The original premise for a 403(b) plan was to allow for additional retirement income to be saved by employees of public schools and non-profit 501(c)(3) organizations. However, there’s recently been a movement to get rid of or decrease the pensions’ benefits.
This puts mounting pressure on the 403(b) plan to become the core source of income. In my home state of Illinois, the cost of living adjustment in state run pension plans for public school teachers is under fire. If you’re a teacher and the cost of living adjustment is cut from the pension, that means your cost of living adjustment may need to come entirely from your 403(b) plan contributions.
Calculating your 403(b) need
Before calculating how much income to plan for from your 403(b), we must start with how much money you want to live off annually when you retire. If you have a spouse or partner, what income do you need from their contribution? What do they need from you? Then, we look at your potential sources of income.
- Will you be receiving any pensions? Do they have cost of living adjustments or are they fixed? If you have survivor benefit, it is important to calculate all your income options. Do not assume that a 50% survivorship benefit is adequate for spouse and any dependents.
- Will you be receiving Social Security? If so, how much Social Security will you be receiving? I have seen statements from Social Security, including my own, that say somewhere around 2040 that I will only receive 75% of what it’s telling me today. What is your thought on how the Social Security system crisis will get resolved? Unlike pensions, Social Security does have a cost of living adjustment.
Let’s say that you expect Social Security or your pension to provide $26,000 and you want to live on $50,000. That means that your 403(b) needs to create $24,000 annually, or $2000 a month, in income. The following hypothetical uses the following assumptions:
- You have not saved any money so far.
- You are 40 and plan work to age 70.
- You’ll live to a healthy age 100 based on medical advances.
- Investment returns average a 7% return before retirement (after fees).
- Investment returns average a 7% return after retirement (after fees).
- Inflation or cost of living (COLA) increases at a rate of 3.72%.
You would need to save $10,000 per year, increasing by 5% per year (e.g. $10,500 in year 2). A 403(b) plan allows you to save $18,500 per year in 2018 and $6,000 more per year (for a total of $24,500) when you reach 50. This answer is based on simply spending as you need. These are gross numbers as future tax rules are impossible to predict.
Of course, no one knows how long they will live, so this may or may not be enough. There are other strategies such as using a single premium fixed annuity with a COLA which would alter how much you need to accumulate. There are several benefits with a single premium fixed annuity with a COLA:
- Provide for and tailor a survivor benefit that does not have to be a spouse.
- Shift the risk of outliving your money to an insurance company/companies.
- Hedge the risk of outlasting your money. You won’t run out based on their claims paying ability.
- Diversify the risk of insolvency. You can’t do that with a pension.
- Increase payments for life. If you pick a 3% COLA adjustment your $2,000 payment at age 70, this becomes $4,000 24 years later.
On the flip side, you lose the premium you gave them. This allows them to pool the risk among other fixed annuity investors. This is just like a pension. There is no money left over to provide for children or charities, just one survivor. Don’t let the term fixed annuity throw you, it’s essentially what most pensions leverage when it’s time to payout.
Need help calculating your 403(b) needs?
None of my clients and prospects that have 403(b)s ever told me they received education on their 403(b) plan from their employers. Not too surprising considering it was originally thought to be a supplement to other sources of income. I’ve talked to some sponsors of 403(b) plans and their feeling is that their people are on their own to make their own choices. I find this surprising. It’s not clear what one should do besides save money and I guess hope for the best regarding their investments. In academia, I find this puzzling as investing is taught in business schools by their own professors. If you’re like a lot of people, math was not your best subject. Ideally, this education would come from your employers.
Since that is rarely the case, you may want someone to help you strategize the best way to use your 403(b) and customize a detailed plan for you. Look for credentials such as the Charter Retirement Planning Counselor® or Certified Financial PlannerTM professional. Take the step towards tailoring a plan that you will be comfortable in implementing to meet your unique retirement needs.
James Brewer is a Certified Financial Planner™ (CFP®) and president of Envision Wealth Planning in Chicago, IL who uses Financial Life Planning as a tool to propel client’s values, goals, and passions forward.
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