Teachers, particularly those who work for the government, may have a pension plan as part of their compensation package. There are two main types of pension plans: defined benefit plans and defined contribution plans. Teachers commonly have a defined benefits plan, although this may vary in private school teaching. Pension funds are large institutional investors that are significant in many investment markets.
Defined Contribution Plans
A defined contribution pension plan allows employees to annually transfer some of their salary to a common investment fund, where it grows through further contributions and investment growth. The employer may also contribute to the plan. Several different types of defined contribution plans exist, with the 401(k) plan being perhaps the most well known. The amount of money that employers and employees may contribute each year depends on the type of plan and the tax year. These plans often have tax incentives to induce employees to contribute to them, such as tax deferral on contributions.
Defined Benefit Plans
A defined benefit plan sets a predefined level of benefits that eligible retirees will receive. Eligibility rules may include requirements for age and years of service. The monetary benefits may be a flat rate of money or be a percentage of the employee's final salary. Defined benefits plans may also provide health coverage benefits.
State Retirement Funds
Pension plans depend on having a pension fund to support the current and future liability of pension payments. Both types of pension plans operate using a pension fund that consists of the contributions, if any, of the participants. The funds must strike a balance between growth to meet future obligations and safety to satisfy current obligations. For this reason, pension funds make use of several asset classes, including stocks, bonds and fixed income. In the case of public teachers, each state has a Teachers' Retirement System that administers the pension fund for its teachers. The system is a defined benefits plan.
These plans are a significant obligation on the part of state and local governments. If the obligations exceed the amount of money currently in the fund, the excess liabilities are called unfunded, and may be expressed as a percentage of the total liabilities. For example, if a state has $1 million in unfunded liabilities with $10 million in total obligations in its pension funds, it is said to be 90 percent funded or 10 percent unfunded with respect to pensions. The burden of pension liabilities can affect the suitability of a state or local government for investment. If, for example, a city is selling municipal bonds but has an impending sharp increase in its amount of unfunded pension liabilities, it may be too risky to purchase those bonds.
Andrew Gellert is a graduate student who has written science, business, finance and economics articles for four years. He was also the editor of his own section of his college's newspaper, "The Cowl," and has published in his undergraduate economics department's newsletter.