There was enough ambiguity in the tax laws of the 1930s that Congress decided that FICA only applied to private sector employers. States were exempt from paying into Social Security. Instead, they would continue to offer their own retirement plans.
In the 1950s, changes in tax laws allowed states to participate in the Social Security program. Many states chose to fully cover public sector workers, but 21 states and the District of Columbia chose a different route. They preferred to fund a retirement pension for some or all of their employees, believing that their own system would provide a better pension.
Those outliers can bypass Social Security only if employees are covered by a “qualified” retirement plan that provides a benefit equal to or better than if the employee had earned Social Security.
Who are these public sector employees?
The federal government is a public sector employer. State and local governments also employ thousands of workers in public sector jobs, from police and firefighters to your city clerk and property assessor.
Millions are employed in government jobs. Today, nearly 22 million people are employed by local, state and federal governments, accounting for about 15% of all employees in the U.S.
Public school teachers are also public sector employees. According to Bellwether Education Partners (Aldeman and Rotherham, June 2019), “There are 3.2 million public school teachers in America, making it the most common occupation for full-time working women in the country. But the pension system does not serve the majority of the teacher base.”
With state and local governments feeling the pinch and pressure to meet pension obligations, the generosity of these plans is being scaled back. And the newer or shorter workers are in a precarious position to lose retirement benefits.
As many as a million workers at risk
The Boston College Center for Retirement Research (BCCRR) Social Security research team, led by Dr. Alicia Munnell, recently released a report looking at the benefits for public sector workers. The purpose of the study was to quantify the number of state employees who might receive lower benefits (monthly income) from their state pension plans than if they worked for the same wage in a covered job.
They found an alarming number of employees who could end up in a worse situation in their old age. In fact, based on their model and research of a wide variety of public retirement plans in effect today, the BCCRR team estimated, “In total, 750,000 to 1 million unfunded employees are at risk of receiving retirement benefits that fall short of the social Levels of security benefits.”
This is quite concerning, especially when you think about public sector jobs where there are already staff shortages. Public school teachers are scarce. Knowing that retirement benefits can be small is probably part of the reason for higher quit rates and lower induction rates for teachers.
In 15 states, teachers do not have access to Social Security. In another 6 states, only a fraction of teachers are short of teachers. It depends on whether they work for an uncovered school district or district or work in another district where teachers in the same state are covered by Social Security.
Bellwether’s research findings are alarming: 50% of newly hired teachers leave without retirement. And a third qualify for a pension, but it’s worth less than their own contributions.
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How Public Retirement Plans Work
Most state pension plans have been in existence for more than 100 years. The earliest retirement plans for state workers date back to 1911 (Massachusetts) and 1857 for the New York City Police Department. But rules have changed over time, mostly at the expense of the newest employees.
In most retirement calculations, the ultimate benefit is based on years of service, the employee’s highest salary in a given number of years (usually the highest 3 years), and a benefit factor. Before an employee is eligible for a pension, he must work in that job long enough to become vested — 3, 5, or 10 years in most plans.
A hundred years ago, civil servants stayed in their jobs in the public sector for decades. They settled and retired with a substantial pension. In many cases, pensions yielded a slightly higher benefit than social security.
But today we have a much more mobile workforce. And the workers of today are very different from those at the beginning of the last century.
Where trouble lurks
Being a school teacher today requires more courage and determination than ever. Burnout is high. Many young teachers start early in this career, but leave after just a few years. They can leave with a small pension if they have worked enough years to earn accrued benefits. However, inflation will erode their small benefit in subsequent decades before they even retire.
If they were covered by Social Security, those years would count toward eligibility for benefits. (One needs at least 10 years of income to qualify for future retirement benefits). Their wages would be included in the calculation of their Social Security benefits and adjusted for wage inflation.
On the other hand, if a teacher is a career teacher and works long enough to qualify for a full pension, he may receive a higher pension benefit than Social Security. But that’s only at the beginning of retirement. In general, public pensions are fixed dollar benefits with no adjustments to the cost of living. So a $2,500 retirement benefit at retirement loses purchasing power and buys only about $1,200 worth of goods 25 years into retirement.
Another disadvantage of public pensions is that they are not transferable. Therefore, when a teacher moves to another county within the state or to another state, he cannot take the pension valuation with him. They may receive a pension upon retirement, but its value was frozen at the date of the move. Social Security benefits are accrued throughout the career.
Perhaps the biggest concern with pensions is when a married person opts for a one-time payout pension. If the retiree dies first, his or her spouse will not have any pension income. Social Security was specifically designed to protect the worker and his dependent wife (and now modernized to cover both spouses who are the lowest earner).
Key Differences Between Public Pensions and Social Security
The BCCRR team noted how public retirement benefits are highly correlated with point of entry into a public sector job and duration. Does the employee come in at 24 and spend the next 30 years in the same district doing the same or a similar job? Or is the employee 38 and will he retire at 55? What about the 22-year-old teacher who leaves at the age of 29 before becoming permanent?
The results for the certainty of their retirement income will be drastically different. It is unrealistic to think that a young adult will know how their career decisions could jeopardize their retirement some 40 years into the future.
A social insurance program is designed to protect lower-income workers and dependent spouses. Defined benefit plans are designed to reward employees with a long career. And the income of the higher earners is protected at a higher level.
It seems that there must be a day of reckoning for public pension schemes. Unless the states can provide a more guaranteed retirement income comparable to that of Social Security, many officials will face a very uncomfortable retirement.
About the Author: Marcia Mantell, RMA®, NSSA®
Marcia Mantell is the founder and president of Mantell Retirement Consulting, Inc., a retirement development, marketing & communications, and education company supporting the financial services industry, advisors and their clients. She is author of “What’s the Deal with Women’s Retirement Planning,” “What’s the Social Security Deal for Women” and blogs at BoomerRetirementBriefs.com.
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