CHAPTER 1: Primary Retirement Plans

I speak to about five or six new public employees daily, three of whom will bashfully confess that they are “really bad at this stuff” and say things like, “I know nothing about money” and “I feel so embarrassed that I don’t understand my pension.”

If you are reading this and you just said, “Hey, that’ s me!” please, take a deep breath. None of this is quantum physics. (I actually do have a client who said all of those things to me who teaches, no joke, quantum physics.) You are not alone, and you ARE up to the task.

We’ re going to break this down, together, and you

’ re going to “get it” for the first time. And I’ m going to give you a massive long distance high five, an A+, and a shiny new apple.

Through this book I’ m going to explain these things and I sincerely apologize if my explanations are oversimplified. I promise I am neither intentionally nor unintentionally being condescending. It’ s just crazy important that I speak to everyone, regardless of their level of knowledge on the subject. For the record, I think most of my clients are way more capable than they think they are. Give yourself permission to say, “I think I get this!”

Before we go on though, why is all of this so confusing?

One of the culprits is time. Your pensions and other primary retirement plans aren ’t that complicated. Your state’ s pension website has a ton of useful info on it and the customer service reps and planners on the phones are extremely well informed and helpful. However, those pension system reps aren ’t exactly coming to you, so if you want to figure this stuff out, you need to seek the information out for yourself. But, many of you don’t even know what questions to ask, and you don’t have five minutes to pee let alone an hour-plus to wait on hold and have someone explain step-by-step how your retirement works.

We’ re going to take you through that in a way that won’t take a lot of your time.

You likely have a Primary Retirement Plan, which might be either a Pension Plan or some other type of Qualified Retirement Plan, and it’ s supposed to be the backbone of your retirement.

When you were hired, your employer likely set up a retirement plan for you, and you might contribute to it as well. Most pensions require mandatory employee contributions, and other qualified retirement plans typically provide you with an employee match only if you also make your own contributions. This money usually goes into one of two types of plans, Defined Benefit or Defined Contribution, and sometimes a combination of both.

Vesting- You always own the contributions you made to your retirement plan. Vesting is the amount of time you have to work for an employer until you own the contributions that the

employer made on your behalf. The question “Am I vested?” means,

“Am I entitled to receive all of the retirement benefits in this plan?” “What is the vesting period?” means, “How many years do I have to work before I am entitled to receive all of the benefits in this plan?”

Quick Overview

Two types of Primary Retirement Plans:

1. A Defined Benefit Pension PlanThis is an agreement between you and your employer, that if you work for a certain length of time and/or you are a certain age, you will earn a monthly payment from that employer for the rest of your life. It’ s called a Defined Benefit Pension Plan because it is defined not by how much money went into the plan in the first place, but by the benefit you will receive from it each year over the course of your lifetime. From now on we ’ re just going to call it a pension.

Now, the payments you will receive from the pension system will usually be significantly less than what you were making while you were working, but you should still be able to depend on this direct deposit or check on a monthly basis forever, because you earned it. Man did you earn it. It’ s important to note here that pension payments and the guarantees provided by a pension system are only as good as the pension system that is making them, as many states, companies, cities, etc. have underfunded pensions.

There is no one formula for determining what a pension will be. Pensions vary depending on what state you are in and who your employer is. Some states, like Florida, have one large State Pension System that applies to many people who work for the state: teachers, firefighters, police officers, correctional officers, and elected officials. Texas has a pension that is just for school employees. Teachers ’pensions in TX are larger than teachers ’ pensions in Florida, but in TX teachers do not pay into Social Security. My point is: they are all different.

To simplify this even more:

Pension = Monthly Check

I’ll be frank, pensions are not what they used to be, and they are getting worse not better. Your grandparents and mine had better pensions than you do and I’ m sure it never even crossed their minds to question their benefits, because they knew they would always be there. Today, sadly, things have changed. Pensions have massive commitments (in the trillions) and many of them are underfunded to some degree. In order to keep their promises to retirees they frequently ask working people to contribute more out of their own paychecks or reduce members ’ Cost of Living Adjustments.

Cost of Living Adjustment, COLA- is an increase in the amount of money a person receives annually to keep up with inflation. This is something you may receive in your normal pay while working and something that, we hope, applied to your pension benefits.

I’ m a huge fan of all period-piece drama and one of the shows I recently re-watched in its entirety was Mad Men. When I watch a show like that and they mention money, ex: Don gives his estranged brother an envelope with $4,000 in it. I immediately google: $4,000 in 1960, and I see that today that would be worth $34,647. Mind Blown. Now, 60 years is a long time, but let’ s consider half of that time, $4,000 in 1960 would be worth $17,662 in 1990. That’ s 30 years.

Many of the people I work with have their hearts set on retiring at 62 and these same people might very well live into their nineties. Bottom line, 30 years is a long time and the buying power of money is something that you cannot ignore when planning for retirement.

Pros and Cons of having a Pension:

Pros: • You get a check every month until you die • You might have some sort of cost of living adjustment on your pension. • You might have a survivorship option for a spouse if you die prematurely, but you usually have to choose it before retiring. • You can usually take a pension after a certain number of years of service regardless of how old you are. Ex: many teachers start working in their early twenties and are able to start taking a pension in their early to mid-fifties without penalties, where lump sum money is subject to penalties if you are under the age of 59.5 or 55 if fully retired.

Cons: • The survivorship options, especially for non-spouse beneficiaries like your kids, aren’t always the best. • Unless you have an option that allows you to get a lump sum of money, some states call it DROP or PLOP, LOL, your pension doesn’t have any liquid cash value. You can’t ask for an advance on next year’s pension if you have an emergency.

According to the Social Security Fact Sheet from December 2019, “49% of the workforce in private industry has no private pension coverage”.

https://www.ssa.gov/news/press/factsheets/basicfact-alt.pdf

2. Defined Contribution Plan-

If 49% or less of the country does not have a pension, then what do they have? Sadly, some have no retirement at all. But a good portion of workers in this country have what’s called a Defined Contribution Plan, which is defined by the contributions made to it (money paid in) and any gain or loss that money experiences based on the underlying investments inside the plan. If you or your spouse have ever worked for a private company, this plan would most likely be a 401(k). If you work for a public school, private school, or university, it’s most likely a 401(a) or a 403(b), maybe even a 457(b), or they could call it an ORP which is often a 403(b) with a fancy name.

For the purpose of this discussion those tax codes mean nothing. It’ s a Defined Contribution Plan but we ’ re going to call it a Qualified Retirement Plan.

The pros and cons of a Qualified Retirement Plan are:

Pros: • Your plan is liquid once you retire. You can use the money however you want, remembering that you do have to pay taxes on it when you start using the money. • You have more choices about how your money is invested. After you retire, you can take your money to whichever advisor or investment platform you want, or you can manage it yourself. • Typically, there are more survivorship options for non-spouse beneficiaries like kids. • Your plan is portable. If you switch jobs often or don’t plan on being at your job for a long time, this may be a better choice for you than a pension, which usually has longer vesting requirements. Cons: • You have to pay yourself out of the plan for the rest of your life—you have to make this last FOREVER. • Since you have to pay yourself for a lifetime and have no idea how long that will be, you may not really know how much you can afford to pay yourself. • You have to either manage the investments for yourself or choose someone to do it for you. • In most cases there are restrictions on when you can use your money without IRS tax penalty, so if you are younger than the plan allows, accessing your money might cost you an additional 10% penalty.

To simplify even more:

Defined Contribution Plan = Lump Sum

Now Stop

Take a minute and figure out what type of Primary Retirement Plan you have. Do you have a Pension Plan or a Qualified Retirement Plan?

If you have no idea which type of plan you have and would like some assistance figuring that out, you can contact your state or school’ s pension system. Ask them what type of plan you are in

and what your benefits will be when you retire. If you

’ ve moved around a lot and have service in a bunch of different states and schools, it’ s going to be more complicated. I often refer to this as a Retirement Treasure Hunt. Either way, the representatives on the phone are there to help you, do not feel shy or embarrassed about trying to track down six years of service you did in Virginia 25 years ago. If you have vested retirement benefits, you are entitled to them.

Tip: Call pension systems early in the day, it will be easier to get through and you may not wait on hold as long.

Paying Taxes

With both plans we

’ re going to discuss, neither you, nor your employer has paid any taxes on this money yet. So, when you take money out in retirement, you have to pay taxes on it. Sorry, no getting around that, really.

Social Security

I’m not going to go into the solvency of Social Security, not even a little bit. That’s not what this book is about. My point with bringing up Social Security is that the people I work with who are retiring when they are old enough to take full Social Security, or close to it, are in a far better position than those retiring earlier. This may seem obvious, but it’s worth mentioning. Many teachers start teaching in their early twenties and they want to be finished teaching in their mid-fifties, but unlike firefighters and police officers (whose pensions often cover 75% or more of their working salary) teachers’ pensions are usually far less generous. The earliest age a person can start receiving Social Security benefits (not disability) is currently 62, and the magical age one can enroll in Medicare is currently 65. A teacher retiring before he meets these benchmark ages, might find himself position where it’s hard to make ends meet.

Survivorship

I want to talk briefly about survivorship on a pension but since the rules differ vastly depending on where you live, we won’t be here for long.

If you are married, there are usually options where you can choose to take a smaller percentage on your pension for your lifetime with the stipulation that if you were to die before your spouse, your pension would continue for the rest of his or her lifetime. This option isn’t currently available for domestic partnerships, at least not in my home state.

In “Susan’s” hypothetical case, to choose a survivorship option for her spouse would be about a 20% reduction in her monthly benefit, so instead of Susan’s pension being $2,900 a month it would be $2,300 a month if she chooses the survivorship option. But if she were to pass away the pension would continue on for her husband or wife.

That’s almost $600 per month that Susan is, essentially, leaving with the state in order to have this protection. Is it worth it? Maybe?? It really depends on how long Susan lives.

Let’s just say, I’ve seen it both ways. Several times in my career I’ve experienced a client choosing an option without survivorship only to pass away after taking only a few pension checks, leaving their spouse (who really could have used the pension) SOL.

I’ve also seen people living on a pension from a deceased spouse and that’s a really nice gift someone can leave behind. Money isn’t everything, but money makes life a lot easier, especially when you are on your own.

I can’t make this decision for you and I’m even wary to make suggestions on this point. I can help weigh the pros and cons, but this truly is a personal decision that really needs to be made between two people in light of estimated financial need for both parties.

Life Insurance—Another Possible Solution

It’s a pretty common practice, and it’s not a bad idea, to not take the survivorship option on a pension and use all or part of the

difference between the two pension amounts to purchase a life insurance policy that would protect the surviving spouse in case the primary pension owner passes away prematurely.

It’s an excellent idea! But it’s not an idea without flaws or potential potholes. The most obvious being, life insurance, especially permanent (or “cash value”) insurance can be expensive and gets more expensive every year that you wait to buy it. And in most cases, you have to be healthy enough to qualify for it. So, while this is an excellent idea in theory, it’s an idea that usually works better when executed many years in advance of retirement, not on the day you fill out your exit papers.

If you are 65 and looking to purchase a permanent-life insurance policy for $500,000 it might cost anywhere from $500-$800 a month while the same coverage might cost between $300-$500 if you made the decision ten years earlier—far in advance of having to pull the trigger on the survivorship question.

Side note: There are some excellent polices out there that have optional riders built into them that you can purchase to cover long-term care, critical-illness, chronic-illness, and even disability. I mention this for a few reasons, the first is because I often see teachers’ paychecks listing payments for cancer, critical illness, accident etc. I want you to know that in most cases these types of coverages can be purchased elsewhere for more coverage and less out of pocket. The major benefit to the supplemental benefits that you might be paying for out of your check is just that, the convenience of having it come out of your check. And that you are probably just too busy to research these

policies and strategies on your own.

You really should have someone who knows what they are doing help you put a holistic plan together that addresses all your current and anticipated needs, as far in advance as possible. You should generally not cancel coverage before new coverage is in place and you should always be careful when replacing a policy that you’ve have had for a long time. We are here to help, e-mail info@presfinancial.com or call 877-216-9573.

Before we go on, I need you to go pull up on a computer screen, or better, print out a current paycheck. I want you to look for life insurance, cancer policies, critical illness policies, hospital indemnity policies, and disability policies. We’ll limit it to things that you are paying more than $10 per check to make things easier. Highlight them, and when you get time on your own or

with our help, I’d like you to call the individual companies and ask about your coverage.

Now, don’t put the check away! It’s your ticket to enter The 403(b) “Circus”.