Teaching Retirement: Navigating The Investment Maze

Teachers have a number of options when it comes to investing for retirement. It's important to start saving early to meet your financial goals. While pensions are available to teachers, they are notoriously unreliable as they are underfunded in most states. Teachers can also take advantage of tax-advantaged retirement savings programs such as 403(b) and 457(b) plans, which are similar to 401(k) plans. These plans allow teachers to contribute money during their working years, with the funds growing tax-advantaged until retirement. Additionally, teachers can invest in Individual Retirement Accounts (IRAs), which offer tax advantages and flexibility in investment choices. It's crucial for teachers to carefully consider their investment options and seek professional advice to ensure a comfortable retirement.

Pension plans

In California, teachers pay into the State Teacher Retirement System (STRS). Teachers automatically join the pension system with their first paycheck, and a portion of their gross pay (about 10%) is contributed to the system. After retirement, teachers receive payments from STRS. The pension formula depends on three things: end-of-career pay, the number of years teaching in California public schools, and age at retirement.

The pension system in California has undergone changes to ensure sustainability. For teachers hired after 1 January 2014, the system is described as 2% at 62, meaning those who retire at 62 generally receive an annual retirement benefit for life equal to 2% of their final salary times the number of years served. For teachers hired before this date, the system is described as 2% at 60, which offers full lifetime retirement benefits earlier.

In addition to pension plans, teachers may also have access to defined contribution plans, such as 403(b) and 457(b) plans. These plans are tax-advantaged retirement savings programs where the employee or employer may contribute to the employee's individual account. The employee bears the investment risk.

Social Security

In the US, teachers' access to Social Security depends on the state they work in. In some states, teachers are covered by Social Security, while in others, they are not. There are currently 11 states that have opted out of Social Security for teachers: Alaska, California, Colorado, Connecticut, Illinois, Louisiana, Maine, Massachusetts, Missouri, Nevada, and Ohio. Three more states have varying degrees of coverage in different school districts: Georgia, Kentucky, and Rhode Island. This means that teachers in these states may not be eligible for Social Security retirement benefits and will instead rely on their pension plans.

The history of this discrepancy dates back to the formation of Social Security, which initially excluded state and local workers due to constitutional concerns about federal taxation of states. In the 1950s, the law was amended to allow state and local governments to enroll their employees in Social Security, but not all states opted in. As a result, teachers in certain states are covered by pension plans instead of Social Security.

For teachers who are covered by Social Security, it is important to understand how their benefits will be calculated. The Windfall Elimination Provision (WEP) and the Government Pension Offset (GPO) are two rules that can impact Social Security benefits for teachers. The WEP affects individuals who are eligible for Social Security based on their work history but also have a pension from work where they did not pay Social Security tax. It results in a recalculation of Social Security benefits, leading to a lower benefit amount. On the other hand, the GPO applies to individuals who are entitled to Social Security spousal or survivor benefits and have a government pension. In this case, the Social Security benefit is reduced by two-thirds of the monthly pension amount.

To summarize, Social Security coverage for teachers varies across the US. While some states include teachers in Social Security, others provide alternative pension plans. Teachers should be aware of the rules and regulations regarding their retirement benefits, especially if they have worked in multiple states or have a spouse with Social Security benefits. By understanding the intricacies of Social Security and pension plans, teachers can make informed decisions about their financial future.

Investment plans

As a teacher, you may have two types of defined contribution investment plans available to you: 403(b) and 457(b) plans. These are tax-advantaged retirement savings programs provided by certain employers. The earlier you start investing, the more your savings and investments will grow over time due to compound interest, helping you reach your investment goals with less money out of pocket.

With a 403(b) plan, you can have money deducted from your paycheck and put into your chosen investments. In 2023, the IRS's contribution limit was $22,500. In 2024, it is $23,000. Your contributions are generally tax-deductible, and your investment earnings are tax-deferred; you pay tax on that money only when you make withdrawals in retirement. If you'd prefer to pay the taxes now instead of when you retire, you can contribute to a Roth 403(b) instead if your employer offers the option.

Your employer may make matching contributions to your 403(b) plan, although that's less common than with 401(k) plans. For example, your employer might match 50% of your contributions, up to 6% of your salary. So if you earn $75,000 and contribute at least 6% of your salary to the plan, your employer would kick in an additional $2,250. That's essentially free money for retirement.

You may be able to have both a 403(b) plan and a 457(b) plan. If you work for a public school district, you may be able to participate in a 457(b) plan in addition to or instead of a 403(b) plan. As with 403(b) plans, your 457(b) contributions come directly out of your salary, and your money grows tax-deferred until you withdraw it.

If you work for a private school that is classified as a tax-exempt organization, you may not have access to a 457(b) unless you are a highly compensated employee; those are the federal government’s rules. One downside of 457(b) plans is that employers usually don’t provide matching contributions. But there’s also an upside: when you leave your job, you can start taking distributions from your 457(b) without penalty, even if you haven’t reached retirement age.

If you’re considering early retirement or early partial retirement, a 457(b) can help you fund that goal. With both 403(b) and 457(b) plans, your contributions were limited to $22,500 per year in 2023 and are limited to $23,000 in 2024. If you are over 50, your plan may allow an additional catch-up contribution of $7,500 in 2024, the same as in 2023.

But there’s another perk with 457(b)s: participating in one doesn’t preclude you from contributing up to the maximum to a 403(b). If you maxed out your contributions to both a 457(b) and a 403(b) in 2023, you’d be putting away a whopping $45,000 ($46,000 in 2024)—more if you're over 50. And with a 457(b), when you’re three years away from the plan’s stated retirement age, you can opt to start saving even more—either twice the annual limit or the sum of the current year’s limit and any unused portions of previous years’ contribution limits, whichever is less.

Whether you participate in a 403(b), 457(b), or both, make sure you understand the fees associated with both the plan itself and the investments offered within it before you contribute. Particularly if your employer provides no match, you might consider contributing to a traditional IRA or Roth IRA. You will enjoy a wider selection of investment options than in the employer plans and fees that may be significantly lower.

Tax-advantaged retirement accounts

• B) Plans
• B) plans are tax-advantaged retirement savings programs offered to teachers and other employees of public educational institutions, certain non-profits, and churches or church-related organizations. They are similar to 401(k) plans, allowing you to contribute pre-tax money directly from your paycheck to invest in certain products. The investments grow tax-deferred, and you pay taxes only when you make withdrawals in retirement. Some employers may also contribute to your 403(b) plan, providing a great opportunity to boost your savings.
• B) Plans
• B) plans are also tax-advantaged retirement savings programs, but they are offered by state and local government agencies and certain non-profit organizations. Like 403(b) plans, they do not promise a specific payment upon retirement, and the employee bears the investment risk. These plans offer flexibility, as you can start taking distributions without penalty when you leave your job, even if you haven't reached retirement age. Additionally, if your employer offers both a 457(b) and a 403(b) plan, you can contribute to both, maximizing your tax-advantaged savings.

Traditional Individual Retirement Accounts (IRAs)

Traditional IRAs are tax-deferred savings accounts that allow you to contribute pre-tax money and defer taxes until you make withdrawals in retirement. These accounts are not tied to an employer, and anyone with taxable earnings can contribute, as long as they are below certain income limits. While the contribution limits are lower than employer-sponsored plans, IRAs offer more investment options and can be a great way to transfer money from a former employer's 401(k).

Roth IRAs

Roth IRAs are tax-advantaged accounts that are funded with after-tax money. While you don't get an immediate tax benefit, the earnings in these accounts grow tax-free, and qualified distributions can be made tax-free and penalty-free. There are income limits for contributing to Roth IRAs, but they are widely accessible to middle-class workers. Additionally, Roth IRAs do not have required minimum distributions (RMDs) and can be contributed to beyond the age of 70.

Health Savings Accounts (HSAs)

HSAs are tax-advantaged savings accounts designed for individuals with high-deductible health plans. Contributions to HSAs are tax-deductible, and the funds grow tax-free. While typically used for medical expenses, HSAs can also be used as a retirement savings vehicle. Withdrawals for non-medical expenses before age 65 are subject to income tax and a penalty, but after age 65, HSA distributions for non-medical expenses are taxed as income, similar to a traditional IRA.

529 Plans

While not specifically for retirement, 529 plans are tax-advantaged savings accounts that can be used for education expenses. These accounts are often used by parents or guardians to save for their child's future college or university tuition. Contributions to 529 plans are made with after-tax money and grow tax-deferred. Withdrawals for qualified education expenses are tax-free, making this a great way to save for education costs while reducing your tax burden.

Individual Retirement Accounts (IRAs)

A Traditional IRA is a tax-advantaged savings plan, where contributions may be tax-deductible. This means that the individual can deduct the amount they contribute to the IRA from their taxable income, reducing the amount of tax they pay. However, when money is withdrawn from the account, it is taxed as income.

A Roth IRA is also a tax-advantaged savings plan, but contributions are not tax-deductible. Instead, qualified distributions from a Roth IRA may be tax-free. This means that, unlike with a Traditional IRA, there is no tax to pay on withdrawals in retirement. Roth IRAs are often used by people who expect to be in a higher tax bracket when they retire, as they can pay taxes on the money now, rather than later.

There are several other, less common types of IRAs:

• Payroll Deduction IRA: Set up by an employer, allowing employees to make contributions by payroll deduction to an IRA they establish with a financial institution.
• SEP IRA: A Simplified Employee Pension plan set up by an employer, who contributes directly to an IRA set up for each employee.
• SIMPLE IRA: A Savings Incentive Match Plan for Employees set up by an employer, allowing employees to make salary reduction contributions, with the employer making matching or non-elective contributions.
• SARSEP: A Salary Reduction Simplified Employee Pension Plan, a type of SEP set up by an employer before 1997 that includes a salary reduction arrangement.

IRAs offer individuals a degree of flexibility and decision-making power over their retirement investments. However, it is important to note that some investments are not allowed in an IRA, and there are maximum amounts that can be contributed to these accounts each year. For example, for the 2024 tax year, the contribution limit for Roth IRAs is $5,500, while the limit for Traditional IRAs is $7,000 if you're under 50, and $8,000 if you're 50 or over.

Frequently asked questions