Retirement ABC's for Teachers
For most teachers, retirement planning is a three-legged approach consisting of a teacher's pension, Social Security, and personal retirement accounts. It is important for teachers to understand each of these tools and determine what choices they can make to maximize their benefits.
Most public school districts participate in a high quality pension system, typically organized at the state level. Pensions follow a formula which determines a benefit percentage based on your number of years of service and age at retirement. The benefit percentage (for example, 50% or 63%) is multiplied by your final salary base to determine your pension payment. The calculation of the base salary varies from state to state, but may be the average of your highest three years of income, or it may be based solely on your last year, or even on another formula.
The way to increase your pension benefit amount is by maximizing your income during the final period that is used to calculate your benefit. You might increase your income by taking on additional duties, such as being department chair, or by teaching summer school. If your benefit percentage is 50%, you know that for every extra $1,000 you can make now, you'll receive $500 a year more in pension for the rest of your life.
Many employees with a pension will choose to retire early once they become eligible. While continuing to work will increase your benefit percentage, there is a definite allure to getting "paid" 50% of your salary to not work. If they choose, teachers who retire early from public schools can work in private schools or in another profession and will receive both their pension and their new salary.
State pension programs are costly and in some cases underfunded, so it is possible that some pensions could be discontinued in the future. Even if this happens, it is likely that current participants would be grandfathered into the benefits they have been guaranteed. It is a good idea to study your own pension program carefully and ask questions to understand what risks the plan faces. It is also possible that future earnings will not receive the same credit as past earnings when calculating pension benefits and that future benefits will not be as robust as they are today.
Last consideration: within their state, teachers may be able to change jobs and school districts with no impact on their pension. If you are considering moving out of state, however, you may be starting over in terms of pension eligibility.
In my home state of Texas, most public schools districts have opted out of the Social Security system. In other states, such as New York, teachers participate in both their own pension program and Social Security. If your state has opted out of Social Security, teachers do not have contributions withheld from their pay. However, this also means that your years of teaching will not make you eligible for a Social Security benefit. If you are not having money withheld for Social Security, you might consider setting aside some additional funds into a 403(b) or Individual Retirement Account (IRA).
If your state has opted out of Social Security, there are two ways that you might become eligible for a Social Security benefit: through your own earnings outside of teaching, or as a “spousal benefit” based on your spouse's Social Security benefit. In both cases, however, the Social Security benefit you receive may be reduced because of your teacher's pension. Here are the details:
1) Your individual Social Security benefit. If you work outside of teaching (before, after, or during your teaching career), you need 40 credits to be eligible for your own Social Security benefit. You receive 1 credit for earning $1,200, up to a maximum of 4 credits per year. To be eligible for Social Security, then, you need to make at least $4,800 (outside of teaching) for 10 years. Keep this in mind if you do retire early. If there is an opportunity for you to moonlight or freelance while teaching, you might also be helping to create a future Social Security benefit.
Unfortunately, Social Security looks at your other Government Pension benefits (such as a teacher's pension) and may reduce your SS benefit under an offset program called the Windfall Elimination Programi (WEP). I won't give the full calculation of how the WEP is determined, but for 2015, the maximum monthly reduction in SS benefits under the WEP is the lesser of $413 or one-half of your non-covered pensionii amount (i.e. teacher's pension, or other Federal, State, or Local pension). The WEP would apply to anyone who has both a state-sponsored teacher's pension and a Social Security benefit based on his or her own earnings.
However, there is a way to avoid the WEP and receive your full Social Security benefit. The WEP penalty is reduced and phased out if you have between 20 and 30 years of “substantial” Social Security contributions. For 2014, “substantial” means earnings of $21,750 or more, and this amount increases with inflation each year. If your state participates in both the state pension and Social Security, you are likely to meet the requirement to waive the WEP, and would receive your full SS Benefit provided you have 30 or more years of substantial Social Security contributions.
If your state has opted out of Social Security, however, it would be more difficult to meet the “substantial”
requirement through part-time or summer work. This means that for states that have opted out of Social Security, even if you qualify for a SS Benefit, it is likely to be reduced under the WEP.
2) Spousal Social Security benefit. If your spouse is eligible for Social Security, you may be eligible for a spousal benefit. At your full retirement age, you would be eligible to receive one-half of your spouse's primary insurance amount. While the WEP program described above reduces your own Social Security benefit, there is a similar penalty applied to spousal benefits, called the Government Pension Offsetiii (GPO).
If you're divorced, you are still eligible for a spousal benefit based on your ex-spouse's earnings, provided you were married for at least 10 years. And while the GPO applies to spousal benefits, we should note that neither the WEP nor the GPO would apply to Social Security survivor benefits for a spouse or minor children.
Unfortunately, Social Security statements do not include calculations of the WEP, GPO, or any details on spousal benefits. In other words, even though you receive a statement from the SSA showing you are eligible for a certain benefit amount, they do not calculate the WEP or GPO penalties until you actually retire and file for benefits. You can make an estimate of these penalties using the calculators available on the Social Security website, or by contacting your financial planner for assistance.
Retirement and Investment Accounts
In addition to pensions and Social Security, the third leg of retirement planning is what you save on your own. In addition to brokerage and saving accounts, teachers typically can contribute to a 403(b) plan through their employer, and may be eligible to participate in Individual Retirement Accounts (Traditional or Roth IRAs) outside of work. Teacher's pensions are good but by no means extravagant, so all teachers should be investing and not relying solely on their pensions.
A 403(b) is similar to a 401(k), but is specific to non-profit employers. A 403(b) plan provides a pre-tax contribution that is conveniently withheld directly from your paycheck. Unlike a 401(k), however, employers rarely make a match or contribution to an employee's 403(b). As a result, participation rates in 403(b) accounts are often lower than the 401(k) participation rate we typically see in the for-profit sector. However, 403(b) plans are a great tool for teachers to save for retirement and should not be overlooked.
A Traditional IRA is a good choice if you're eligible and looking for an additional tax deduction. If you don't need the tax deduction, a Roth IRA is a great choice for teachers, as the account will grow tax-free. Both your pension and Social Security benefits will be taxable, so adding a Roth IRA gives you one source of retirement income that you can access tax-free. The other benefit of an IRA is that it offers virtually unlimited investment options whereas a 403(b) plan typically restricts participants to choose from a handful of mutual funds.
There are two advantages of the 403(b) over a Traditional IRA: first, you can contribute up to $18,000 for 2015 ($24,000 if over age 50) to a 403(b), versus only $5,500 ($6,500 if over 50) to an IRA. Second, you may not be eligible for an IRA, based on your joint income, wheras you will always be eligible to participate in a 403(b) and take the full tax deduction. This is especially valuable for a family where the teacher's spouse has a high income and they want to maximize their joint savings and tax deductions.
Just as a stool needs all three legs to stand, teachers should be focusing on maximizing their retirement income through their pension, Social Security, and contributions to Retirement accounts. Together, these three components can provide a secure and comfortable retirement. All three pieces take many years to grow, so an early start is valuable, as is a consistent dedication to saving, investing, and learning.
If you have any questions on this article, please feel free to email me at firstname.lastname@example.org.
Dr. Scott Stratton, CFP®, CFA
Good Life Wealth Management LLC
iiWEP maximum penalty chart: http://www.socialsecurity.gov/retire2/wep-chart.htm