A pension is perhaps the biggest advantage teachers (and many other public employees) have in saving for retirement. Unfortunately, it’s a complex topic, pension rules and benefits vary, and information isn’t always clear. Understanding YOUR pension is important to effectively plan for your financial future.
In this post, I’ll explore how pensions work, identify the key pieces of information you need, and provide examples from real pension plans. Using this information, you’ll be well equipped to factor your pension into your financial plans.
What Is a Pension?
A pension is a defined-benefit retirement plan. It differs from the far more common defined-contribution plans like a 401k or 403b.
In defined-contribution plans, you contribute a set amount of money and the money grows (or shrinks) based on market returns. When you are ready to withdraw, you can withdraw whatever money is in the account.
A defined-benefit plan, or pension, works differently. You still contribute a percentage of salary to the plan (in some cases the employer contributes for you as a benefit) but are promised a set amount to withdraw at a future date. The amount is not determined by market returns but instead by factors set by the pension plan.
Some pensions allow you to withdraw your assets once you’ve separated from service. This isn’t usually to your benefit with a government pension.
The remainder of this post reviews a pension as if you are going to take the annual benefit payout.
Related Post: 4 Simple Ways To Include Your Pension in FI Planning
Who Has One?
Fewer people than in the past. While pensions used to be relatively common, and a staple of the American middle-class, they are declining.
Private pensions, in particular, are increasingly rare. Public pensions still exist, though are constantly under pressure. Many local governments did not provide good stewardship of pension assets and either did not contribute or, worse, raided, pension plans to cover government shortfalls.
Many public employees still have access to a pension. New tiers, with lower benefits have been introduced to help lower costs. Access to a pension is still an advantage for many teachers in their retirement planning. Yet, the benefits newer educators receive are often lower than those who entered the system earlier.
How Does a Pension Work?
If your employer offers a pension, you have to work a set amount of time to become a qualified member and vested.
Once vested according to plan rules, you are eligible for a payout at some future date. When you officially retire according to the rules of the plan, you receive a set amount of payout determined by the rules of the plan.
Lots of rules, right? Yes, but they are published and can be understood with just a little effort. That’s what this post is about.
That payout is determined by the interaction of several factors. The factors, and how they interact to determine a payout vary by pension plans.
If you learn the factors included in the calculation and are willing to make some assumptions you can make a reasonable estimate of your future pension payout!
What Will My Pension Pay Me?
I wish I could easily answer that question for you. Unfortunately, the factors included in the benefit calculation vary by pension. The value for each variable varies by person and circumstance – age, salary, etc.
Furthermore, remember when I mentioned earlier that some pensions have added different tiers? Each of these tiers likely has different rules or factors for retirement eligibility and calculating payout. That means that even in the same local government, two workers doing the same job may have different payout calculations!
This makes it impossible to provide a general answer.
Instead, I can teach you how to make a solid estimate of your future pension benefits. That’s the point of this post.
As always, before making any crucial life decisions with this information, you may want to consult a financial professional who is familiar with your circumstances and the workings of your specific pension.
I am not a reliable source for universal individual pension estimates. This post is about education not concrete financial guidance.
Pension Variables You Must Know
Some pension plans do a great job of providing the information you need in an easy-to-read plan document or website. Others…well, not so much. Search for the information online and/or ask your HR department to provide you with the plan document.
Hopefully, you can find these things easily. If not, prepare for some exciting reading.
Becoming vested in a plan means that you now “own” your assets in the retirement plan. In the case of a pension it means you are now eligible for a future benefit. It does not mean you can begin collecting immediately, just that you are eligible for benefits according to the plan rules.
The first thing you will want to know is the rules for becoming “vested” in your pension. Answer the following questions:
- How long do you have to work to become eligible?
- What qualifies as eligible work? (employers often have different rules for part-time or temporary work.)
Vesting periods can range from 6 months of full-time work to 5+ years, or any combination in between. In some cases, you are deemed partially vested immediately upon working, but not fully vested for an additional period of time.
Be sure you understand both how, and when, you become eligible for your pension payout.
What Plan Tier?
I’ve listed this as an entirely separate section because it is critical. One of the most alarming things I frequently see is older teachers telling younger teachers they “only need their pension” or that they have a great retirement waiting.
Far too often, pension payouts have been reduced for newer employees. Retirement eligible dates are farther out. It is still a useful benefit, but not one that is likely to leave you living lavishly in retirement.
Determine which tier or “plan” you are eligible for so you’ll use the right factors in estimating your future payouts.
Don’t think this matters? In researching for this post, I discovered that Texas now has more than 6 Tiers. It takes a multi-page flowchart to determine which Tier you are in. Yikes.
Know how much of your salary goes to your pension. This isn’t something you can control, but I’m constantly surprised by colleagues who have no idea a percentage of their salary is withheld for their pension. This is an important part of starting to track your overall financial life.
It’s also important when comparing pension benefits. Should you ever be deciding between two jobs, or two potential locations, the difference in contribution may be enough to influence your decision.
In my comparison below, the employee contributions range from 2.5% to 9% of salary. That’s significant money!
Retirement Eligibility Variables
Determining when you are eligible for retirement generally depends on your age, your years of service, or a combination of the two.
Some plans have a partial retirement option which allows you to retire earlier for a reduced benefit. This too depends on age and/or years of service.
Years of Service
The years of service is simply the number of qualified years you work in the system. The “qualified years” portion is important because, you guessed it, what qualifies varies by plan.
This can be especially tricky for educators who often work a “year” of September to June. Some plans build their service calculation on this year. Others however, use the traditional year which complicates things if you are considering retirement at the end of a school year in June.
For estimating purposes, you can just count the number of school years you are likely to work.
Make sure you pay attention to this though, especially as you are nearing retirement eligibility. You don’t want to be banking on a year of service and find out you are 6 months short.
This is exactly what it sounds like. Your age in years. Easy for estimate purposes.
When you are actually considering retirement however, make sure you pay attention to how age is included in the plan rules. Is it the year in which you turn an age, or only after turning that age? Again, this could be a difference of several months.
Rule of X
The “Rule of X” is common in educator pensions and is simply the combination of your age and years of service.
For example, the rule of 80 means your age and years of service must add up to 80 or more for you to be retirement eligible.
Let’s say someone started teaching at 24. How long would they have to teach to meet the rule of 80?
After teaching 28 years, they would be 52. 28 + 52 = 80. Rule met.
This is sometimes also called a “weight” or “accrual factor.”
What is the number variable your pension uses as a multiplier to calculate benefits? This is most often expressed as a percentage to be included in the calculation.
Final Average Salary
This seems like it should be a simple variable, but it isn’t just your income for your final year of service. Instead, the calculation of what final salary to include in your pension benefit is different in almost every plan I’ve reviewed.
In most plans, it’s the average of a set number of years. The number of years, and their rules for inclusion may vary. Some plans allow for “spiking” of this number through accumulated leave payout in the final years. That is increasingly rare as systems look to keep benefit payouts down.
Examples of final salary calculations include:
- An average of the final three years of your salary
- An average of the three years of highest compensation regardless of when they occurred
- An average of five consecutive full time years worked
Teacher Pension Benefit Calculation Formula
Most benefit calculation formulas look like this:
Factor * Final Average Salary * Years of Service = Annual Benefit
Dividing the annual benefit by 12 provides you the monthly benefit.
Yes, the formula itself really is relatively simple for most pension plans.
Plan Funded Status
Now this isn’t a variable from your pension plan and isn’t necessary to estimate your future payout. It’s good to know though because it can be a proxy for how reliable you should consider your potential future pension.
It is difficult to estimate future conditions and legal decisions. I can’t provide you a scientific formula for how to use this information. Yet, I know I’d feel more comfortable with a pension that is at least 80% funded than one that is currently only 15% funded. If you want to get very mathematical, you can discount your assumptions based on a confidence factor.
This uncertainty is why we built our original FI plan with no pension assumptions. As we get closer, and confidence increases (if?), we’ll factor it in.
For a quick review of state-level pensions, I check the yearly update of this research:
Each plan should also have a document displaying system funded status, which you can usually find by googling “<pension system name> funded status.”
For example, “Texas Teacher Retirement System Funded Status” led me to this document, which showed funded status at 76.9% in 2018.
Again, this is not required for you to calculate your potential benefit, but it is useful information to have.
There is nothing worse than reading a bunch of information about variables, factors, and rules and then not seeing how it works. Fortunately, we’ll go through some examples below.
Let me stress again – these examples are to help you understand how to best do your own pension review. I spent about 20 minutes each reviewing the rules for my examples and they should not be counted on for useable estimates.
What I Did
I created four fictional teachers, selected four random starting years, and four random states. Well, okay the states weren’t entirely random – I know teachers working in each one. Then, I searched online until I found information about the state-level teacher pension options.
The four retirement starting dates and states used:
|STATE||YEAR STARTED TEACHING|
In each case I recorded the information I suggested above:
- Pension Tier
- Vesting requirement
- Member contribution
- Eligibility requirements
- Years of Service
- Final average salary rules
- Calculation Formula
- Percent of pension obligations funded
Then I assumed that in each case the teacher started at age 25 and worked until the first year they were eligible for full retirement.
Magically, they all ended up with a final average salary calculation of $75,000.
I also made notes of anything unusual I found in my quick review.
(Note: If you are from one of these states and I missed a nuance or you believe I have wrong information – please let me know!)
Then, I produced an age of retirement and benefit estimate for each educator. I’ll first walk through each individual example and conclude with a summary chart. Hopefully, this helps you better understand how to produce an estimate for your own pension!
Example 1 – Texas 2010
|Teacher Retirement System of Texas||(Source)|
|Vesting||5 years of service|
|Member contribution to pension||7.7%|
|Retirement eligibility||Age 65 *or*Age 62 + Rule of 80|
|Final Average Salary (FAS)||Average of 5 Highest Years|
|Benefit Formula||FAS * .023 * Years of Service|
Observations – Texas has a lot of tiers! The rules, particularly around retirement eligibility, are very different depending on the tier in which you fall.
If the example teacher starts working in 2010, they will be first eligible to retire with full benefits at age 62 because they meet the Rule of 80 by age 62. Those who entered the profession earlier, and are therefore eligible under different rules could have retired at age 53 based ONLY on the rule of 80. Tiers make a big difference!
Remember, benefit calculation is: Factor * Final Average Salary * Years of Service
For this teacher, that looks like this:
|Annual Benefit||Monthly Benefit|
Summary of Example 1:
Again, this is not a real example of potential benefit because the final average salary is pulled out of thin air. A quick review of salaries shows a teacher in Texas will likely be earning more than $75,000 a year in 2047.
Example 2 – Oregon 2001
|Oregon Public Employees Retirement System||(Source)|
|Member contribution to pension||2.5%|
|Retirement eligibility||30 years of service or age 60|
|Final Average Salary (FAS)||Average of three highest years|
|Benefit Formula||FAS * Years of Service*1.67%|
Observations – It appears that the 2.5% contribution to the main pension benefit is new. Employees contribute 6% of salary to their pension benefit, but until recently, this all went to a separate account that functions like a pseudo-401k. Now, for a Tier 2 member (as estimated here), this will be 2.5% to pension obligation and 3.5% to this Individual Account Plan.
This seems like a great benefit, but adds a second layer of complexity to estimates. I am just focusing on the base defined-benefit portion for purposes of this post.
For this individual, the teacher pension benefit calculation looks like:
|Years of |
To get the monthly benefit, you just divide by 12…
|Annual Beneft||Monthly Benefit|
Summary of Example 2:
The Oregon teacher will ultimately contribute a lower % of salary, and can retire 7 years earlier with full benefit, but the benefit is lower than for a Texas teacher making a similar amount. That second account (Individual Account Plan) however, will likely cover some of that gap.
Again, I point this out simply to see how the different variables impact an estimate. These are not actual comparisons.
Example 3 – Illinois 2006
|Teacher Retirement System of Illinois||(Source)|
|Member contribution to pension||9%|
|Retirement eligibility||5 years | Age 62|
10 years | Age 60
20 years | Age 55 (reduced)
35 years | Age 55
|Final Average Salary (FAS)||Highest of 4 consecutive years in last 10 years|
|Benefit Formula||FAS*Years of Service*2.2% (Cap of 75%)|
|Percent Funded||40.6% (2019)|
This was the most complex one for me to analyze based on a quick look. The retirement eligibility rules and final average salary calculations were the most complicated. There is a cap on the benefit payout at 75% of final average salary.Illinois has since implemented two other tiers.
Still, with less than 20 minutes I was able to produce an estimate for this mythical teacher. With 35 years of service they could retire with full benefit at age 60.
Again, remember: Factor * Final Average Salary * Years of Service = Annual Benefit
|Factor||Final Average Salary||Years of Service||Annual Benefit||Monthly Benefit|
Don’t forget the 75% cap for this Illinois plan though! The estimate is above that, so the benefit would be reduced to $56,250.
Summary of Example 3:
*75% of Final Average Salary
Now, you’ve probably got it. We’ll do one more just in case!
Example 4 – Tennessee 2014
|Retire Ready Tennessee||(Source)|
|Member contribution to pension||5%|
|Retirement eligibility||Rule of 90|
|Final Average Salary (FAS)||Highest 5 years|
|Benefit Formula||1% * FAS * Years of Service|
Observations – Tennessee, like Oregon, also has instituted a hybrid model which includes a defined benefit (pension) option, and a 401k portion. For the pension portion, the member contributes 5%. The factor is a relatively low 1%. The Tennessee pension system is one of the best funded in the nation, so certainty of benefits is relatively higher.
We enter the information as usual, and get:
|Annual Benefit||Monthly Benefit|
Not surprisingly, the relatively low factor here results in a lower benefit than other calculations. In this post, I’m focusing only on the benefit calculation. If I was comparing teacher pensions I’d definitely want to include some estimate of the potential 401k option.
Summary of Example 4:
Example Information Summarized
Here is a summary chart of the different plans. Again, I show this to compare the different factors and rules with each pension. This is not an actual estimate of benefits or true comparison between working in each of these states. Our mythical teachers entered the system at different years but somehow managed to make exactly the same final average salary.
Common factors – Starting at age 25, retiring as soon as eligible for a full benefit. $75,000 final average salary assumed for all. Results of four pension plans:
*Oregon and Tennessee contribute additional percentages (3.5% and 2% respectively) to a separate individual account. This results in additional benefit.
The point of this was to practice understanding a pension and how to build a reasonable estimate, not to compare plans. You have certainly noted how different each state is, and how much your state rules matter. Do with it what you will.
Putting It All Together
Now, you are ready to dig in and do your own estimate! Trust me, this is doable and a worthy use of your time.
I’ve even prepared a resource to help you out.
This button will take you to an Excel sheet with a place to record the information from your own pension. It also has a very simple potential benefit calculator.
The second and third tabs include the simple information/formulas used in the four examples above.
Please adjust the variables and calculations to meet your pension rules and own individual circumstances but I hope this helps you understand your pension better.
Again: Before making any decisions based on this information, I recommend consulting a professional with knowledge of your specific pension system.
Understanding Your Teacher Pension
Now, use the information (and spreadsheet!) in this article to start building an understanding of your own pension and potential payout.
- Review your plan document
- Record the critical information
- Estimate your potential payout (or work with an adviser to do so)
- Use this estimate to inform your future financial planning.
Understanding your pension is an important part of understanding your overall financial picture. You can better decide how, or even if, to include a future pension benefit in your financial plan.