As an educator, you have a unique set of financial considerations that don’t affect other professionals.
Teachers may be eligible for a state-sponsored pension plan. These pension programs vary by state and eligibility is usually contingent on years of service, but they are specifically created to help teachers with retirement planning. And even if you are eligible for a pension, do you know if it is going to provide you with enough income in your retirement years? Now is a good time to find out.
Preparing for retirement as a teacher takes the same thoughtful financial planning as any other individual planning for retirement. However, the added complexity that comes with managing your pension benefits and the other financial tools you have access to can lead to potential missteps if you aren’t careful.
Considerations Concerning Your Pension
Know How Long You Are Required to Work to Receive the Full Amount of Your Pension
If you retire too soon, you may not receive the full amount of your pension. Most, if not all, pension programs require a certain amount of years of service in order to receive the full pension amount. The Teachers’ Retirement System has what is known as a ‘cliff’ when it comes to vesting. The cliff merely refers to the amount of service credits required to qualify for a lifetime pension.
Being aware of your service credits prior to retirement will help ensure that you don’t retire without satisfying the minimum of 10 years of service credits. Learn the rules of your specific pension program so that you can plan your retirement accordingly. In the state of Alabama, for instance, The Retirement Systems of Alabama offers retirement resources to teachers so that you can fully understand your service benefits. Here’s what you need to know if you are a teacher in Alabama.
Tier I versus Tier 2 Employees in The Retirement System of Alabama
Tier 1 plan member: Any member of the Retirement System who received service credit in the Employees’ Retirement System or in the Teachers’ Retirement System prior to January 1, 2013.
- You have at least 10 years of service credit and have attained the age of 60.
- You have accumulated 25 years of service credit at any age.
Tier 2 plan member: Any member of the Retirement System who first began eligible employment with an Employees’ Retirement System or the Teachers’ Retirement System on or after January 1, 2013, and who had no eligible service in the Employees’ Retirement System or the Teachers’ Retirement System prior to January 1, 2013.
- You have at least 10 years of service credit and have attained the age of 62.
If you are a Tier 1 employee, you contribute 7½ percent of your earnable compensation. Your pension is based on the average of the highest three years out of your last 10 years of employment. This number is then multiplied by the number of years of employment, times a benefit factor of approximately 2 percent.
To calculate your full benefit, you take the Average Final Salary x Years and Months of Service x Benefit Factor ÷ 12 = Maximum Monthly Benefit.
Average Final Salary: $42,000
Service Credit: 27 years and 6 months
$42,000 x 27.5 x 2% ÷ 12 = $1,925 per month
If you are a Tier 2 employee, you contribute 6 percent of your earnable compensation. Your pension is based on the average of your highest earning 5 years out of your last 10 years of employment, multiplied by the number of years of employment, times a benefit factor of 1.65 percent.
Average Final Salary: $42,000
Service Credit: 27 years and 6 months
$42,000 x 27.5 x .0165 ÷ 12 = $1,588.13 per month
Take Advantage of a Defined Contribution Plan
The type of retirement plans we discussed above are known as Defined Benefit Retirement Plans (DB). The amount paid to a retiree under such a plan is typically based on a fairly simple formula like the one I shared previously. It takes into account the years of employment and the employee’s compensation during the last few years of service.
Defined Contribution (DC) Plans, on the other hand, are designed to build assets that are owned by the individual with the intent that those funds would be used to supplement retirement in whichever fashion the retiree chooses.
The most well-known variety of a Defined Contribution Plan is the 401(k) in the private sector. Other types of DC plans are commonly known as 457(b) and 403(b) plans and are the most widely utilized DC plans for teachers and other municipal employees.
The biggest advantage of a 457(b) plan over a 401(k) plan is that there is no 10 percent penalty for withdrawals prior to age 59½. but you would still have to pay ordinary income tax on the withdrawal. A second advantage for the RSA 457 plan is the ability to make larger than normal deferrals in the last 3 years of service before retirement. If you did not defer the maximum deferral amount in the years beginning with 1986 and were eligible to participate, you may “catch-up” unused eligible amounts for one to three years. This is only possible if you are within three years of normal retirement age and are eligible for an unreduced pension. The maximum annual deferral is $36,000 in 2017. The normal maximum deferral for a 401(k) for a person age 50 or older is limited to $24,000.
The Retirement Systems of Alabama offers a 457(b) plan known as RSA-1.
Understanding the Benefits of Your 457(b) and 403(b) Plans:
- You don’t pay income tax on allowable contributions until you begin making withdrawals from the plan, usually after you retire. Allowable contributions to a 457(b) plan are either excluded or deducted from your income.
- Earnings on the amount in your 403(b) or 457(b) aren’t taxed until they are withdrawn
- You are allowed to defer up to $18,000 per year of salary in 2017 if you are under the age of 50. Anyone 50 or older may defer up to $24,000 in 2017.
- A 457(b) or 403(b) plan may be used to bridge the gap between: a) leaving employment and later becoming eligible to draw retirement at age 60 or 62, or b) the gap if you begin retirement before you are eligible for Social Security benefits.
Utilize Tax-Efficient Investment Tools
If you decide not to make tax-deferred contributions to a Defined Contribution plan like a 457(b) or 403(b), then you may still be able to contribute to another type of tax-advantaged plan known as a Roth IRA. You would normally set this type of plan up as an individual, outside your teacher retirement plan.
Funds like this work to supplement your regular retirement account, and the gains grow tax-free. Roth IRA contributions are made in after-tax dollars, which means that you pay tax on your principal contributions (when you put money into the account), but qualified distributions will never be taxed.
Current rules for this tax-efficient vehicle for the 2017 fiscal year include:
- Modified gross income limit: single individual must earn less than $133,000, couples filing jointly must earn less than $196,000.
- Maximum contribution limit: single individual is capped at $5,500, the contribution limit is $6,500 for individuals over the age of 50.
Plan for What Comes After Your Teaching Career
Knowing what comes next is a natural step toward a comfortable retirement. This is especially true if you retire before you begin collecting your retirement benefits.
If there is going to be a gap between retirement and when you begin receiving distributions, you’ll need a way to bridge the income gap. Knowing the tools available to help bridge this gap is essential. Some teachers can accomplish this via non-retirement investment vehicles, while others decide to work in some other field after they leave the classroom. In either case, having a plan makes all the difference.
Information is one of your best resources when planning for your retirement. Know that as a teacher you have many retirement tools available to you that are intended to help you retire successfully. Leveraging these tools to maximize your chances for success is an opportunity you have today.
You have worked hard to be able to retire comfortably. Having a plan and sound guidance can help make this transition financially worry-free. If any of these topics raise questions for you, we would love to talk to you about ways we can help with making good decisions about planning for and transitioning to retirement.