Their needs are the same, but the tools are different
Retirement Planning for Teachers
by Gary Foreman
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Whether you're just starting a career or nearing the end, planning for retirement is important for everyone. Teachers are no exception. They face the same challenges we all do (having enough money to last through our retirement years), but they do have some different retirement vehicles with which to work.
To help us learn more about the retirement planning decisions that teachers face, we contacted Certified Financial Planner® Justin Rush. Mr. Rush specializes in working with teachers in Ohio and is the founder of JGR Financial in Northeast Ohio.
Q: What makes the 403(b) plans so popular for retirement savings?
Mr. Rush: 403(b) plans are typically available to employees of certain tax-exempt organizations and educational institutions. They are popular savings vehicles for several reasons, but perhaps the greatest factors are: 1) Employers promote them as an employee benefit and 2) Contributions are usually automatically deducted from a participant's paycheck, thus making it very easy to contribute to the plan.
Q: Most people who are eligible for 403(b) plans are also eligible for a pension. When choosing options, should those plans be coordinated?
Mr. Rush: When eligible for a 403(b) and pension, the plans should be coordinated. In particular, employees should consider the potential future benefits derived from each plan. This requires careful planning and attention to cash flow needs, taxes, and other sources of future income (e.g. Social Security, investments, and maybe even other pensions).
In addition, some employers offer a Roth 403(b) option, which is slightly different from the traditional 403(b) plan. When participating in a traditional 403(b) plan, employee contributions lower their taxable income today. However, distributions later in life are taxable. In contrast, participants in a Roth 403(b) receive no tax benefit today. However, provided certain criteria are met, earnings grow tax-free and distributions later in life are received tax-free.
A typical pension will be taxable upon receipt so it's important to weigh the tax consequence of this stream of income with other potential sources of retirement income, such as a traditional or Roth 403(b).
Q: Should teachers consider other retirement plan options?
Mr. Rush: Absolutely! As mentioned above, it's important that teachers evaluate their 403(b) options (e.g. Traditional vs Roth).
In many cases, however, the 403(b) may not be the best option at all. Many 403(b) plans have very high expenses and limited investment options. In such case, a traditional IRA or Roth IRA may be a better retirement plan savings option.
Similar to a traditional 403(b), a traditional IRA provides a tax break today. However, distributions received later in life are taxable. A Roth IRA provides no tax benefit today. However, earnings may grow tax-free and distributions later in life may be received tax-free.
IRAs have lower contribution limits than a 403(b) plan and are subject to certain income limitations that may disqualify a teacher from participating in the first place. However, these are two options that should at least be considered as their expenses may be significantly lower than 403(b) plans and they may also provide greater investment flexibility.
Q: How do retirement goals play into the decision making process?
Mr. Rush: Understanding short- and long-term goals plays a key role in determining which retirement savings option is best for you. For some people, setting goals may seem overwhelming, and rather than letting long-term planning be a barrier to saving for retirement, I'd encourage them to simply save as much as possible to any of the plans previously mentioned.
However, for those willing to do some planning upfront, they'll be in a better situation to maximize their retirement savings potential. The following are some items to consider when planning for retirement that should help you decide what type of retirement plan is best for your situation:
- How long do you need to work to meet retirement spending goals and what might future expenses look like?
- Will you be eligible for multiple sources of retirement income? If so, how do they all work together? Common sources of retirement income include pension(s), Social Security, and investment income.
- Given your anticipated retirement income, what are taxes projected to be?
Q: Most retirement plans limit investment options. How can teachers get proper diversification among the various plans?
Mr. Rush: IRAs typically provide more investment options than a 403(b) plan. As mentioned above, it's important to consider all plans you are eligible for and investment flexibility and diversification is a key reason for doing so.
Q: Taxes play a big role in terms of which retirement accounts should be accessed first. Is each case unique? Or are there some general rules that apply to everyone?
Mr. Rush: Each case is unique when it comes to planning to minimize taxes in retirement. However, to the extent someone may "diversify" their sources of retirement income by saving to various types of accounts while working, they may create future tax planning opportunities.
For example, if you receive pension income and also take distributions from a traditional 403(b) during retirement, both sources of income are likely fully taxable. Whereas, if you receive pension income and also take distributions from a Roth 403(b) or Roth IRA during retirement, the pension will likely be fully taxable, but the Roth account(s) may provide tax-free income. The different tax treatment of these sources of income may enable you to optimize your tax situation, especially if you must coordinate your retirement income with other income your spouse is eligible for (e.g. Social Security).
Just like it's important to diversify investment holdings, it's important to diversify retirement savings by making use of accounts that have various tax benefits (and consequences) today and in the future.
Justin Rush is a Certified Financial Planner®, member of the Finance for Teachers Network (http://advisors.financeforteachersnetwork.com/), and NAPFA member (napfa.org). His specialty is working with teachers in Ohio at various stages of their career. For more information for teachers visit his blog at jgrfinancial.com.
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