Comparing CalSTRS Pensions to Social Security Retirement Benefits
Summary: This study compares Social Security retirement benefits to CalSTRS pension benefits and finds a significant disparity between the plans, despite the employee contributions being relatively similar.
For example, the average CalSTRS participant retires at age 62, which is the current earliest age one may collect Social Security retirement benefits. At age 62, the average CalSTRS retiree collects 56% of their final salary in the form of a pension, whereas, depending on their income, the average Social Security recipient collects between 29% and 36% of their final salary in the form of a retirement benefit. At age 65, the oldest age necessary to collect the full CalSTRS benefit, a CalSTRS retiree with 35 years experience will collect a retirement benefit equal to 84% of their final salary. At age 65 a Social Security recipient will collect a retirement benefit between 30% and 35% of their final salary.
The study then examined how much more a CalSTRS participant might have accumulated based on having 8.0% of their paycheck withheld vs. only 6.2% for a Social Security participant. For a CalSTRS paticipant retiring at age 65 with a final income of $80,000, the study estimated the value of this extra 1.8% in annual contributions to equal $155,814 after 35 years of withholding. This is equal to 3.6 years of the difference in the amount of a typical annual CalSTRS pension and a typical Social Security annual retirement benefit, i.e., it does not come close to closing the gap between the typical Social Security benefit vs the typical CalSTRS benefit. A more in-depth analysis of contribution comparisions between CalSTRS and Social Security will be the topic of a subsequent study.
In general, the study calculated the average annual CalSTRS pension to exceed the average annual Social Security benefit by between 1.5 and 1.9 times for those retiring at age 62, and by between 2.4 and 2.8 times for those retiring at age 65.
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“California’s educators do not participate in Social Security, retire on average around age 62, and earn a retirement income that replaces only about 56 percent of their salary.
CalSTRS Statement on Proposed Pension Reform Act of 2014 Ballot Measure, October 17, 2013
A frequent objection to public sector pension reforms is that pension benefits are received in place of Social Security. While many public employees do earn Social Security benefits along with pensions, in the case of public school teachers they do not. So how does a pension from the California Teachers Retirement System (CalSTRS) compare to a Social Security benefit?
There are various ways to make valid comparisons between a CalSTRS pension and a Social Security retirement benefit, and this article will explore some of them. In order to make these comparisons, we will rely on statements from CalSTRS or information available on their website, along with information available online from the Social Security Administration. All source data will be linked to within the text. For each of the cases to follow, we will summarize the baseline assumptions, then present the comparisons.
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(1) How much will a person retiring at age 62, with a final income of of $80,000, receive via a CalSTRS pension vs. a Social Security retirement benefit?
A 62 year old CalSTRS retiree, based on the average presented in the above-referenced October 2013 press release, will earn an annual pension of $44,800.
A 62 year old private sector retiree working through 2013 with a final income of $80,000 will receive a Social Security retirement benefit of $23, 544 per year. This is based on inputting into the Social Security Administration’s online “Quick Calculator” a birth date o f 1-1-1952, a benefit start date of 2-1-2014, and a final annual pay of $80,000 in 2013.
As can be seen, in this first, admittedly simplistic analysis, the average CalSTRS retiree will collect a pension 90% greater than a Social Security recipient fitting the same profile, nearly twice as much. Put another way, in this example the CalSTRS particpant receives a pension equivalent to 56% of their final $80,000 salary, and the Social Security participant receives a pension equivalent to 29% of their final $80,000 salary.
Social Security, unlike pensions, however, has the characteristic of being progressive, in the sense that lower income participants will collect a greater percentage of their earnings in the form of a Social Security benefit than higher income participants. Since information on the average teacher salary earned by 62 year old retirees is not readily available, here are the same comparisons made with lower final annual earnings:
Case 1: CalSTRS Pension vs. Social Security
Retirement Age 62, Various Final Year Earnings
As can be seen from the above chart, there is a considerable improvement on the amount a Social Security beneficiary will earn at lower levels of income. But even at a $40,000 annual salary, which it is reasonable to assume virtually all veteran CalSTRS participants will collect if they are still working into their early sixties, the Social Security benefit is only 36% of final salary, whereas the CalSTRS pension remains at 56% of final salary. Since CalSTRS formulas are applied regardless of income levels, it is accurate to apply this assumption to make this comparison.
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(2) CalSTRS benefits for employees hired after January 1st 2013 have had their benefit formulas reduced. How does this affect the comparison between a CalSTRS retiree and a Social Security retiree?
To answer this question it is necessary to make some assumptions regarding length of service, since the averages used by CalSTRS spokespersons are calculated based on existing retirees. From the “Retirement Benefits” section of their website, CalSTRS retirement benefits are calculated according to the following formula (readers may click on each variable for more detailed information from CalSTRS):
Here’s how this works: “Service Credit” refers to years of full time employment (there are ways employees can increase their service credit, such as through converting unused sick time into additional service credits, but we will set that aside). The “Age Factor” is a multiplier which increases the older a beneficiary is when they retire, and the “Final Compensation” is how much they earned in their final year of full-time work. In some cases final compensation is calculated using the average of salary earned during the final three years worked.
In practice, this formula would work as follows: If someone worked 30 years, their service credit is 30. If they are 65 years old, their age factor is determined according to a table; for a 65 year old under the new benefit formula, the age factor is 2.4%. So if their final salary was $80,000, their initial annual pension would be 30 (service credit) x 2.4% (age factor) x $80,000 (final salary) = $57,600.
Since new employees hired after January 1st 2013 are the only ones affected by the recent reductions to benefit formulas, they won’t have any significant impact on pension averages for decades. But to ensure this analysis avoids any overstatement, all comparisons used will be based on the new formulas, the so-called “2% at 62” employee pool – all of whom are new hires. Here is the statement on the benefit changes from CalSTRS, found on the first page of their 2013 Member Handbook:
“Of special note, the California Public Employees’ Pension Reform Act of 2013 made significant changes to the benefits for members first hired on or after January 1, 2013, to perform CalSTRS creditable activities, and other changes that affect both new and existing members. As a result, CalSTRS now has two benefit structures:
• Members first hired on or before December 31, 2012, are under CalSTRS 2% at 60.
• Members first hired on or after January 1, 2013, are under CalSTRS 2% at 62.”
Under CalSTRS’s new pension benefit formulas, which are marginally less generous than their old pension benefit formulas, if you retire at age 65, you are entitled to an “Age Factor” of 2.4% (ref. column 4 in the table on CalSTRS “Age Factor” information page).
Immediately one may see that earning a pension equivalent to the amount CalSTRS represents as “average,” 56% of final salary, would require a participant to work for 23.3 years, since 23.3 x 2.5% = 56%. Referring to the table depicting Case 1, above, this means that to earn a pension that exceeds the Social Security benefit by the amounts pertaining to various levels of final salary between $40,000 and $80,000 – all quite significant – one would only have to work 23 years.
For the sake of a fair comparison, however, it is necessary to examine the Social Security benefit at age 65, since that is how old a CalSTRS participant now must be before they can earn the maximum multiplier (or “Age Factor”) or 2.4%. This, in turn, requires one to speculate as to how many years a Social Security recipient would have to work in order to get the amount calculated by the “Quick Calculator” benefit estimator provided by the Social Security Administration.
Fortunately, in the “Frequently Asked Questions” section of the Social Security website, this can be found:
“8. How does the Quick Calculator estimate my past covered earnings? Answer: The calculator bases your estimated past earnings on the latest earnings figure you provide, the national average wage indexing series, and a relative growth factor that is initially set to 2 percent.”
Digging deeper, it can be seen from the Social Security website’s page “Benefit Calculation Examples For Workers Retiring In 2014,” that in these “Quick Calculator” estimates, as they put it, “We use the highest 35 years of indexed earnings in a benefit computation.” This is helpful for validating the assumptions necessary for a proper comparison at age 65. The Social Security estimates assume at least 35 years of work.
Here then, are the benefits one may expect from the revised, reformed and diminished CalSTRS benefit formulas, compared to the current Social Security retirement benefit formulas, for a 65 year old retiree who has worked for 35 years. This shows the same final annual income variants as case 1, ranging from $40,000 to $80,000.
Case 2: CalSTRS Pension vs. Social Security
Retirement Age 65, Various Final Year Earnings
As is readily apparent on the above table, working for 35 years creates a major improvement in the pension benefits enjoyed by a CalSTRS participant; instead of collecting the average 56% of final salary at an average age of 62, by age 65 – if they have worked 35 years – they will collect a pension equivalent to 84% of their final salary. For a Social Security participant, waiting an extra three years to retire scarcely makes a difference. Depending on their income, they will collect at retirement benefit equivalent to somewhere between 30% and 35% of their final year of earnings.
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(3) But CalSTRS participants contribute 8.0% of their salary into the pension fund, and Social Security participants only contribute 6.2% of their salary into the Social Security fund. What’s that worth?
Before answering this question, it should be intuitively obvious that contributing 1.8% more into a fund will not fund a lifetime retirement annuity that is between 1.5 and 2.8 times greater than if one had retained the 1.8% asZ take-home pay.
The table below shows in detail exactly how much more money someone might be able to save over the course of a 35 year career by putting 1.8% of their paycheck into a fund that yielded 7.5% annual interest.
Case 3: CalSTRS Pension vs. Social Security
Additional Savings Possible By Contributing 1.8% More Per Year
As shown above, after 35 years, putting an extra 1.8% of earnings per year into an investment fund will only increase the total savings by $155,814 (contributions of $37,438 plus investment earnings of $118,376). At age 65, as shown in Case 2, a CalSTRS participant who worked 35 years and retired at a final salary of $80,000 (also used in this case) will earn an initial annual pension of $67,200. A Social Security participant, using identical assumptions, can expect an initial annual retirement benefit of $23,940, a difference of $43,260 per year. This means the extra withholding made by the CalSTRS participant earns an extra amount, $155,814, that is used up in 3.6 years.
According to the online Life Expectancy Calculator provided by the Social Security Administration, in 2014 a 65 year old American may expect to live, on average, for another 20 years. This means that contributing another 1.8% on the part of CalSTRS participants compared to Social Security participants will still leave, on average, a gap of $709,386 in lower benefits earned by the Social Security recipient (16.4 x $43,260).
Because much has been made of the extra amount CalSTRS participants have withheld, it is important to emphasize that every assumption used in this analysis is conservative. The “growth factor on past earnings” is only 2%, matching the one used by the Social Security Administration in their estimates. This low percentage is unlikely to accurately reflect earnings growth, especially in the public sector, where in general over the past three decades earnings growth has kept pace with inflation. Using a lower than representative growth factor of 2.0%, working backwards from the present into the past, results in early career pay estimates that are higher than what probably was the case. This causes the early career contributions to be overstated, causing compound interest to accrue on larger amounts, resulting in a larger ending fund balance than would have actually been achieved.
Similarly, this example uses a 7.5% earnings estimate throughout. While CalSTRS claims to have achieved this result historically, it is not clear they will be able to achieve it in the future, for a variety of macroeconomic reasons that are the topic of ongoing debate.
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About the Author:
Ed Ring is the executive director for the California Policy Center where he oversees execution of the Center’s strategic plan. He is also the editor of ProsperityCalifornia.org and UnionWatch.org. Previously as a consultant and full-time employee primarily for start-up companies in the Silicon Valley, Ring has done financial accounting for over 20 years, and brings this expertise to his analysis and commentary on issues of public sector finance. Ring has an MBA in Finance from the University of Southern California, and a BA in Political Science from UC Davis.