Most Colorado educators are generally aware of the formula that calculates their PERA pension benefit:
Years of Service Credit x 2.5% x Highest Average Salary (HAS)
They also are generally aware of which HAS Table they use so they know when they qualify for a “full” retirement (non-green-shaded areas of your HAS Table).
If you are unfamiliar with either of these things, make sure you investigate further before continuing with this post.
But many educators are not fully aware that they have to choose one of three benefit options when they retire. These options differ in the monthly benefit they pay to you and the benefit (if any) they pay to your cobeneficiary if you die first (typically a spouse, but it doesn’t have to be).
Option 1: This pays you a lifetime monthly benefit as calculated by the formula. When you die, your monthly payment will stop and your beneficiary will receive nothing. (Unless you die fairly soon after retiring and you still have a remaining balance in your DB account, in which case they will get that remaining balance as a lump sum plus a 100% match. It typically only takes a few years for your monthly benefit to exhaust the portion of your DB account that you contributed.)
Option 2: This pays you a lifetime monthly benefit which is slightly lower than what is calculated by the formula. The reason for this is that when you die, your cobeneficiary will continue to receive 50% of your monthly benefit for the rest of their life. How much lower your monthly benefit will be than the Option 1 level depends on your age and the age of your cobeneficiary. Take a look at this spreadsheet for the current Option 2 factors (these factors periodically change as actuarial assumptions change). If your cobeneficiary predeceases you, then your benefit will “pop up” back to the Option 1 level.
Option 3: This pays you a lifetime monthly benefit which is lower than what is calculated by the formula (and slightly lower than the Option 2 benefit). The reason for this is that when you die, your cobeneficiary will continue to receive 100% of your monthly benefit for the rest of their life. How much lower your monthly benefit will be than the Option 1 level depends on your age and the age of your cobeneficiary. Take a look at this spreadsheet for the current Option 3 factors (these factors periodically change as actuarial assumptions change). If your cobeneficiary predeceases you, then your benefit will “pop up” back to the Option 1 level.
To help illustrate this, let’s look at a specific example of a 58 year old teacher who uses HAS Table 2, has 34 years of service credit, their Highest Average Salary (HAS) is $90,000, and their cobeneficiary is 60 years old.
Option 1 Benefit: 34 x 2.5% x $90,000 = $76,500 yearly benefit ($6,375/month). When they die, the monthly benefit stops.
Option 2 Benefit: $76,500 x 0.961847 (Option 2 factor) = $73,581 yearly benefit ($6,132/month). If they die before their cobeneficiary, their cobeneficiary continues to receive $3,066/month for the rest of their life. If their cobeneficiary predeceases them, their monthly benefit pops back up to $6,375/month.
Option 3 Benefit: $76,500 x 0.915142 (Option 3 factor) = $70,008 yearly benefit ($5,834/month). If they die before their cobeneficiary, their cobeneficiary continues to receive $5,834/month for the rest of their life. If their cobeneficiary predeceases them, their monthly benefit pops back up to $6,375/month.
Member Yearly Benefit
Member Monthly Benefit
Cobeneficiary Monthly Benefit (if you die first)
Which option you choose obviously depends on a lot of circumstances in your life, including (but not limited to) the relative ages of you and your cobeneficiary, the health of you and your cobeneficiary, any retirement your cobeneficiary has, how much savings you have in other accounts that you can draw from, your spending needs, and your values. While this is obviously an important choice, it’s not one you have to make until you are retiring, at which point you typically have at least some insight into all of these factors.
First, a caveat. Health care – and health insurance – are complicated and nuanced topics that are heavily influenced by individual circumstances and options. The following post should be generally applicable for folks who are in a similar situation as we are, but you should always investigate the particulars for your situation carefully. This post is not designed to be a comprehensive look at this topic.
An important consideration – and worry – for folks when they retire is health insurance. This is especially true if you retire before the age of 65 when Medicare kicks in. Health insurance itself can be very expensive, and a major medical condition can have a dramatic impact on your financial situation even with health insurance. Colorado PERA retirees have an important benefit in addition to their defined benefit pension – PERACare. (They also offer dental and vision insurance if you want it.) PERACare is health insurance that PERA retirees can get through PERA. It is guaranteed issuance (which was very important before the Affordable Care Act, and still nice now) and is even partially subsidized as part of your retirement benefit. But it’s still pretty expensive.
For my family, we need coverage for three: myself, my wife (also a PERA retiree, so we get two subsidies), and our daughter who is in college and is considered our dependent. Our cost for the Kaiser High Deductible Health Plan ($3,500 individual, $7,000 family deductible; $6,050/$12,100 max yearly out of pocket) is $1,654 per month, which is almost $20,000 per year (and that’s after $460/month, $5,400/year in subsidies). (Dental and vision cost an additional $140/month, $1,680/year). Obviously, that’s a significant amount of money – plus whatever out of pocket costs we have (note the high deductible) and, for those who have smaller pensions than we do, can be financially crippling. But I still consider us lucky to have the option because so many other people do not.
Before the Affordable Care Act (ACA), folks who didn’t have an option such as this either had to get coverage under their working spouse’s plan, pay for a very expensive policy on their own (assuming they could even qualify for a policy), or simply go without. The ACA was a huge improvement, guaranteeing issuance and offering plans at a variety of premium levels and coverage levels. And, for folks at the lower end of the income scale (up to 400% of the federal poverty level), your costs were at least partially subsidized. The cost of your premiums were capped at a certain percentage of your income (see the left side of the table below), with very large subsidies if you were on the very low income end, and gradually tapering off to fairly small subsidies the closer you got to 400% of poverty level. But once you crossed the 400% of poverty level cliff, the subsidies dropped to $0.
Prior to this year, our income – like many PERA retirees – was too high to receive any subsidies, so the cost of plans through the ACA marketplace was higher than our (subsidized) cost through PERACare. So when we retired, we signed up for PERACare. But then this year the current administration passed the American Rescue Plan Act, which did many, many things, one of which was a huge change in the ACA subsidies. For all the folks up to 400% of poverty level, the subsidies increased dramatically (see the right side of the table above), and – for the first time – there is a subsidy for those making above 400% of poverty level. Which includes us. Which is the reason for this post.
Note: While the subsidy theoretically exists no matter how high your income, it effectively phases out for higher incomes because the cap is at 8.5% of your income, and eventually that exceeds the base level premium for ACA insurance.
While I was generally aware of the change in subsidies when the American Rescue Plan Act passed, I didn’t really take the time to do the math for our situation until I read this blog post. Now, I really should have already figured this out on my own because I knew all the information, but it’s one of those things that just didn’t sink in enough to make me do the work to figure it out (not that it was that much work). As you’ll see shortly, that’s going to end up costing me several thousand dollars in premium savings for the months that I didn’t take advantage of this. The reason for this post is to share this information in case this post ends up being the one that makes you do the work to figure it out.
Note: The amount of subsidy you get for an ACA marketplace plan is based on your Modified Adjusted Gross Income (MAGI) for the 2021 tax year. Technically, the subsidy is a tax credit you get when you file your 2021 taxes, but they let you estimate what your income is going to be and reduce your monthly premium throughout the entire year, then there is a “true up” when you file your taxes. So it’s important to do a fairly good job of estimating your 2021 MAGI so you don’t end up underestimating your income, which will result in overestimating your subsidy and you could end up with an unwelcome tax bill next spring. This can affect other decisions you might make during 2021, like withdrawing from your pre-tax retirement accounts or doing a Roth conversion, both of which will increase your MAGI and therefore reduce your subsidy.
So, let’s take a look at the details. When you go into the ACA Marketplace (they are by state, here’s Colorado’s), you can enter in all your information and then it will list all of the different policies you can get, along with their premiums and coverage levels. Policies are generally grouped into Bronze (lowest premium, lowest coverage), Silver (medium premium, medium coverage, and the base for which subsidies are calculated on), or Gold (highest premiums, highest coverage). Because we’ve always been on Kaiser and like it, I then narrowed it down to Kaiser choices. And then from the Kaiser choices, narrowed it down to the two that qualify as high deductible health plans that qualify for a Health Savings Account (see this post for more on the value of HSAs).
So, with those parameters, my choices are a Bronze policy (KP CO Bronze 6500/35%/HSA) and a Silver policy (KP CO Silver 3500/20%/HSA). The Silver policy is very, very, very similar to the coverage I’m currently getting through PERACare (with PERACare having slightly better prescription drug pricing), so that’s pretty close to an apple-to-apples comparison. The cost (after subsidy) of the Silver policy for three of us through the ACA Marketplace? $1,326 per month. That’s a $328/month, or almost $4,000 per year savings over my PERACare policy, for essentially the same coverage. Wow.
But if I then consider the Bronze policy, which does have a higher deductible and a higher maximum yearly out of pocket cost, the premium drops to $996/month, which is almost a $7,900 per year savings over my PERACare policy (and a $330/month savings over the Silver policy through ACA). We are taking on more risk with the Bronze policy (because of the higher deductible and higher out of pocket max), but that will only affect us if we have a really bad year (and even then the premium savings covers about two-thirds of the difference). The vast majority of years (and hopefully every single one of them, we’ll come out ahead of the silver policy).
Normally open enrollment for ACA policies is in the fall (effective January 1st of the following year), but the American Rescue Plan Act extended open enrollment through August 15th. If we enroll now, our plan will start August 1st and last the rest of this calendar year (and we can drop our existing coverage through PERACare). (If I had been on the ball, I probably could have done this by May 1st, so we’ve missed out on 3 months of savings due to my inattention.) Then this fall, during open enrollment, I can choose to enroll in the same Bronze plan through the ACA marketplace (at whatever the 2022 rates are), switch to the Silver plan if we decide we want to, switch to any of the other ACA plans, or even switch back to PERACare. That’s an important point to keep in mind, you are making decisions one year at a time here. So if you figure out you made a poor decision, or if your health care needs change, you are only “stuck” with your current plan for the rest of that calendar year, and then you can change to a plan that better meets your need going forward.
So, if you are a Colorado PERA retiree, or any retiree who is getting health insurance from someplace other than the ACA Marketplace, it’s probably worth your time to explore the ACA plans, see what your costs might be after the new subsidies, and see if it might make sense to switch. (And, if you choose a plan that is HSA eligible, put those premium savings into your HSA until you max it out.)
Final Note: Currently the American Rescue Plan Act’s changes to the ACA marketplace are only in effect for 2021 and 2022. The current administration wants to make those changes permanent, but we’ll see what happens. If this is something you would like to see made permanent, contact your Congressperson and Senators.
I’ve written a bit about health insurance before, going through the options for Littleton Public Schools (LPS) and Douglas County School District (DCSD). I was recently helping someone and thought I would update the numbers given LPS’s current insurance offerings, and also spend a bit more time talking about possibly using your HSA as an additional “stealth” retirement account.
First, a caveat: Health insurance is complicated and differences in individual circumstances as well as specific scenarios will vary. These are some “generic” examples that give you an idea of ways you can compare plans, but will not cover every circumstance.
LPS currently offers four choices for health insurance: CIGNA OAP, CIGNA CDHP, Kaiser DHMO, and Kaiser HDHP. The CIGNA CDHP and Kaiser HDHP both qualify as high-deductible plans, so you are eligible for an HSA, and the district contributes $1,250 a year into your HSA for employee only coverage, or $1,700 a year for any dependent care coverage. The following table summarizes the yearly premiums for each plan as well as the deductibles, coinsurance and maximum out-of-pocket expenses you could have.
The table below allows you to compare CIGNA OAP with CIGNA CDHP with HSA, and then Kaiser DHMO with Kaiser HDHP with HSA (and, of course, then CIGNA to Kaiser). The examples I chose for illustrative purposes are $2,000 a year in charges if you have individual coverage and $4,000 if you are covering any dependents. The total out of pocket listed in the tables is comprised of the total you pay in premiums, plus any out of pocket costs, minus the district contribution to your HSA if you choose one of the HDHP plans ($1,250/year for individual, $1,700 for any dependent coverage).
Note that these are rough estimates – for simplicity’s sake it just assumes you pay the 20% coinsurance after the deductible – but that totally depends on what services you need, so your exact total could differ (but it should be a pretty good estimate for comparison’s sake). You can do the math (or contact me and I’m happy to help) for amounts different from the $2,000/$4,000 examples. Also keep in mind that if you have expensive prescription drugs, that could change the calculations (because you typically pay for those out of your deductible in HDHP plans). Finally, keep in mind that you may – or may not – be having health care premiums taken out pre-tax (and pre-PERA), so that can impact your overall totals as well (but they are still directionally accurate).
In general, there are very few scenarios where the high deductible plans are going to cost you more (mostly involving expensive specialty prescription drugs). And even if in one given year it costs you more, you’ll likely more than make up for it in the “normal” or even “good” years where you spend less. Another important consideration to keep in mind with the HDHP plans is that if you don’t spend what is in your HSA (either contributed by the district or additional pre-tax dollars contributed by you), that money rolls over for future years (so you have the potential of $1,250/$1,700 from the district plus your own contributions to the HSA to rollover each year, plus any investment gains over time). So in years where you have lower expenses, the savings from an HDHP plan are even greater than shown above (because your premium costs are the same no matter how much care you get, but your out-of-pocket costs vary with how much you use the plan).
As you can see, for these examples ($2,000/$4,000 in costs), the high-deductible plans come out much better and, not surprisingly, Kaiser comes out better than CIGNA. (And, in years where you spend much less than $2,000/$4,000, the high deductible plans will come out even better.) In general, the only reason to go with CIGNA over Kaiser is if you already have an established relationship with a doctor with CIGNA and don’t want to lose that relationship. And there’s very few circumstances where it makes sense to go with the OAP or DHMO over the high-deductible plans.
If you do go with a high-deductible plan, then there’s a strategy to really supercharge your HSA. HSAs are designed to help you pay for health care costs with pre-tax dollars (not just pre-federal and state, but pre-FICA as well, but not pre-PERA). Similar to an FSA, they allow you to reimburse yourself for health care costs out of your HSA. Unlike an FSA, however, the entire balance in your HSA can rollover from year to year if you don’t spend it, the total amount you can contribute each year is higher, and you can invest the money in your HSA if you choose (typically there is a minimum threshold you have to keep in cash, but then you can invest any amounts above that).
So, while most folks use the HSA to reimburse themselves as they incur health care expenses, the ideal scenario is that you start with an HDHP with HSA when you are young (although this works for any age pre-Medicare), but do not reimburse yourself from the HSA (just pay from your checking account). Instead, invest the money in the HSA and use it like a stealth retirement account. This assumes, of course, that you can afford to contribute to your HSA while still paying any out-of-pocket health care costs out of your regular cash flow. (You can keep track of your health care expenses over time and reimburse yourself at any time, even for costs incurred in the past, as long as they occurred while you were enrolled in a high-deductible plan.)
The reason this is so powerful is that the money in your HSA never gets taxed (if you eventually use it for health care expenses), so it’s better than either a Traditional or a Roth 401k/403b/457/IRA. Ideally, you would max out your contributions to the HSA each year. For 2021, the limit is $3,600 for individuals or $7,200 for families (any dependent coverage), with a $1,000 catch-up contribution if you’re 55 or older. Keep in mind this includes the employer contribution, so subtract off $1,250 for individual or $1,700 for any dependent coverage to find out what you can contribute yearly (divide by 12 for monthly contribution). (And, if your spouse has their own HDHP with HSA through their employer, make sure to subtract off their employer contribution plus anything your spouse is contributing to the HSA.)
Then, once you’ve met the minimum that your HSA provider requires to be kept in cash (typically in the $100 – $2,000 range), you can set up an “automatic sweep” of any additional contributions into your investment account. You typically have a wide range of investment choices through someone like TD Ameritrade, so you can invest in low-cost, diversified index funds. Over time that money will grow and, again, will never be taxed. (Note that it is never taxed as long as you eventually use it for health care expenses. Once you turn 65, you can also use it for anything you want and pay taxes on it, but no penalty.)
In effect, you can use your HSA as another retirement account, in addition to your Traditional and/or Roth IRA, 401k, 403b or 457. But, unlike a traditional account (which is tax deferred, but you pay taxes when you withdraw), or a Roth account (which you pay taxes up front, but then withdrawals aren’t taxed), an HSA is never taxed (contributions are pre-tax, investment gains are tax free, and withdrawals are tax free). This is why HSAs should be near the top of your priority list for investing for retirement (second only to contributing to a 401k/403b/457 up to any employer match, and since most teachers don’t get an employer match, that makes HSAs your #1 priority).
So, let’s do a hypothetical to just give you an idea of what this could look like. Let’s take a 25-year old teacher just starting to contribute to their HSA. Let’s assume that in addition to the employer (district) contribution, they max out their HSA. Let’s also assume they have a spouse and therefore are able to contribute $7,200 per year into their HSA ($1,700 from the district, $5,500 from the teacher). For simplicity’s sake, we’ll ignore that the $7,200 will go up over time (and the current $1,000 catch-up provision once you and/or your spouse turn 55) and that they have to have a minimum amount kept in cash before they can invest (that will be more than made up for with the increases to the $7,200 limit in the future). We’ll assume they invest monthly in the Vanguard Total Stock Market Index Fund (VTSAX), and we’ll assume an 8% return per year. (Historically, the return would be higher than 8%, but going forward it may not be so going to be a bit conservative here.) We’ll assume they continue to invest $7,200 a year ($1,700 from their employer) for 40 years (until age 65, when they will be covered by Medicare), and then start withdrawing money for any accumulated or future health care expenses.
So, how much will they have at age 65? $1.8 million. Tax free (and the money has never been taxed). And it will continue to grow after that, since they are unlikely to pull the full $1.8 million right away. (And, at the historical return of closer to 10%, you’d have $3.2 million. Even at only 6%, you’d have over $1.1 million.)
Now, it may be unlikely that they’ll continue to teach until age 65, so they may lose the employer contribution before age 65. But, even if they do, they can still contribute up to the maximum with their own money, so the numbers still work. And given the fact that the $7,200 maximum per year goes up over time, and there’s the post-55 catch-up provisions, the final amount will likely be well over $2 million.
So, if you’re not currently using one of the high-deductible plans, consider switching. And consider maxing out your HSA each year and, to the best of your ability, paying for health care expenses out of your normal cash flow and let compound interest do its magic inside your HSA. This could end up being your best retirement account