Six years, three months, and fourteen days. If you have a countdown clock like this for your retirement, you might be a Police Officer. Law enforcement can be a rewarding and fulfilling career. On the other hand, that fulfillment can also come with stress, missed family gatherings, and unpredictable schedules.
For all the pros and cons of a career in law enforcement, an officer typically knows when it is time to hang it up and join the retiree club or the “check of the month club” as some like to call it.
Preparing to join this club is one of the most critical parts of your career. However, it is also one of the most overlooked aspects of your career. Not having a proper retirement/financial plan can be a recipe for disaster and ruin your future.
We will look at some of the most important aspects you should plan for and why police officers and law enforcement typically require more sophisticated financial advice than the average retiree.
Be sure to stick around until the end to see how you can get a free, personalized pension report (so long as you a member of a public, state pension system in any one of the fifty states – this includes any public employee).
Understanding Your Pension
A career in law enforcement can present some unique opportunities in retirement. The biggest opportunity is most retirees will often be entitled to receive a defined benefit pension payment.
It is critically important you fully understand what type of income your pension will provide to you in retirement. You must learn how it is taxed, and if there are any choices you will need to make when electing your benefit, such as beneficiary/survivor options.
Calculating Your Benefits
Most law enforcement pensions are calculated using a mathematical formula consisting of years of service, final salary, and sometimes age. However, the actual formula will vary significantly by state. Many pension systems are now moving towards a hybrid system for new members, which consists of a lower defined benefit pension plan combined with a separate investment account (similar to a 401k style plan).
The individual investment account is a defined contribution plan, meaning it typically will not pay a guaranteed or pre-determined benefit when you retire. It will be the retiree’s responsibility to convert those funds into income if they so wish.
Basically, you will simply have a lump sum in this account at retirement. This type of account is often held in mutual funds or annuities and may be subject to market volatility.
Why are pension plans doing this?
To shift the burden of having to provide guaranteed income from them over to YOU. It is now the responsibility of the officer to figure out how to make that money last their entire life. This has been happening in the private sector for years.
Tiered Retirement Systems
Additionally, many pension systems now also have a tiered system. With the tiered system, each tier will have its benefits, which are generally determined by the date of hire. For example, an officer hired before the year 2012 may only have to work twenty-five years to receive a full pension while an officer hired after the year 2012 may have to work thirty years to get full retirement. Again, these tiers are determined by the respective pension boards and will vary widely by state.
This is why we will be providing any reader with a personalized pension report if they would like to see the details of their plan!
Unknown Legislation Reforms
It is also vitally important to remember that even though pension plans are defined benefit plans, changes can still be made through legislation. This has happened in several states for both active and retired pension members.
Simply put, this means lawmakers can make changes to your pension, and there isn’t a whole lot that can be done about it. This seems to happen during and after major economic situations. Add the fact that many pension plans have billions of dollars in unfunded liabilities, and this just adds fuel to the fire.
I am worried about what pension legislation the future holds in the aftermath of the Covid-19 economic crisis. Just remember, pension reform usually indicates particular pension funds are not faring well or the economy is struggling.
Dealing With Inflation
Speaking of pension reform through legislation, many states are also eliminating the cost of living adjustments for retired officers. This will reduce the buying power of your pension as you get further into retirement because of inflation.
Inflation averages 2-4% per year. If a retiree begins drawing their annual pension of $50,000 in the year 2020 and never receives a cost of living increase, that same $50,000 pension will not have nearly the same buying power in the year 2030, 2040, and so on. With each state being unique, it is essential you fully understand your pension plan inside and out before retirement.
Will Guaranteed Income Be Enough?
One of the great benefits of a pension is the guaranteed income for life. However, these pensions also create an unusual problem that is unique to police and fire pensions. Law enforcement and public safety careers are generally “short” when compared to other professions and lines of work.
In New Jersey, for example, where I am a police officer, a Tier 1 Police & Fire Pension Member can receive sixty-five percent (65%) of their final year’s salary after twenty-five years of service. This creates a unique problem if you want to retire completely and never work again. You will only have twenty-five years to build a supplemental nest egg to your pension.
The problem is many first responders fall into the mindset that they do not need to save for retirement because they will receive a pension benefit. In reality, this is a dangerous mindset, and nothing could be further from the truth.
Gone are the days of your pension being sufficient and your sole source of retirement income. Times have changed far too much, and the importance of additional retirement savings cannot be stressed enough.
Supplement Your Pension
As mentioned earlier, many states are eliminating the cost of living adjustments for retired officers, which is creating a clear need to have a supplemental nest egg. This is especially true if you retire at a young age. Some officers will be able to leave with a pension as young as thirty-eight years old.
As you have a short window to build this nest egg, it is essential to start as early as possible and contribute as much as possible. It is equally important to pay attention to your additional investments, to make sure the assets are suited to your goals and risk tolerance, and to make sure the investments are appropriately allocated.
Generally, as you near retirement, your investments should usually become more conservative and less volatile because you may not have time to recover from significant losses. Significant events such as 9/11, the 2008 financial crisis, and the recent coronavirus pandemic highlight the importance of having a well-diversified and risk-appropriate portfolio.
We never know when an economic crisis will hit, and the last thing that you want is for your retirement portfolio to take on significant losses as you enter retirement. No one can accurately, successfully, and consistently time the market.
Choosing The Best Supplement
To maximize the value of any additional accounts to your pension, it also becomes vitally essential to take advantage of tax-advantaged accounts. These accounts can include a traditional IRA, Roth IRA, 457b, or deferred annuity.
A traditional IRA or 457b is funded with pre-tax dollars, offering instant tax savings, but a tax liability will be due when withdrawing any money. A Roth IRA is funded with post-tax money and will be tax-free upon withdrawal as long as the withdrawals are within IRS guidelines.
If you are unfamiliar with the advantages and disadvantages of each type of account, it is important to consult with a financial professional (ideally an independent fiduciary) who can assist you with choosing the right account and investments. In fact, in most cases, it is possible to have more than one tax-advantaged account.
Don’t Ignore Life Insurance
Another great benefit of many state pension plans is they usually provide their members with a group life insurance benefit. This is a great added supplemental benefit while you are still in your working years. However, this benefit is usually inadequate or non-existent in retirement.
Life Insurance is often a much-overlooked piece of the retirement puzzle. It can provide income replacement, cover final expenses, and help with estate planning needs. Also, life insurance can provide a legacy to children and other heirs, help with college funding, and even provide tax-free retirement funds if appropriately structured by an expert. Your run of the mill life insurance agent usually will not be able to do this type of specialized policy design.
Life Insurance During Employment
As we said, during your working years, most departments and pension systems will provide a group life insurance benefit to you at no cost. This policy will strictly offer a death benefit and will generally be based on your current salary.
For example, in New Jersey, a Police & Fire Pension member’s beneficiary will receive a benefit equal to 3.5X the member’s salary. Again, this is purely a death benefit, and these group policies do not offer any cash value, living benefits or long-term care benefits, and could be taxable.
Life Insurance After Retirement
Upon retirement, this benefit will generally cease or significantly reduce. To stay consistent with our New Jersey example, once a member retires that benefit equal to 3.5X the annual salary drops to half of the member’s final salary, or 50%.
To put this in perspective, we will assume a member retires making $100,000 per year. During their working years, their group life insurance benefit would be $350,000. However, when they retire, it drops to $50,000. That is a big difference and often not nearly adequate for most people’s situations or needs.
Some pensions systems will allow you to continue full coverage at a cost in retirement. Unfortunately, this cost is often far too expensive concerning the benefit(s) being offered. Again, in this scenario, you are merely purchasing the group policy, which will provide significantly few benefits other than a death benefit and will usually be overpriced at this point.
Many officers find they can obtain similar coverage, with additional living benefits at a cheaper rate, by using their own privately owned life insurance policy. If we are honest, who wants to pay for life insurance that can only be used if they die? Call me selfish, but I like the idea of owning life insurance that can also benefit ME while I am still alive.
Obtaining The Proper Coverage
It is also important to sit down and analyze how much coverage you need as this figure will most likely be different than the standard “three and a half times salary” provided by your employer.
This is different for everyone and depends upon your situation.
Another benefit of obtaining your insurance is purchasing a policy with riders for long term care or an accelerated death benefit. There are so many “what if’s” in retirement relating to health and wellness, and your retirement accounts should not act as an emergency fund in case you need long-term care or other medical treatments.
The need for long term care can quickly cripple even any well-funded retirement portfolio. Therefore, it is critical to factor the possibility of needing long term care into your plan. However, this could be a topic for an entire article.
How To Use Life Insurance While You’re Alive
The takeaway here is these riders will allow you to access your death benefit while you are alive to use for long term care costs, serious illnesses, and other serious injuries. Nearly all accelerated death benefit riders will allow you to access your death benefit if diagnosed with a terminal disease. This allows you to decide how the money is distributed and utilized and also can cover medical expenses if needed. There are other ways to fund long-term care needs through separate policies that focus mainly on long-term care and nursing home needs.
Another strategy to implement during retirement is creating your supplemental pension or an entire second pension if you will. This is because many law enforcement officers will not be eligible for social security. This will depend upon your state and sometimes your agency as well.
Creating this additional income stream can be done by utilizing a deferred or immediate annuity with a guaranteed lifetime withdrawal benefit. When the guaranteed lifetime withdrawal benefit is activated, the annuity will provide income for life just as your pension does. The only difference is that the payments are made to you from a company rather than the state, county, or city.
Surprisingly enough, many of these annuity companies are in much better financial shape than the state pension plans. Go figure…
Consider An Annuity
These guaranteed payments can be made monthly, quarterly, or annually. If the funds that were contributed to the annuity were held in a Roth IRA account, then the payouts will typically be tax-exempt.
Having a portion of your retirement assets in a guaranteed payout account will act as your own cost of living adjustment. This payout will help you weather any market volatility and will reduce the temptation of making emotional, financial decisions in low markets.
Annuities can be a complex financial product and payout will vary from company to company. It is best to consult with a true fiduciary to choose the best annuity for you and not the best annuity for the financial professional.
Some annuities will also offer additional benefits such as an increased payout if the owner is confined to a nursing home or continued payments to a spouse upon the owner’s death. Annuities can also be used for things like college funding and wealth transfers to heirs.
Learning Who To Trust
If you are uncomfortable with financial concepts and strategies, it is best to plan for retirement with the help of a trusted financial professional and one that specializes in working with law enforcement and public safety. Throughout your career, you should discuss your goals annually and adjust your finances accordingly.
I like to use a simple concept with my clients:
- And Evaluate.
Each year we plan what we want to accomplish financially over the next year and throughout the client’s career.
We then prepare by setting up the proper accounts and develop a contribution schedule. Funding supplemental retirement accounts are often not as hard as people may think.
The execution is continuing the contributions throughout the year.
At the end of a year, we evaluate the progress and adjust accordingly as we reenter the “planning stage.” We also make sure that our financial plan covers any possible “what if” in retirement.
Every dollar has a purpose and covers a need, goal, or want. This simple concept allows me to work with my clients as a team, ensuring their financial objectives are met. As a police officer myself, please remember you should only be working until you are 90 because you want to, not because you financially have to.
Retire Like You Deserve
Even with a pension, I have encountered many retired law enforcement officers who struggle in retirement. They are forced to work during a time when they should be relaxing and reaping the benefits after years of a stressful and challenging job. You only get one shot at retirement, so make sure you get it right the first time. There are no do-overs.
To Your Retirement…
These are the most common retirement questions I get:
- How much should I invest in my supplemental accounts?
- What should I be invested in? When should I make changes?
- How do I decide when I should retire? Am I going to be safe in retirement?
- Is my group life insurance enough to keep my family safe?
- Where should I keep my retirement funds after retiring?
- How can I keep more of what I’m earning?
- How do I decide on my pension benefits?
- How do my benefits affect my taxes and Social Security?
- What should my spouse be doing?
If you are wondering the same, have similar questions, or would like personalized advice, you can schedule a one-on-one call with Gary by clicking the calendar:
Don’t forget to contact us for your free, personalized pension report as mentioned above. We can show you potential income at different ages, factor in social security income if applicable, show the details or your particular plan, and determine any income gap.
About Gary D’Alessio
Gary D’Alessio is a police officer with 12 years of law enforcement experience in New Jersey. He is also a financial advisor and co-founder of Thin Line Financial Group. His mission is to educate and help public sector employees plan for their retirement and be well prepared for their futures.
Find more resources & tools, including a free retirement webinar at: https://thinlinefinancialgroup.com/
**This information is meant to be educational and informative. It is not meant to replace or substitute personalized or individual financial, investment or tax advice.