to data about teacher retirements. Even the most basic descriptive data, like what kind of teachers are retiring, is not collected because states too often allow pension systems to run as quasi-independent fiefdoms. If policymakers had access to data on the effectiveness of teachers who are retiring, policy changes could be implemented to try to influence their choices.

In most places, however, it is legally difficult, sometimes impossible, to change the pension systems, so these problems will take a while to unwind. As you'd expect, pension-fund managers and teachers' unions are not too keen on the idea of reform. State pension officials won't share data with researchers who are calling for reform, let alone invite them to meetings. Unions, meanwhile, see traditional pensions as an inviolable right and worry that any reform will shortchange teachers. They are right to worry, but the current system is not sustainable, so the best way to protect teachers and retirees is to come to the table and help fix the problems.

It all sounds wonky, sure, but so did subprime mortgages when they first started popping up in news stories. And this time, the experts have been very clear that absent major reform, this shoe is going to drop. Don't say you weren't warned.

Rotherham, who writes the blog Eduwonk, is a co-founder and partner at Bellwether Education, a nonprofit working to improve educational outcomes for low-income students. School of Thought, his education column for TIME.com, appears every Thursday.