How California and School Districts Can Help Teachers Save for Retirement

While most observers agree that Southern California public school teachers should be better compensated, there is less agreement about how to pay for the added costs. Teachers’ salaries understandably dominate public discussion about compensation but one undervalued way of helping teachers is to improve their retirement savings options.

The United Teachers Los Angeles (UTLA) strike earlier this year was resolved, in part, by giving the Los Angeles Unified School District’s (LAUSD’s) teachers a pay increase. But the pay raises may not be fiscally sustainable, especially after voters resoundingly defeated a parcel tax the district had floated as a way to cover the costs of the new labor contract. Even if the measure had passed LAUSD’s long-term math might not have added up, but without the new revenue stream, the district is almost certainly careening toward a fiscal crisis.

LAUSD is in trouble, in part, because it has high fixed costs— administration, bond interest, and retiree health care benefits—that are being spread across a declining student population and the declining local control funding formula dollars. Absent a dramatic windfall of new state support, the district may well have to claw back the teacher raise, directly or indirectly, in coming years. LAUSD’s latest budget, for example, already includes a small reduction in health care subsidies for its Medicare-eligible retirees and future cuts may be in the offering.

In LAUSD and other school districts, many teachers save for retirement by placing some of their income in 403(b) plans. Like private sector 401(k) plans, 403(b) savings and investment gains aren’t taxed until the employee retires. One may wonder why teachers participate in these defined contribution retirement plans when they are already set to receive defined benefit pensions from the California State Teachers’ Retirement System (CalSTRS) — but many teachers understandably feel the need to supplement their pensions since CalSTRS members aren’t eligible for Social Security. New teachers receive two percent of their final compensation per year worked when they retire at age 62. So, if they teach for 30 years, they would retire on 60 percent of their final salary before taxes, which may not provide a comfortable living. Thus, teachers often use 403(b) plans to increase their retirement income.

While 403(b) plans have many similarities to 401(k) plans, there is one critical difference: many 403(b) savers invest in insurance products rather than mutual funds, stocks, and bonds – the staples of 401(k) plans. These insurance products often have high fees because the insurance provider must compensate its commissioned salespeople who sell their 403(b) offerings. Further, these products often have high surrender charges when they are cashed in so that the customers, teachers in this case, will hold them long enough to generate enough fee income to pay salespeople and boost the insurer’s bottom line. One popular 403(b) insurance product, for example, caps returns at three percent annually, has a 15 percent surrender fee and offers agents sales commissions of up to 11 percent. As a result, an army of commissioned agents targets teachers in CalSTRS with aggressive sales pitches for these projects.

But when teachers put their retirement savings into one of these insurance products, they effectively lose the option to later transfer their money into low-cost index funds due to the high surrender charges. CalSTRS and taxpayers would be well-served to encourage teachers to invest in more efficient options. CalSTRS actually offers a low cost 403(b) option called Pension2, but most teachers invest in insurance company products, perhaps because those are far more aggressively marketed to them.
Teachers are subjected to these aggressive sales tactics, in part, because of an obscure state law—Section 770.3 of California’s Insurance Code, which prevents school districts from negotiating terms with 403(b) providers. Although this section is commonly called the “any willing provider” provision, perhaps state law should be updated to clearly allow LAUSD and other school districts to make relatively low-cost 403(b) plans, like those from Vanguard and Fidelity, available to teachers. Similarly, the state could empower school districts to “default” teachers into the existing low-fee CalSTRS 403(b) plan while still allowing teachers the freedom to opt-out and choose any another plan.

The state and school districts should be eyeing simple reforms that could enable many more teachers to increase the amount they save for retirement, a development which should be welcomed across the political spectrum.

This column first appeared in the Orange County Register.