Why Your Pension May Not Be Enough

Pensions are not as straight forward as you may think. Most of us signed up for this career with the thought of a pension being all we needed for retirement.

Unfortunately, our pensions may be giving us a false sense of security, which leads us to believe that additional saving and investing are unnecessary. However, this can be a dangerous outlook. 

Relying On A Government Pension

Local, state, and federal governments provide public sector employees with varying plans depending on age, amount of time in service, and employment levels within a particular field such as public safety. There are complicated formulas to determine precisely how much you can expect to receive in retirement, but often these figures are less than you would expect or require.

Many states have recently implemented pension “tier” systems where benefits are reduced for employees who are enrolled in the pension system after certain dates.

Pension reform, reduced benefits, and pension funding deficits have made it apparent that having additional income outside of our pension check may be required to enjoy a comfortable retirement..

Calculating Your Pension Benefit: How Much Will You Get?

For this example, we’ll pick the State of New Jersey (since this is where I am a police officer), to illustrate how pensions could measure up to current salaries. 

In New Jersey, pensions for local and county police, firefighters, correctional officers, and other public safety workers are all calculated the same way:

For this example, we will only look at Tier 1 benefits, although New Jersey does have three tiers of pension benefits based upon enrollment date.

Tier 1 Pension Benefits In New Jersey

Members receive 65% of their final compensation at 25 years of service (any age). The average final compensation of a police officer in New Jersey is $105,106. Final compensation is usually calculated by your last working year’s salary, which is also typically your highest salary during your career. Again, this will vary by state.

Therefore, a police officer who retires after 25 years of service with a final compensation of $105,106 would receive an annual pension benefit of $68,318.90.

Not too shabby, but where do we make up the other 35% of our salary, which equates to $36,787.10 per year? Remember, we still pay income tax on our pensions, and many of us will have additional costs in retirement that were taken as payroll deductions during our working years, such as health benefits.

Pension Formulas Throughout The United States

If you are outside of New Jersey, you can find your individual state’s pension formula on the National Conference of State Legislatures website. In New Jersey, there are no Social Security benefits to supplement public sector pensions.

NJ public safety workers are not eligible for social security benefits unless they held secondary employment or previous employment where they were able to accrue credits. So, unless we downsize or simplify our lives in retirement (which is not always an option), how do we generate more income? In most cases upon retirement, public safety workers will be taking a pay cut right from the get-go.

Should I Put Off Retirement?

While many of us are counting the days until we can retire, it may be worth it to put off retirement for a year or so after your eligible retirement age. New Jersey offers an additional 1% per year for each year of service after 25 years.

For example, at 30 years of service, the annual pension benefit would increase to 70%. Again, this applies to Tier 1 members. Sorry to all those new guys and gals out there. New Jersey does mandate that you retire by age 65 (70 if you’re the chief of police), and overtime is not included in your final compensation number.

Don’t worry; there are plenty of other things you can aside from working longer.

Note: For our examples, we’ve provided reference states that don’t offer Social Security benefits in addition to pensions. Keep in mind, some states do offer social security benefits to first responders.

According to the Social Security Administration, the average social security monthly payment is $1,335. While rare, some of you may be eligible to receive both a pension and Social Security income. If this is the case, you’re in a pretty strong position for retirement. But read on – we have some more information for you. 

Don’t Ignore These Retirement Financial Concerns

Upon retirement, your expenses may and probably will change. However, maybe you downsize your house, or the kids go off to college, making trips to the grocery store less expensive, so stretching your dollar a little thinner doesn’t necessarily worry you. But we all know life has a way of throwing unexpected financial issues at us.

Concern #1: Length Of Retirement Is Increasing

People are living longer. According to the National Institution of Aging, in 2010, there were approximately 524 million people who were age 65 or older. This trend is expected to continue with this number growing to 1.5 billion by 2050.

The good news is we are living longer, but that means we are going to need even more money for retirement.

Are you prepared for that?

Concern #2: Pension Gaps

As we continue to live longer, the state and city-run pension plans continue to struggle with funding. Will there be enough for everyone in retirement? This is definitely a concern in New Jersey. According to research from the Pew Charitable Trusts, nationwide pension systems recorded a $968 billion shortfall in 2013 (the most recent data). This shortfall included the promised pension benefits and the available funding in the coffers. Some states, like New Jersey and Texas, have even more significant pension gap issues. The New Jersey Police & Fire Pension is currently hovering around $49 billion in unfunded liabilities (not good).

Concern #3: Health Decline

As you can imagine, the longer you live, the more medical care you will need. With the increase in medical costs, we also need to account for these retirement expenses as well. What if you need long-term care? This can get mighty expensive.

Concern #4: Personal & Life Changes

Add in a few grandkids, and you may find yourself spending even more money when you’re older. Living paycheck to paycheck in retirement will not be a fun way to spend your golden years when you should be going on family vacations or traveling to visit family.

You won’t live forever, and you don’t want to miss out on life’s special moments because retirement planning wasn’t a priority when you were younger.

Concern #5: Life Always Happens

Murphy’s law always seems to happen at the most inconvenient time. Reaching that “vested” milestone for your retirement is often more difficult than first responders think. Life could get in the way of achieving that pension milestone, which could throw a major wrench in your retirement plans.

There are a million scenarios we could get into here. The bottom line; expect the unexpected.

Assessing your pension situation may give you the motivation to come up with a Plan B and even a Plan C when it comes to your retirement planning. 

Save For Retirement By Paying Yourself First

The earlier you save and invest, the larger your nest egg will be when you retire. (Don’t panic if you’re nearing retirement – better late than never when it comes to savings – but earlier is undoubtedly better).

While having a pension when you retire is incredible, we can’t rely on it to be our only source of retirement income. The unknowns in retirement do not work well in conjunction with a single source of income. Luckily, there are several options we can do to increase our quality of life when we retire.

Choose An Investment Strategy To Fully Fund Retirement

Many of us have other retirement accounts, such as the ones listed below. Most private-sector employees have to rely solely on their savings, so first responders do have a leg up. But that doesn’t mean we shouldn’t be saving on our own.

Most public safety employees have a 457b plan or other deferred compensation plans through their employer, which is in some ways similar to an IRA (similar – not the same).

Here are some of the advantages and downfalls with each traditional account type:

Roth IRA

Traditional IRA

Traditional IRAs can be volatile, are tax-deferred, and fees can be high depending upon the investments within.

An IRA or Roth IRA is not in and of itself an investment. They are simply tax codes. Growth and performance within these account types will vary greatly depending on the assets you hold.

Mutual Funds

Mutual Funds are subject to loss, they can have high fees & sales charges, but can help you diversify. Growth in a non-qualified account may be eligible for capital gains tax rates. Non-qualified brokerage accounts are liquid at any age.

457b Plan

Subject to loss, no guaranteed income in most cases, fees can be high, and growth is tax-deferred. 457’s can offer liquidity before age 59 1/2 in certain scenarios.

403b Plan

Subject to loss, no guaranteed income in most cases, fees can be high, growth is tax-deferred. There can be a 10% penalty on withdrawals before age 59 1/2.

*457b and 403b plans vary greatly depending upon your employer’s investment options and how the accounts are structured (i.e., variable annuity). Contributions to these retirement accounts can reduce your taxable income for the year in which you contribute.

Certificate of Deposit (CDs)

Typically low-interest rates, not always 100% liquid.

Regular Savings Account

Little to no growth in most cases but almost always 100% liquid. Almost equivalent to putting your money under the mattress. You’ll notice there’s a lot of “subject to loss” and “volatility” above. How can we reduce that if you’re a conservative to a moderate investor?

*None of these accounts provide guaranteed lifetime income like a pension does except for maybe a savings account, but you’re not even getting enough growth to pace inflation.

Making The Most Out Of Your Investments

Once you have accumulated funds in any of these accounts, it is essential to see how they will be taxed; and how and at what age they can produce income for you. If you haven’t started saving yet, these could be considerations you make before choosing an account type.

Once you retire, accumulated funds within these accounts can be transferred or rolled over into several different annuities, which can act very similarly to a pension. They provide total principal protection (they eliminate loss and volatility) and also offer yearly guaranteed income payments, just like a pension does.

In some cases, the income can even increase year after year to offset inflation. For example, you can take a lump sum from a 457b plan and transform it into a yearly income that will also be guaranteed. The exact income numbers will depend upon your age and accumulated funds.

An annuity is the closest thing to a defined benefit pension. It is basically like your own private pension plan. In retirement, it is essential to remember that it’s not all about the nest egg; it is about the cash flow – cash flow is king!

The only difference between an annuity and a pension is that instead of being funded by a local, county, or state government (like your pension check), an annuity payment is supported by an insurance company (make sure you pick one that has strong financial ratings).

With an annuity, you could be looking at two checks every month that are guaranteed for life – your pension check & an annuity check.

It’s important to remember that a lump sum in a retirement account does not do us much good if we’re going to lose a large percentage of it to taxes or if we can’t turn it into a lifetime income stream. You have to turn your accounts into cash-flowing assets.

Pay Yourself First!

If you’re still working, you should be contributing a percentage of each paycheck towards some type of supplemental retirement account. This could be a privately owned Roth IRA or an employer-sponsored 457b plan. However, in many cases, there’s no employer match for public safety and other public sector employees.

Shelter Portions Of Your Money

If you are still relatively young and have many working years left, better alternatives or additions to your Roth or Traditional IRA could be an indexed universal life policy (IUL) or an indexed whole life policy (IWL).

Simply, how this works as a financial vehicle is that the policy has a cash account that is “indexed” to a stock market index. This means that in years when a particular market index, such as the S&P 500, The Dow or NASDAQ has a negative return, your account does not lose value. You have what is called a floor of “0.” The worst-case scenario is that your cash will remain level.

However, in years where the market index goes up, your account grows. This eliminates the risk of loss and takes market volatility out of the equation as you are still able to participate in some market gains but do not expose your cash value to any losses, negative years, or bear markets. The cash account could also have a fixed rate of return (i.e., 3% or 4%).

Pay Attention To Tax Benefits

Also, the cash value within this type of account is protected from income tax. It is protected as long as the policy is not over-funded to the point that it becomes a MEC or Modified Endowment Contract (this is a nice retirement perk) as most retirement accounts are just tax-deferred.

As long as you follow the funding rules, an IUL or an IWL is BOTH tax-deferred and tax-free. There is no other financial vehicle that offers this benefit. A small monthly contribution throughout your career could allow this account to multiply since it has what is called an annual reset feature allowing all gains to be locked in and added to your principle.

In 457b, IRA, and 401K accounts, all of your profits are also subject to loss if you have a market-based investment, but not with the IUL or IWL. Therefore, your cash compounds and grows very quickly. Then when you retire, you can draw from your cash tax-free—pretty sweet deal.

What I Do For Retirement

With all of that being said, I often get asked what “I do” for my retirement. Personally, I contribute to a 457b plan through payroll deductions at my police department.

In addition, I have several Roth IRA accounts (I tend to prefer getting my taxes out of the way now) with varying investments. I have a non-qualified indexed annuity, and I own both an IUL and an IWL. I have contributed to all these plans/accounts for most of my career.

I also don’t live in my car and eat Ramen Noodles to do this. I simply pay myself first and treat these retirement contributions like other bills I might have since my plan is to be completely retired by the age of 45. I include this segment to show what’s possible with some simple planning and implementation. It all comes down to priorities within your budget and paying yourself first (I keep saying it because it’s important).

Track And Calculate Your Retirement Contributions

Compound interest calculators can help you understand how compound interest works. With a retirement calculator, you can keep track of your monthly additions and contributions, current principal, and interest/growth rate on your retirement accounts. Believe it or not, but you may enjoy watching how fast your money is growing in value. 

Building a nest egg can be transformed into a cash-flowing asset to supplement your pension. With this strategy, understanding how much you should invest each month, and mitigating risk is crucial.

Once your nest egg is built, you can turn that into another guaranteed income stream in addition to your pension with the use of a variety of indexed annuity accounts (I mentioned this before).

Wrapping It Up

Yes, pensions are helpful. But pensions are not guaranteed to ensure you will retire comfortably. There are too many variables in life, and a pension should not be your sole retirement plan. Instead, it should be part of a complete retirement income plan.

Avoid trusting the government to take care of you when you retire. Retirement should be when you can finally slow down and enjoy everything you have worked so hard for over the years. To achieve this goal, a plan must be in place. You only get one life, prepare now so you can live your retirement the way you want. Time is the one thing you’ll never be able to get back (deep, I know).

To Your Retirement…

If you’re concerned about retirement, click here to schedule a free call with Gary