Police Officer Retirement Plan, Is Your Pension Enough?

Retirement looks different for individuals depending on the field of work that they are in. Depending on your occupation, you have varying degrees of income, and therefore a different number of years that are respectively spent working toward retirement, and actually spent in retirement. Different occupations also include different retirement benefits, which may include options such as 401ks, insurance, and in particular cases, pensions. Law enforcement officers play a particularly important role in the maintenance of societal structures and despite their fundamental role to the success and safety of their fellow citizens, can face some particularly challenging retirement prospects when compared to other occupational fields.

Pensions

Law enforcement officers are among a small list of other occupations including teachers, government officials, insurance employees, and nurses that are offered the benefit of pension plans. Pensions include the pooling of money by an employer that is set aside and invested on behalf of the employees, for their use when the time of retirement comes. There are two distinct types of pension plans that differ in the method by which the money is pooled and distributed.

The two types of pension plans are Defined-Benefit plans and Defined-Contribution plans. With the former, employers determine a definite amount of benefit distributed when the time comes for one of their employees to retire. The amount that is given to their retired employee is based on a calculation conducted by taking into account variables such as that individual’s pre-retirement earnings, as well as the number of years that the employee worked prior to retirement. The funds are guaranteed to the individual regardless of the performance of the investments in the larger pool, and the organization/business that you previously worked for is liable to cover the cost of all payments, even when the investment funds are unable to cover the cost. These payments are made for the remainder of the retired person’s life, and sometimes the benefits are even transferred over to that individual’s spouse after they pass away.

In the second type of pension plan, the Defined-Contribution plan, companies pool money for their employees’ retirement-payment in the form of contributions that are made (to varying degrees) by matching the contribution of the employer themself. A further determination of the amount that the individual receives is based upon the performance of the investments in the company pool. Since the organization/company makes matched contributions, they lose their liability to ensure the payments are made once the individual retires. 

Pensions For Law Enforcement Personnel

Defined-Contribution plans are much less expensive than Defined-Benefits plans, which has resulted in the large popularity of Defined-Contribution plans. A more popular and better-understood example of these plans would be 401k retirement plans. Since 401k plans have developed into such a popular option in their own right, the term ‘pension’ is now usually reserved for circumstances of Defined-Benefit plans.

Today, the Bureau of Labor Statistics suggests that roughly 90% of public employees and 10% of private employees are offered Defined-Benefit plans. Included within this group of public employees, is law enforcement personnel. Even though Defined-Contribution plans shift the liability of the retirement funds to the employee’s former place of employment, will Defined-Contribution pension plans be enough?

A Closer Look at Defined-Benefit Plans

In order for an individual employed by law enforcement to be qualified for their pension plan, they must meet certain qualifications that are particular to the state that they retire in. There are also different determinants for the amount of benefit that you are entitled to based on the state you’re employed in. 

In most states, law enforcement officers must have reached the age of 55 and they must have served for a minimum of 20 years to collect benefits. Normally, the retirement benefit for the retired individual is 50% of the base salary of an officer at the same location, at the time of their retirement. Some states may add additional stipulations to the benefits agreement that allow for increased rates of benefit for more than 20 years served. Another example of how benefits could be determined would be to utilize a formula. In the state of New Hampshire for example, this rate is determined by multiplying the average of the individual’s top-three earning years by the number of years, then by 2 percent.

The good news about pension plans such as this one is that there is much more clarity as to the sort of income that you can expect to be earning in retirement. While you may earn more than 50% of an officer’s base salary if you work more than 20 years, you at least have a base understanding of what income you’ll have (and if it ends up being more, all the better for you!). After this is determined, you’ll have a better idea of what other plans you may need to put in place in order to end up with a successful retirement situation.

Running Through the Numbers

So how much will you actually have as a law enforcement officer once you do retire? To have a more clear understanding of decision making, we can run a calculation to determine this amount. As we said before, the determining factor depends on the specific stipulations of the pension plan in your state, however for this example we will move forward with an assumption that your plan provides benefits at a rate of 50% of an officer’s base salary, per year.

The average police officer salary in the United States is $54,616 in 2020. So at 50%, retirement income would annually provide about $27,308 before taxes. Since money is contributed to your pension on a pre-tax basis, the money will be taxed at the income bracket your annual withdrawals would accompany. With this money alone, you may find yourself being taxed on as much as 12% of this income which could reduce your annual withdrawals to around $24,000. 

Depending on the way that you plan to spend your retirement, this could fall short of the needs or plans you have put in place for yourself. In less than ideal situations, it could become necessary for you to work a part-time position to supplement the pension benefits you’re receiving. If your state offers the stipulation to your pension plan, there could be an additional benefit to working past the decided upon service period of 20 years in order to receive higher than 50% of the salary on an annual basis. Per year, this amount could be an added 2-2.5% depending on the state you reside in. Still, you must consider whether working additional years past your desired point of retirement is more beneficial than taking advantage of other potential retirement savings vehicles.

Weak Points of Pension Plans

Other than the potential low level of retirement income benefits, pensions have become less popularly used for several reasons. While increased technologies and medical advancements have allowed us to live longer lives, benefit payment plans could run into issues down the road as more and more people live longer and longer, and therefore need more money than was needed before. Adding to the issue is the possibility of payment gaps between the pool of money collected by the state-run retirement plans, and those hoping to receive benefits from that pool. This issue could become increasingly pervasive for the reason discussed previously, in terms of the generally increased lifespan of individuals receiving pension benefits.

Other than changes taking place with the actual pension system itself, there are additional factors to take into account that could change the amount of income that you require in retirement. More than just the missed-opportunity for desired travels/purchases when you retire, your health as you age becomes a larger consideration for your financial success. Medical costs can be quite expensive as we age and inevitably fall victim to the challenges of old age. You also have the prospect of additional costs in retirement such as those associated with a growing family (grandkids), who you will most likely be wanting to devote your time and resources to.

Options When Pensions Fall Short

While the option of taking an additional part-time job in retirement is most likely not your first choice, there are luckily several other financial vehicles that can make sustained retirement living possible without the need to continue your employment (at any level). Many non-employee-sponsored retirement accounts can be opened which allows for increased saving and retirement income possibilities. With the particular versatility of the pension system, you’ll most likely want more sources of income to draw on when the time of retirement comes.

IRA Accounts

One option that is suggested for individuals to take advantage of whether they are going to receive a pension plan or not, is to open up an Individual Retirement Account (IRA). These types of accounts come in two different forms: Roth IRAs, and Traditional IRAs. The difference between these two types of accounts is attributable to the point at which the income you’re contributing to the account becomes taxed.

With Roth IRA accounts, money is taxed up-front, meaning that all money that ends up in the account, as well as any money that would have compounded and grown, can be withdrawn without the need to pay taxes on them. Traditional IRA accounts on the other hand, are taxed at the annual income bracket you are at when you withdraw the money in retirement. Based on this alone, it makes the most sense for an individual who expects to be in a higher tax bracket when they retire than they are in currently, to open a Roth IRA account. On the other hand, an individual who expects to be in a lower tax bracket in retirement is better suited for a Traditional IRA account.

Maximum contributions for both accounts are the same, however Traditional IRA accounts mandate specified required minimum distributions (RMD) from the account beginning at the age of 72. Roth accounts don’t include RMD, however an added stipulation for Roth accounts is that it must have been open for at least 5 years before the individual is allowed to withdraw any money. Additionally, regardless of the account type, you are able to access the funds in the account after the age of 59.5 (longer in the case of having a Roth account open for less than 5 years).

Other Considerations

Other than IRA accounts, there are additional options to consider in choosing the best option for your retirement plans. You might consider vehicles such as savings accounts, CDs, mutual funds, or a variety of additional investment options that can supplement your pension. Having more than one retirement savings account provides you with tax diversification.

Since pension benefits are taxed when you make withdrawals, you may want to consider opening an additional account that is guaranteed to you such as a Roth IRA which is free to grow and not limited by the prospect of required minimum distributions if you don’t need access to the money right away. The longer the money stays in the account, the more it will grow for your future use, or to pass along to your family and loved ones. This way, you can make withdrawals on the accounts that require distributions, while still having a nest egg that continues to grow.

Retirement planning is a complex process that requires individuals to look far into the future and make an investment today in order to stay on track with their goals for the future. Pensions (in the more traditional sense of the word) are becoming somewhat of a rarity, and with increased speculation as to their reliability as a source of income in retirement, it’s never been more important for individuals in occupations such as law enforcement to diversify the options that they have available to them. Your financial advisor can help you to come up with a plan that employs whatever retirement savings plan you might already have in place, with additional resources that will help you to realize the full extent of your retirement goals. Put a plan in place today by contacting your advisor, to ensure that when the time comes to exit the labor force, you can do so gracefully with the resources that you need.

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