FI for Colorado Teachers Part 6: Case Study 2: Teacher Married to a Non-Teacher

TL;DR: This case study looks at a teacher married to a non-PERA-covered employee and lays out several paths for retiring (or achieving work-optional status) by age 45.

part6

Part 1 in this series describes the “what” and the “why” of Financial Independence. Part 2 discusses the process of “how.” Part 3 looked at the possible “what its” and “yeah, buts” objections to accomplishing FI. Part 4 discusses how knowing the rules around taxes can allow you to optimize your finances and help you achieve Financial Independence. Part 5 was a detailed case study of how a teacher married to another teacher could achieve financial independence by age 45. This post is very similar to part 5, but will look at three scenarios for a teacher married to a non-PERA-covered employee, and lay out some possible paths to achieving Financial Independence and retiring early (or achieving “work optional” status).

You might want to go back and read paragraphs two through seven of part 5 for the background and context for these scenarios (decided not to copy and paste here). Go ahead, the rest of this post will still be here when you come back. Just like in part 5, you really have to look at the spreadsheet and the associated google doc for each scenario to see how the plans unfold.

Scenario 1
Teacher married to a non-PERA-covered employee, in their third year of work in 2020, with a one-year-old child. They were hired before July 1, 2019 (which affects what’s included in PERA-includable salary), and assumes the teacher is eligible to purchase 5 years of PERA service credit.

Please note that while I’ve gone over all the spreadsheets many, many times, there is still a possibility that there is a mistake (or more than one). It could be a mistake in a formula, or it could be a mistake in overlooking some aspect. Please, please, please, if you find something that you think might be incorrect, let me know so that I can take a look and adjust it.

Scenario 2
This is similar to Scenario 1, except assumes the teacher is not eligible (or just choose not to) purchase five years of PERA service credit. This lays out a path to retiring at age 43.

Scenario 3
This scenario looks at two twenty-three year olds just starting their employment, and assumes the teacher was hired after July 1, 2019 (which affects how their PERA-includable salary is calculated as well as when they are eligible to retire). This lays out a path to retire at age 45.

Reminder
After looking at some or all of the scenarios in-depth (the links to the doc and the spreadsheet for each), remember to look back at Part 3, the “What Ifs?” and the “Yeah, Buts” to recall that this is a choice. You should align your goals with your values, and you may choose to do some things differently than I’ve schemed out, or not to do this at all. That’s perfectly fine, of course, but be intentional about it.

For example, some folks will look at the “net to live on” columns in these different scenarios and say that’s just not possible. Well, first, realize that is the actual amount you can spend, not your total “income”, which is different than the way a lot of folks think about their spending. And, second, realize that it is possible to live comfortably but not extravagantly on that amount of money, you just have to decide if it fits with your values and goals. I encourage you to actually think it through and then make some decisions that do align with your values and goals, don’t just let your financial life “happen” to you.

  • Part 1: The Concept
  • Part 2: The Process
  • Part 3: The “What Ifs?” and the “Yeah, Buts”
  • Part 4: Tax Optimization
  • Part 5: Case Study 1: Teacher Married to a Teacher
  • Part 7: Single Teacher

FI for Colorado Teachers Part 4: Tax Optimization

TL; DR: This is the fourth in a series of posts for Colorado teachers that looks at the tax code and discusses how you can optimize your financial decisions to take advantage of it. Hint: most people don’t take full advantage of the tax code.

Part 1 in this series describes the “what” and the “why” of Financial Independence. Part 2 discusses the process of “how.” Part 3 looked at the possible “what its” and “yeah, buts” objections to accomplishing FI. This post builds on part 2 and discusses how knowing the rules around taxes can allow you to optimize your finances and help you achieve Financial Independence.

Taxes are an interesting thing. Most folks will begrudgingly admit that they are necessary, but then often go on to complain about how much they have to pay or how unfair the system is for X reason. While there are certainly good arguments that can be made about the fairness of the system and how it could be improved, there are also ways that you can make decisions to address how much taxes you pay. To be clear, this is not cheating on your taxes, this is simply knowing the rules and making decisions to take advantage of those rules. If people would take the time to learn the rules and then adjust their decisions, they might not complain about how much they pay (or, more realistically, complain a bit less).

I am not a tax expert, nor can we go in-depth on all the various aspects of the tax code in this post. But there is some pretty basic information that you can use to your advantage, and some specific aspects that apply just to teachers, both of which you can use to optimize your finances. Spending just a little bit of time learning about the rules and then adjusting your decisions can have a big impact over time.

First, a quick reminder about how Federal taxes work (very simplified, but helpful for our purposes). You have a certain amount of income, some of it earned (your paycheck) and some of it is not (interest, dividends, capital gains, etc.). Some of that earned income you can “shelter” from taxes by investing in tax-deferred accounts, and some if it is automatically sheltered from taxes (your PERA contribution, your insurance premiums if you choose to take them pre-tax, your HSA contributions if you have them, dependent care expenses, etc.).

You then have some deductions to your income which, for the vast majority of taxpayers now, is going to be the standard deduction, with a few other deductions that might apply (for example, teachers also have the $250 teacher expenses deduction they can take).

You then end up with your taxable income, which is taxed using a progressive tax rate (that is adjusted for inflation each year), which means some of your taxable income is taxed at one rate, some of it at another, and perhaps some of it at yet other rates if you have a large taxable income. (Note that some of your unearned income, like qualified dividends and long-term capital gains are treated differently. This is important and we’ll talk about this eventually.) For example, in 2019 for a married couple, the first $19,400 in taxable income is taxed at 10% and any amount over $19,400 and up to $78,950 is then taxed at 12%. If you have taxable income above $78,950 but below $168,400, it gets taxed at 22% (and it continues above that, but most teachers won’t need to worry about that).

Many folks don’t completely understand how this progressive system works and think that all of their taxable income is taxed at whatever tax bracket they are currently in, which can lead not only to misunderstandings about tax policy, but sometimes some poor decisions around your taxes. For example, if your taxable income is $75,000, then the tax you would owe would be $8,612, which is an effective tax rate of 11.48%, not the 12% that many people think that $75,000 would be taxed at. ($19,400 at 10% is $1,940, the remaining $55,600 to get us up to $75,000 is taxed at 12%, which is $6,672 in taxes, for a total of $8,612.)

But it gets even better, because many people don’t actually owe that amount because they also get tax credits. Tax credits are different than tax deductions. Tax deductions get subtracted from your income to then determine your taxable income, but tax credits are dollar-for-dollar offsets to the tax you owe. The most common one for many people is the child tax credit, which is currently $2,000 per child (with up to $1,400 of that refundable). So, for the example above, if they had one child they would owe $6,612 in taxes, not $8,612. There are many other tax credits that could apply, so it’s important to investigate those based on your situation.

State taxes in Colorado are much simpler, as they take your federal taxable income, perhaps make a few adjustments, and then calculate your state tax at a flat (not progressive) rate of 4.63%. This means that all the ways you can lower your federal taxable income (deductions, tax-sheltering, etc.) also lowers your Colorado state tax owed, and then there are a few Colorado-specific tax credits you might be able to utilize (one of the most common is contributions to the Colorado 529 college savings plan are exempt from Colorado state taxes). Also, a quick plug (pun intended) for the Colorado Alternate Fuel Tax Credit, which is a $5,000 tax credit for an electric vehicle (and that’s refundable), which means if you have at least $7,500 in federal tax liability, then you can take a whopping $12,500 in total tax credits if you buy an electric vehicle (subject to phase out limits – Tesla and soon Chevrolet will begin ratcheting down).

Sorry if that was more (or less) than you needed, but we needed to set the stage for the next part of our discussion, which is about how best to take advantage of those rules on your path to financial independence. We’re going to focus on four areas: tax-sheltered accounts, Section 125 deductions, HSA contributions, and possibly optimizing to get the Savers Tax Credit.

Tax-sheltered accounts come in two main variants – pre-tax and post-tax. Pre-tax accounts are things like 401k/403b/457/Regular IRA accounts, where the money you contribute does not get taxed in the current year, but then gets taxed when you withdraw it during retirement (hopefully). Post-tax are the Roth variants of those, where the money you contribute is post-tax, meaning you do pay taxes on that money in the current year, but then any investment earnings you receive do not get taxed, so when you withdraw during retirement there is no tax liability.

For many folks, particularly if you are on the road to Financial Independence and will be considering retiring (work optional phase) early, the pre-tax accounts are the ones you want to focus on. (This post will not be able to go in-depth on why this is probably preferable to using Roths, but there are many resources on the web that discuss this.) This lowers your taxable income (both Federal and State, and often keeps you in the lower tax brackets), allows your investments to grow tax free, and sometimes helps you qualify for the Savers Tax Credit (more on that in a minute).

Every public school teacher in Colorado has access to PERA’s 401k plan (which is a good one). Most teachers then also have access to a 403b and a 457 plan. The 403b is going to be through a vendor other than PERA, but the 457 could be through PERA or that other vendor. Having access to that 457 is a huge advantage for teachers (and most public employees), because it not only allows you to shelter additional money, but also allows you to access that money when you are younger with no penalties (which is huge if you are planning on retiring/work optional at a younger age). (If your district does not offer you a 457 plan, talk to your Human Resources department ASAP. Even if they don’t want to deal with an outside vendor, setting it up with PERA is very easy for your district to do since they already are setup for the 401k.)

In 2019 you can contribute up to $19,000 to your 401k or your 403b – the limit applies to the combined amounts you can put into one or both of those accounts. (If you are over 50 you can contribute an additional $6,000, so up to $25,000). Note that this is per person, so if you are married your spouse can also contribute up to $19,000 (or $25,000 if over 50). But an important point to understand, particularly as your income increases as you grow older, is that you can also contribute up to $19,000 (or $25,000 if over 50) to your 457 plan. That’s in addition to the 401k/403b contribution. Essentially, public employees have double the amount they are able to shelter. (And, in fact, the 457 plan even has an additional “last-three-years” catch-up provision that can effectively allow you to contribute twice as much – $38,000 currently – each year for the last three years you are with with that employer.)

And the 457 is even better than the 401k/403b, because it’s considered “deferred compensation”, which means that you can access that money as soon as you leave that employer. This is different than a 401k/403b, where if you access the money before age 59.5 you may have to pay a penalty. (Note, there are ways to access a 401k/403b before age 59.5 without a penalty, but a 457 is so much easier if you have that option.) This means that if you do achieve Financial Independence and enter the “work optional” stage by quitting your teaching job, you can immediately access any money in your 457 to use as living expenses, even if you are way short of 59.5.

When we get to the case study posts (starting with part 5), we will go more in-depth on how to use this in the best possible way, but here are the two most important points to remember:

  1. Invest as much as you can in your 457 plan and increase it every year until you max it out.
  2. Once you max out the 457, invest as much additional as you can in the 401k/403b.

Many folks look at that and say, “That’s great, but I need money to live on.” That is certainly true, but keep in mind that since these contributions are coming out pre-tax, they don’t actually reduce your net pay by your total contribution. For example, if you contribute $19,000 in a year to your 457, and you normally would be in the 22% federal tax bracket (plus 4.63% Colorado tax bracket), your net pay “only” decreases by $13,940. Now, that’s still a fair amount of money, but it’s a lot less than $19,000. (And, as we’ll see, it might actually be even less than that if you can qualify for the Savers Tax Credit). As you’ll see in the case studies, if you can rein in your lifestyle expenses, most folks can actually save more than they think.

The second area to be aware of is Section 125 Plans. This refers to the part of the tax code that allows you to receive part of your income pre-tax if it is used for particular expenses. The added benefit for teachers is that it comes out pre-PERA contribution (although that will be changing for new hires hired after July 1, 2019). What are these particular expenses? They include insurance premiums (health, dental, vision, etc.), dependent care expenses (child care), and flexible spending account contributions (unless you have a high-deductible health plan, which we’ll discuss below).

All of these end up being expenses you can pay with pre-tax dollars (and pre-PERA dollars for current PERA employees), which can save you a significant amount of money. Again, if you were going to be in the 22% federal tax bracket, plus the 4.63% Colorado tax, you would save 26.63% of the total you spend on these areas. Plus, if you’re a PERA employee hired before July 1, 2019, you save an additional 8% on your PERA contribution (and that will be increasing over the next few years to at least 10% as part of the legislation passed in 2018). (Note that if it is coming out pre-PERA, you want to stop doing this in your last 3-5 years of employment in order to maximize your Highest Average Salary calculation. The amount you “lose” in tax savings during those years is more than made up for in pension income over time.)

If you have access to a High Deductible Health Plan (and most teachers do), then you also have the ability to contribute to a Health Savings Account (HSA). Employers also often kick in a small amount to your HSA in order to encourage you to sign up for the plan. Your contributions do not come out pre-PERA, but they do come out pre-tax and pre-FICA. HSA’s are known as “triple-tax-advantaged” accounts, because they are the only accounts that allow you to contribute pre-tax, earn pre-tax, and withdraw pre-tax. Basically, you never pay tax on this money (as long as you use it for medical expenses). And unlike an FSA, you don’t have to “use it or lose it” each year, can can carry over any balance for as long as you want.

You also have the option to invest this money, which can help it grow even more. From an FI perspective, this is an amazing account, especially if you can afford to not withdraw any money for medical expenses along the way and just let it grow tax free. As long as you save your receipts, you can always withdraw the money in the future when you need it, or you’ll likely have future medical expenses anyway. If you never have medical expenses (unlikely, but it could happen), then you can still withdraw it after age 65 and simply pay taxes on the withdrawals (but no penalty).

If you do have a High Deductible Plan, you can’t also contribute to an FSA (the HSA takes its place). But many district will have a Limited Purpose FSA that you can contribute to, and that money can be used for dental and vision expenses, but not health expenses. While this is “use it or lose it”, if you can estimate your out-of-pocket dental and vision expenses for the year, this is an extra tax strategy you should take advantage of.

Finally, as promised, we’ll talk about the Savers Tax Credit. In order to encourage folks to save for retirement, the Federal Tax code will actually give you money to help save, as long as your income is below a certain threshold. Because all of the previously discussed items (401k/403b/457/HSA/FSA/Section 125 plans) reduce your income threshold, if you can take advantage of enough of them you might also qualify for at least some of the Savers Credit. For example, in 2019 if you’re married and your adjusted gross income is below $64,000, you can claim 10% of your contributions to 401k/403b/457 plans as a tax credit, up to a total of $4,000. So, in our previous example where we discussed that contributing $19,000 to your 401k only reduced your net pay by $13,940, it may actually only reduce your net pay by $12,040, because you might get $1,900 from the Savers Tax Credit (assuming your income is adjusted gross income is low enough to qualify for the 10% Savers Credit). For many teachers, this is possible in your first few years of teaching, as you’ll see in the case studies posts.

There are more tax strategies we could consider, and we certainly will when we discuss the withdrawal stage of Financial Independence, but this gives you the overall approach. By understanding the tax rules and adjusting some of your decisions based on them, most folks can actually save (and invest) much more than they thought. While you can still complain about your taxes, you’ll have actively made some moves to reduce what those taxes were, which will help you on your path to Financial Independence.

  • Part 1: The Concept
  • Part 2: The Process
  • Part 3: The “What Ifs?” and the “Yeah, Buts”
  • Part 5: Case Study: Teacher Married to Another Teacher
  • Part 6: Case Study: Teacher Married to a Non-Teacher
  • Part 7: Single Teacher

 

Focus On: LPS Health Insurance

lpsbenefits

Healthcare and health insurance are complicated. Each person/family has unique needs, and many families have two employer plans to choose from. Therefore it’s really important to look at each person/family individually, so this blog post is going to be a general overview of the health insurance options currently offered by Littleton Public Schools, but your needs may require additional considerations that this post won’t cover.

As a long-time employee of Littleton Public Schools, I’m very familiar with the benefits that LPS offers. I’m also very familiar with the fact that many people don’t like to think much about benefits and aren’t really aware of the different options and what they might mean to them. Again, while each person/family has specific needs, let’s take a look at some general observations about the health insurance options that LPS currently offers.

LPS still offers a choice of two different insurance carriers (which is increasingly rare), CIGNA and Kaiser, and then two plans from each provider (a more traditional, low-deductible plan, as well as a high-deductible plan). So the first decision most people have to make is whether to go with CIGNA or Kaiser. This discussion often ends up being similar to the Apple vs. PC discussions that happened a while back, with folks having very strong opinions on both “sides,” but let me try to share what I know.

The main consideration for most folks is how important it is for them to be able to choose their own doctor. If you have an existing relationship with a doctor (not at Kaiser), and you have perhaps some on-going, chronic conditions that doctor is helping you with, that could be a strong argument for CIGNA. But I’d suggest you really give some thought to both of those conditions to see that they both apply. If either does not, then you have some more thinking to do.

One of the frustrations over the years when I’ve discussed health insurance with folks is the assumptions they make. Many (not all) assume that CIGNA must be better than Kaiser, both because it’s more expensive and because it is not “managed care.” That assumption is not correct. CIGNA is not bad, but Kaiser consistently ranks very high in both quality of care and customer satisfaction (and typically higher than CIGNA). That doesn’t mean that Kaiser is perfect, some folks have had bad experiences with them, but the structure of Kaiser is why their quality of care is so good.

Managed care has a bad reputation, but all health insurers – including CIGNA – are practicing managed care. The difference is that at Kaiser there is a dedicated team to identify best practices based on the research evidence, and that is then disseminated to the doctors, nurses and other staff members to follow. Under plans like CIGNA, doctors have more freedom (which many people like), but the quality of care is more variable from doctor to doctor. An interesting result of all of this is that when folks have a bad experience with a doctor at Kaiser, they typically blame Kaiser, but when they have a bad experience with a doctor with CIGNA (or other carriers), they typically blame the doctor. I am not trying to convince you to change to Kaiser, just to examine your assumptions and make sure you are basing your decision on your needs and the actual evidence.

Once you’ve made the decision between CIGNA and Kaiser, you then have to decide between the two plans they each offer, a more traditional low-deductible, copay/co-insurance type of plan, and the newer (and increasingly more popular among employers) high deductible plans. It is beyond the scope of this blog post to discuss all the pros and cons and the nuances of high deductible plans, but we can look a bit more carefully at the actual out-of-pocket costs under each plan and many folks will find the result surprising.

Before we do that, just a little background. It’s important to understand how LPS decides the district contribution toward your healthcare premiums. Currently (and for many years now), LPS covers 92% of the employee only premium and 54% of any of the dependent options (Employee & Spouse, Employee and Child(ren), Family). That’s notably different than many other school districts in that LPS contributes money toward dependent coverage, not just employee coverage.

Whether that is personally good for you depends, of course, on whether you are covering dependents :-). In effect, employees who choose employee only coverage end up helping subsidize those who choose any of the dependent coverage options. (And a side effect of this percentage method, by the way, is that LPS employees who choose Kaiser end up subsidizing those who choose CIGNA.)

A second piece of background is to understand the purpose of insurance, and particularly group insurance. Folks who grew up in my generation tend to have the view that the purpose of insurance is to “pay for our healthcare costs.” While that would be nice, it’s unfortunately not sustainable. The purpose of insurance (from an individual’s perspective), is to cover outliers. If something bad happens to you (or your family), it prevents catastrophic healthcare costs that you might be unable to pay. (Prior to the Affordable Care Act, medical bills were the leading cause of personal bankruptcies, it will be interesting to see what happens going forward.)

By pooling your risks with those of a group, it becomes affordable for the group as a whole to pay those really high healthcare costs for the (hopefully) few individuals who need it. In effect, those folks who don’t end up with high costs subsidize those that do. When insurance rates go up, it’s not just because the insurance companies are greedy (Kaiser, in fact, is non-profit), it’s because the cost experience of the group (in this case, LPS employees who’ve chosen each particular plan) has been more than the premiums that are paid in. It just takes one or two very expensive cases (a premature baby with complications, brain cancer, etc.) to require higher premiums. To be clear, this is not a bad thing, this is the reason for group health insurance. If you never get sick, the best option would be not to buy health insurance at all. This is the reason for the controversial “individual mandate” in the ACA, for health insurance to work you have to have healthy people involved in order to pay for the sick people.

So now let’s look at the premiums. When folks look at the rate sheet put out by LPS each year, they often skip down to the employee portion of the premium, think about the deductible amount and perhaps maximum out of pocket, and then make a quick decision. For many folks, the idea of a “high-deductible” and paying costs out-of-pocket up front is scary, but if you stop to do the math, the story turns out a bit different. This table shows the total out-of-pocket costs for each plan choice under a couple of sample scenarios. Obviously, your experience will most likely not match the sample scenario, but I tried to pick scenarios that people typically worry about (which is costs that come in right at the deductible amount for the high-deductible plans).

lpsrates

It turns out that under the CIGNA plans, the high-deductible plan is cheaper for almost everyone under almost every scenario. (I think it is actually everyone and every scenario, not just “almost”, but I can’t check every possible scenario so I didn’t want to overstate it.) Check out this google doc for a bit more detail but, basically, with the amount you save in premiums under the high-deductible plan, plus the amount that LPS contributes to your HSA (I’ll write a post soon talking more about HSAs, they are a very attractive option), you come out ahead over the OAP plan even when you have large medical bills. Even better, if you have years where you don’t have large medical bills, you not only come out ahead, but the amount in your HSA (LPS contribution plus whatever you might choose to contribute) rolls over. So not only do you pay less that year, you have “money in the bank” for future healthcare costs.

The math is not quite as straightforward on the Kaiser side, because under the DHMO you have both copays and coinsurance after you meet the deductible, and what those might end up being varies greatly depending on exactly what kind of care you end up needing (plus, ironically, since the premiums are lower than CIGNA, the difference between the two Kaiser plans is not as stark). But, in general, the story is fairly similar to CIGNA. When you have “good” healthcare years with low costs, you will definitely come out ahead with the high-deductible plan and can carry over any money in your HSA. When you have “bad” years with higher costs, you may still come out ahead with the high-deductible plan, but there are certainly scenarios where the DHMO would end up being cheaper. (And, of course, when you compare to the CIGNA plans, Kaiser is less expensive under all scenarios.)

So, which carrier and which plan should you choose? It depends. You also have to look at the benefits offered by any spouse’s plan, your existing health and any conditions you might have. as well as your personal preferences. That’s certainly part of what we’d do if you decide to work with me.

Additional Resources (2017-18)
LPS Benefits Book
CIGNA OAP
CIGNA CDHP with HSA
Kaiser DHMO
Kaiser HDHP with HSA