A Method for Identifying Salary Spiking: An Assessment of Pensionable Compensation and Reform in Illinois

Defined benefit (DB) pension systems determine the size of pension payments using an employee’s “final average salary”. Thus, employees enrolled in DB pension systems face an incentive to “salary spike” – strategically increase late career pensionable compensation – to increase their retirement income. This is an important issue given that public pension systems face increasing scrutiny due to ongoing concerns about their fiscal sustainability. This paper develops an empirical method to quantify the prevalence of salary spiking by identifying cases where end-of-career compensation deviates from expected levels of compensation. We apply this method to the teacher pension systems in Illinois and examine how salary spiking changed in response to policy reform. The results suggest that salary spiking is very common, with about half of late career employees observed as having pensionable compensation that exceeds expectations. Policies designed to dissuade salary spiking by internalizing its costs across districts appear to reduce the prevalence of salary spiking, but there may be unintended consequences for individuals who are not actually spiking, as such discouraging the assignment of supplementary responsibilities to late career employees.