Unique to the many occupational fields that Americans work in are a variety of retirement plan account options available to them. While the most popular form of retirement plan in the private sector is the 401(k), a number of occupational fields including teachers, police officers, government officials, insurance employees, and nurses are given the option of pension plans. Fundamental to the success of our education system is the contribution of teachers, given the essential task of educating our children, teaching them the essential skills that they’ll use for the rest of their lives. Despite their essential role in society, teachers are infamously under-compensated, and as such, face some difficult retirement prospects when compared to individuals in other fields. This article details some of the retirement plan options available to teachers in an effort to help them best make decisions that will set them up for the retirement that they envision for themselves in the present.
Defined-Benefit vs Defined-Contribution Plans
Pension plan options can be placed into one of two categories that differ on the basis of whether or not the funds in the account are reliant upon employee contributions (in addition to employer contributions), the length that the retirement benefits last, as well as whether or not the funds are guaranteed in retirement. The two categories are defined-benefit plans (most popularly seen in the form of ‘pensions’ as they’ve widely become known today) and defined-contribution plans (most popularly seen in the form of 401(k)s).
Pensions, as we’ve come to understand and know them today, are a type of defined-benefit plan that involves an employer setting aside and pooling an amount of money that is invested on behalf of their employees to be used once they reach the point of retirement. When it comes time for an employee to retire, the employer makes payment distributions of a defined amount, calculated on a basis of variables including the employee’s pre-retirement earnings, the number of years the employee worked prior to retirement, and the employee’s age. Whether the pooled investments perform well or not, employees are guaranteed distributions in retirement, even in those situations where the funds are not able to cover the cost of the distributions. The employer is liable to cover any distribution that is owed to its employees. Pension distributions are made from the start of retirement through the end of the employee’s life, while sometimes the benefits are even transferred to the employee’s spouse once they pass away.
On the other hand, defined-contribution plans involve the pooling of money by the employer in the form of contributions that are taken from the employee’s wages, which is then sometimes “matched” to varying degrees by the employer themself. Different from defined-benefit plans, the amount that the individual receives in retirement is reliant upon the performance of the investments in the pool of funds. The liability of the fund performance is passed along to the employee on the basis that the employer is matching contributions to the account. As previously mentioned, the most commonly seen form of defined-contribution plans are 401(k)s for private-sector jobs.
403(b) and 457(b) Plans
Since teachers are public sector employees, they are not offered 401(k)s, rather, they are sometimes offered 403(b)s or 457(b)s. Individuals working full time at a public school or tax-exempt private school should be eligible for one of these two types of defined-contribution plans (in addition to the traditional pension we discussed earlier).
403(b) plans most closely resemble 401(k) plans, and allow employees to make contributions to their retirement account that are drawn from their paycheck to put into investments of the employee’s choosing. Contributions are typically tax-deductible, and the earning on your investments are typically tax-deferred. Taxes are only paid when taking distributions on the account once in retirement. For teachers that are seeking to pay taxes when the money is put into the account, rather than when it is taken out, Roth 403(b) accounts are a better option. Contributions by employers are less common with 403(b)s than typical 401(k)s, yet even with just a 50% match to your contributions by your employer, this could lead to a significant impact on savings for your retirement.
For teachers working in public school districts, there may be the additional option of a 457(b) account in addition to or as an alternative to the 403(b). Similar to 401(k) plans and 403(b) plans, money is drawn directly from the employee’s paycheck in certain amounts and grows tax-deferred, only to be taxed once the money is withdrawn. However, one of the major downsides to 403(b) plans is that employers usually don’t provide contribution matching, which when provided, has the potential to grow the account value an additional significant amount. On a positive note, 403(b) plans don’t penalize the individual for taking distributions before a certain age. Hence, this plan is a great option for individuals looking to retire early or individuals looking to enter partial retirement.
Whether you have a 403(b) or a 457(b), each account is limited to $19,500 in contributions a year, unless you are over the age of 50, in which case your plan may allow additional catch-up contributions of $6,500 a year. One benefit of potentially utilizing both types of accounts would be the fact that participating in a 457(b) doesn’t limit you from maximizing contributions to your 403(b) as well. What’s more, is that once you are three years away from your plan’s stated retirement age, you are given the option to start saving even more: either twice the annual limit or the sum of the current year’s limit added to the unused portions of previous year’s contribution limits, whichever is less.
The Pension Debate
As a matter of comparison, the Bureau of Labor Statistics suggests that roughly 90% of employees in the public sector, and 10% of employees in the private sector are given the option of defined-benefit plans. Teachers are part of the group of public sector employees receiving pensions. Despite the attractive nature of these plans, pensions have come under a fair amount of attention in recent years as the potential for pensions to supply enough income in retirement has been a problem.
In order for teachers to qualify for their pension plan, there are specific criteria that must be met in order to actually receive payments once they retire. Depending on the state you live in, the criteria and specific qualifications to receive payments will vary. There will also be variants in the determining factors that help decipher how much money should be paid to the retired individual once they begin distributions from the pension.
As stated previously, the amount of money that you are entitled to as a retired employee will vary by state. Each state has varying determinants for when employees are eligible to receive pension benefits, as well as how much you are qualified to receive. Eligibility to receive pension benefits usually takes into account a number of factors including your age, as well as the number of years that you were employed. To start, pension plans often operate on a vesting schedule, which essentially dictates that you must have been employed for a certain number of years before you will be eligible to receive benefits once you retire. The number of years you must work to be eligible depends on the specification of the plan and typically ranges anywhere between 6 months to 5+ years.
One of the main critiques of teacher pensions lies within the vesting period. Slightly more than half of the new teachers won’t be employed for long enough in order to qualify for their promised pension amount. While these teachers will receive back their contributions to the pension fund, they will not receive the interest gained on their contributions, and they will additionally lose all of the contributions of their employer, which can be a sizable loss. Additionally, they lose out on the opportunity to receive payments for life in retirement. In these cases, teachers will be much better off having moved forward with alternative retirement plan options. Thus, the importance of choosing a retirement plan that accurately reflects how long you plan to teach cannot be understated.
Other than the likelihood that teachers may not be eligible to receive the benefits of their pension plan if they are not employed for long enough, pensions have generally become unpopular for a number of other reasons. In the 21st century, medical and technological advancements have prolonged the average length of time individuals are living, and thus, receiving annual payments under pension plans. This combination of increased lifespan and more payments to individuals on plans leads to the potential of a pay gap between the pool of money collected by state-run retirement plans and those that are receiving the benefits from the pension pool.
Additional downsides to pensions include the potential of increased expenses as you are in retirement for longer periods of time. It’s likely that your retirement goals include a number of desired travel plans and purchases that you’ve been working toward your entire career. Unfortunately, inevitable in the process of aging is the increased likelihood of incurring expensive medical costs. Other additional costs to consider as you age will include the prospect of costs associated with a growing family of grandchildren, who you will likely be devoting at least some portion of your time and income to as you age.
Variable Determinants For Eligibility and Distributions
When you are eligible to begin receiving pension benefits, and how much you will receive can be determined by a number of variables such as the number of years worked, your age, accrual factors, and your final average salary as a teacher. Many plans work on a “Rule of X” basis, which essentially states your age and number of years worked must add up to a certain amount before you are eligible to retire. For example, if a plan operates on the “Rule of 80,” a person must be old enough and have worked long enough to sum to 80. In this specific scenario, if a teacher begins working at the age of 24, after 28 years of teaching they will have reached the age of 52. 28 years of teaching plus 52 years of age, would sum to 80 and qualify this teacher eligible to receive pension retirement benefits.
Calculating how much is owed to the teacher in retirement also varies by state, and takes into account an average calculation of how much the teacher makes as well as a percentage factor agreed upon in the pension plan. The average salary calculation may take many forms including taking the average of the teacher’s final three years of teaching, an average of the teacher’s highest three compensation years, or an average of five consecutive years employed.
In a hypothetical situation, a teacher’s final average salary may be $75,000, they taught for a total of 37 years, and the pension plan has a factor percentage of 2.3%. Calculated out, 2.3% multiplied by 37 years and $75,000 a year, comes out to be $63,825 in annual benefit. A large benefit to pension plans is that you are able to calculate ahead of time how much you’ll be receiving in retirement, which gives you a better idea of the lifestyle that you’ll be able to afford once you get there. With other types of retirement plans, the account balance may depend on the performance of the investments in your account, which means that their sum is not necessarily guaranteed, and can be harder to estimate.
Putting A Plan In Place
Depending on your retirement goals, your pension could be risky to rely on for retirement alone. Since there is no way of ensuring you will work enough years to qualify for distribution in retirement, just as well as there’s no way of knowing that your annual benefit will be enough to cover costs in retirement, it is generally a good idea to have a contingency plan in place. Unless you are hoping to potentially take on an additional part-time position in retirement, there are a number of other financial vehicles that can better prepare you to live the kind of retirement that you’re hoping for.
Other accounts for teachers to consider might include the previously stated option of 403(b) or 457(b) plans. Outside of defined-benefit and defined contribution plans, there is always the potential to open traditional Individual Retirement Account (IRA) or Roth IRA accounts on your own. These two accounts, differing in their timelines for when the money is taxed, don’t require employee sponsorship and can provide a wider variety of investment selection to better diversify your retirement savings options. Pension benefits are taxed when you take distributions in retirement, so a Roth IRA could be a good option for those looking for a stable source of income in retirement, since the money is taxed when it enters the account, and can grow and be distributed tax-free.
With so many options for retirement accounts and conflicting messages on the best ways to achieve financial success by the time it comes for you to retire, the process of putting a plan in place can be overwhelming. By understanding the benefits and downfalls of the many types of accounts and investments available to teachers, they best prepare themselves for the time in life they spend so many years working toward and planning for throughout their careers.