Pension plus savings vs defined contribution plan for new teacher

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psrande
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Pension plus savings vs defined contribution plan for new teacher

Post by psrande » Tue Jun 11, 2019 1:59 pm

Hello,

My daughter is entering the work force as a public school teacher. She has to choose between a pension plus savings plan or a defined contribution plan. I will provide the best details I have and would appreciate any feedback or comments regarding making a decision:

Pension plus savings:
2% employee contribution to Personal Healthcare Fund with 2% employer match
2% employee contribution to Retirement account with 1% employer match
6.2% employee contribution to Pension with 6.2% employer match
Annual pension payment is average of 5 highest consecutive years pay time 1.5% times number of years worked (example $50000 x 0.15 x 30 = $22500 per year). There is not a COLA increase. Must be vested for 10 years to receive pension. If she leaves before ten years then she gets 100% of employee contributions back plus interest but none of the employer contributions. Or she could leave funds in plan and start back if she returns to public school work in same state. The pension contribution rate could change every year. Currently you cannot start taking the pension until age 60.

Defined contribution plan:
2% employee contribution to Personal Healthcare Fund with 2% employer match (same as above)
3% employee contribution to Retirement account with 3% employer match plus additional 4% employer mandatory contribution (so 7% employer contribution if you contribute 3%)

For both programs:
The retirement account contributions are vested fully after 4 years of employment.
The employee retirement account contributions go into a 457.
The employer retirement account contributions go into a 401K.
The investment options in the retirement account of the Pension plan and the Defined contribution plan are the same.

Personal situation:
My daughter will most likely stay working in state for at least 4 years while boyfriend finishes graduate degree. Unclear if she will stay in state after that to get 10 years vested.

So bottom-line, unless we are missing something, it seems like you are contributing 10.2% to get 3% match and pension VS contributing 5% to get 9% match with no pension. We would appreciate any input.

Questions:

1) Assuming she stays at the same teaching job for her entire career, which would be a better option?
2) If she thinks she will leave before the 10 year vesting period, which would be better?

Thanks for you help!

ShowMeTheER
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Re: Pension plus savings vs defined contribution plan for new teacher

Post by ShowMeTheER » Wed Jun 12, 2019 5:31 am

Although not as lucrative as some teacher pensions, I still like the pension option. Very safe and provides a nice hedge to an otherwise defined contribution world.

If she bolts after five years or so, I don’t think there is a big loss in either case.

dknightd
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Re: Pension plus savings vs defined contribution plan for new teacher

Post by dknightd » Wed Jun 12, 2019 6:31 am

psrande wrote:
Tue Jun 11, 2019 1:59 pm

1) Assuming she stays at the same teaching job for her entire career, which would be a better option?
Likely the pension
psrande wrote:
Tue Jun 11, 2019 1:59 pm
2) If she thinks she will leave before the 10 year vesting period, which would be better?
Likely the defined contribution.

I had a similar decision to make when I started my job. I choose defined contribution.
At the time I was not sure how long I was going to stay there.

After 31 years I would have been slightly better off with pension. But I'm OK anyway.
I had no way of knowing I was going to stay in the same job for 31 years.
I don't regret my decision. It was probably the right one to make at the time.

She should look at the expense ratios for the defined contribution plan. Especially if there is more than one option.

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psrande
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Re: Pension plus savings vs defined contribution plan for new teacher

Post by psrande » Fri Jun 14, 2019 7:57 am

Thanks for the replies....

We realize that there is the personal decision of taking a pension plan with a guaranteed income in retirement vs taking the defined contribution plan that has a higher employer contribution but all the risks that come with managing your own retirement. Wondering if there is a "numbers" way to compare the options realizing that assumptions will have to be made. Thanks.

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dm200
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Re: Pension plus savings vs defined contribution plan for new teacher

Post by dm200 » Fri Jun 14, 2019 8:46 am

I lean towards the pension plus savings because that is more likely to provide that she will not outlive all her money.

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CyclingDuo
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Re: Pension plus savings vs defined contribution plan for new teacher

Post by CyclingDuo » Fri Jun 14, 2019 9:34 am

psrande wrote:
Fri Jun 14, 2019 7:57 am
Thanks for the replies....

We realize that there is the personal decision of taking a pension plan with a guaranteed income in retirement vs taking the defined contribution plan that has a higher employer contribution but all the risks that come with managing your own retirement. Wondering if there is a "numbers" way to compare the options realizing that assumptions will have to be made. Thanks.
You didn't mention in your daughter's particular state and if teachers also will get Social Security in retirement (not all states do).

The pension + savings plan, if staying long term in her state, looks to be an excellent choice and is designed by the district/state to retain teaching talent. The DB plan is designed for portability for employees who may not know their future in terms of teaching career longevity in general, or longevity of remaining in the state while teaching if they do stay in the career.

Although it may be difficult to look at the macro from this vantage point, trying to at least entertain it a bit and uncover potential options in the future could help when looking back to the current time frame to help select which plan to choose. You mentioned her boyfriend has plans to finish graduate school in 4 years. What career and what benefits will he potentially have if they remain together and become a dual income household? What are the chances of them remaining in the state compared to moving to another? It's a rather big decision to make if looking at the macro, but probably the best advice is to ignore the macro of including the boyfriend and what the dual income household and benefits could potentially be, and select a choice based on your daughter's career and income only at this point. The macro with both of them is just too unknown with regard to the future with her boyfriend. If they were married or about to be married, I would alter that opinion and focus in more on the combined macro rather than just entertain it a bit. However, since they are so young it is probably best to exclude him from the immediate decision making process, and only look at her career income.

One consolation for her travel and vacation plans, at least regarding other states, is that she will have time off during the summer months to enjoy what all teachers do: the ability to visit states and countries for vacation. This can help feed the wanderlust and experiences desires all those starting their careers out have. Your daughter has the option to set herself up to be financially independent staring her right in the face all on her own if she remained in the state for her teaching career and capitalized on the pension + savings plan with plenty of time to visit other locales during the time off months. Obviously, there are other factors involved to reach that FI (student loans, avoiding debt, and keeping expenses low, etc...).

When choosing the pension + savings plan (which has some of the money going into the risk portfolio) is setting herself up for the traditional three legged stool of retirement income stream: pension, social security (if your state's teachers qualify to receive it), risk portfolio (savings). Under such a three legged income stream in retirement scenario, there is a reason many teachers who live below their means are PAW's (prodigious accumulators of wealth).

Her contribution for the pension + savings plan would be 10.2%, and the employer would be contributing 9.2% for a combined total of 19.4% all set on automatic pilot. Since your daughter would only be contributing 10.2% from her salary to the pension + savings, she could very easily goose that by contributing to a Roth IRA and or a taxable account to build additional savings provided her expenses are low and she has enough salary to work with in the early years. She would also have the potential to take a side gig in the summer months that brings in some extra income which could be used for additional savings. The DB plan has a 9% contribution from the employer, but only 5% from your daughter's side. So if going that route, she would want to save an additional 5-10% on her own via a Roth IRA, a taxable account, etc... .

Still curious about the SS aspect for her as it helps address the best plan selection if we know she will or will not receive it in retirement.

The three legged stool is what we have in our state: social security, pension, personal savings (457b/403b)

Image

It's an important decision to make, but making a commitment to stay in the state with the pension + savings plan looks like a very viable option to set her up for the best success.

https://www.youtube.com/watch?v=5AjjNTYJ-Yg
Last edited by CyclingDuo on Fri Jun 14, 2019 10:27 am, edited 1 time in total.
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CyclingDuo
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Re: Pension plus savings vs defined contribution plan for new teacher

Post by CyclingDuo » Fri Jun 14, 2019 10:09 am

psrande wrote:
Fri Jun 14, 2019 7:57 am
Thanks for the replies....

We realize that there is the personal decision of taking a pension plan with a guaranteed income in retirement vs taking the defined contribution plan that has a higher employer contribution but all the risks that come with managing your own retirement. Wondering if there is a "numbers" way to compare the options realizing that assumptions will have to be made. Thanks.
You can run the calculations of what her full career contributions would mean in terms of what amount of annual pension she would receive, as well as use a calculator of what contributing $xxx amount of dollars each month into the risk portfolio portion of the + savings portion or the DB plan would return at say a 5 - 7% average return over her career to come up with the potential pools of money 30-35 years from now.

Example: if her pension would pay out $xx,xxx annually starting at age of 60 and you multiply that annual pension amount by a 25-30 year retirement period, it would let you know what size of a portfolio or non COLA SPIA one would need to match that level of annual pension income. If she would receive $40K annual pension x 25 = $1M. $40K x 30 = $1.2M.

Example for the + savings portion: 7% based on a $50K salary would be $291 monthly contributions (combination of the employee and employer contributions to the risk portfolio) at 5% growth would result in around $317K after 35 years at 5% growth, and $485K after 35 years at 7% growth.

Example for the DB plan: 14% based on a $50K salary would be $583 monthly contributions (combination of the employee and employer contributions to the risk portfolio) at 5% growth would result in around $635K after 35 years at 5% growth, and $973K after 35 years at 7% growth.

You can play around with the pension amount, salary amount, additional investments beyond her mandatory contributions for either plan if she contributed to a Roth IRA or taxable account, and return %'s, but it helps you get an idea of what the pension + savings plan would yield over a career compared to the DB risk portfolio only plans.
"Everywhere is within walking distance if you have the time." ~ Steven Wright

megabad
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Re: Pension plus savings vs defined contribution plan for new teacher

Post by megabad » Fri Jun 14, 2019 12:15 pm

psrande wrote:
Fri Jun 14, 2019 7:57 am
Thanks for the replies....

We realize that there is the personal decision of taking a pension plan with a guaranteed income in retirement vs taking the defined contribution plan that has a higher employer contribution but all the risks that come with managing your own retirement. Wondering if there is a "numbers" way to compare the options realizing that assumptions will have to be made. Thanks.
Yeah, I just took lifetime employer contributions for one option vs the other option + the pension. Basically I annuitize everything at time of separation using immediateannuities.com.

At 10 years, using my assumptions, you come out about 30% ahead by using the defined contribution only plan.

At 30 years, using my assumptions, you come out way way ahead (60+%) by using the pension.

I did not factor in survivor benefits. But in general I agree with other posters that the pension is the best option for a long term career in this position assuming the local government is not in dire financial straights. If employee intends to pursue another career in the future, I would just go all defined contribution instead. I am assuming the "Health Fund" above is an HSA. If not, than my numbers will be off.

ralph124cf
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Re: Pension plus savings vs defined contribution plan for new teacher

Post by ralph124cf » Fri Jun 14, 2019 12:35 pm

Some states give a pension instead of Social Security. If there is other work history, then SS is reduced by some percentage of the teacher's pension.

If she files for spousal SS benefits then these are also reduced.

For these reasons I would suggest the defined contribution plan.

Ralph

Sierra2016
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Re: Pension plus savings vs defined contribution plan for new teacher

Post by Sierra2016 » Fri Jun 14, 2019 1:10 pm

Unless the DC account was terminated before eligibility for retirement, she would be subject to the same SS reductions in the DC plan. According the SSA



Withdrawals of the employee's own contributions and interest made before the employee is eligible to receive a pension are not pensions for WEP purposes if the employee forfeits all rights to the pension. This rule applies even if the employer paid the employee contributions.

Withdrawals of the employee's own contributions and interest made after the employee is eligible to receive a pension are considered a lump-sum pension for WEP purposes.

Any separation payment, withdrawal, or refund consisting of both employer and employee contributions is a pension; for WEP purposes whether made before or after the employee is eligible to receive a pension.

Payments received from defined contribution plans (e.g., 401(k), 403(b), or 457 plans) based on non-covered employment are considered a pension subject to WEP regardless of the source of contributions (employer only, employee only, or a combination of both), if the plan is the primary retirement plan.

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dm200
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Re: Pension plus savings vs defined contribution plan for new teacher

Post by dm200 » Fri Jun 14, 2019 1:22 pm

ralph124cf wrote:
Fri Jun 14, 2019 12:35 pm
Some states give a pension instead of Social Security. If there is other work history, then SS is reduced by some percentage of the teacher's pension.
If she files for spousal SS benefits then these are also reduced.
For these reasons I would suggest the defined contribution plan.
Ralph
Not at all clear that the OP refers to situation of no Social Security.

I believe the WEP applies to those who do not "participate"in SS by paying SS retirement taxes. I think that would be the same for DB or DC.

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psrande
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Re: Pension plus savings vs defined contribution plan for new teacher

Post by psrande » Mon Jun 17, 2019 2:25 pm

Thanks again for all of the thoughtful replies.

Just to answer a few questions...the job is in Michigan and sounds like they do take FICA and Medicare taxes out of paycheck so they will get "normal" SS benefit.

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