With a pension, additional savings, and personalized advice all in a row! Teachers are underpaid, overworked, and rarely given the respect they deserve, and that includes how they are advised (or rather the lack of it) when it comes to their retirement planning. Let’s look at how you can become retirement ready when the time comes.
Social Security Options And CALSTRS - What’s the downside?
As a California public school educator and a participating member of CalSTRS, you do not pay into Social Security and, therefore, will not receive a Social Security benefit for your CalSTRS-covered employment. You may be eligible for Social Security benefits from other employment or your spouse but beware of two federal rules—the Windfall Elimination Provision and the Government Pension Offset. These two rules are just what their names imply: offsets or elimination of a portion of the Social Security benefit. However, these rules do not work in reverse, and any Social Security benefit you may receive in retirement has no impact or reduction on your CalSTRS pension benefit.
What is my CalSTRS pension, and how is it calculated?
Let’s begin with what a pension is...it’s a Defined Benefit plan. The key word is benefit - your employer bears all of the risk and responsibility to fund the pension plan for your benefit. You do not have the ability to access this bucket of money until you retire.
If my employer has all this responsibility, how do I know what my pension benefit will be? The pension benefit is a factor of Age at retirement, Years of Service, and Final compensation. This calculation provides an expected percentage of your final compensation that you will receive as a pension benefit. On average, the typical pension provides only 50%-60% of an educator’s final pay in retirement. Can you live on 50%-60% of your pay now? Chances are you won’t be able to in retirement either. Ouch! What can you do to make up this income gap?
Hello Additional Savings… also known as a Defined Contribution Plan
What is an Additional Savings Plan? It is a Defined Contribution plan, commonly known as a 403(b) or 457 plan. The key word is Contribution…made by you from your monthly earnings. You bear all the risk and responsibility to make additional retirement contributions, so there isn’t an income gap in retirement.
Typically, most educators need 80%-90% of their pre-retirement income when they retire. That leaves an income gap of 30%-40%! How can the Defined Contribution plan help me close the income gap? Most often, educators utilize pre-tax contributions. Why? Contributions are made on a pre-tax basis reducing taxable income during their careers, especially if they pay taxes based on a two-income household. Pre-tax contributions grow tax-free until retirement, when withdrawals are taxed as ordinary income.
A growing number of educators also make after-tax or post-tax "Roth" 403(b) or Roth 457 contributions. Roth contributions will not reduce taxable income, but they do grow tax-free. At retirement, withdrawals from your Roth retirement accounts will not be taxed.
Limitations: whether you choose to make pre-tax 403(b)/457 contributions, Roth 403(b/457) contributions, or a combination of the two, it’s important to note that total contributions cannot exceed the annual contribution limit set by the IRS. For 2023 educators 49 and younger may contribute up to $22,500 (a $2,000 increase from 2022). Those aged 50 and above may contribute an additional $7,500 in catch-up contributions (a $1,000 increase from 2022) for a total of $30,000.
Your Future Is With Vector Wealth
Teachers are some of the most influential people in the world. They help shape our future, so they must have the proper support. Teachers should never feel alone, fearful or helpless when it comes to their finances. Making pre-tax, Roth, or a combination of these two types of contributions is an area where we see a real disservice to our educators. Though one contribution option may seem better than another, a full understanding of the tax consequences in retirement is paramount. Please consult with your trusted tax and financial advisor to design a contribution plan that specifically meets your goals for and in retirement. Don’t have trusted advisors? Let Vector Wealth Management and our team help you plan accordingly to ensure you are retirement ready when the time comes. Retirement shouldn't be scary; it should be a time of fearless financial freedom!