Colorado PERA Retirement Options 1, 2 and 3

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.


Option

Member
Yearly Benefit

Member
Monthly Benefit
Cobeneficiary
Monthly Benefit
(if you die first)
Option 1$76,500$6,375$0
Option 2$73,582$6,132$3,066
Option 3$70,008$5,834$5,834

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.

Health Insurance: PERACare vs. the ACA Marketplace

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.

source

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.

Fees Matter: Vanguard, PERA, TIAA and MetLife Comparison

Inspired by some of the work Ben Johnson has been doing, I decided to revisit two posts I’ve previously done on the retirement plans (401k/403b/457) available through Littleton Public Schools and Douglas County Public Schools. (Note that the expense ratios are slightly lower now than when I wrote those posts.)

It’s probably worth reading at least one of those posts for context, but I basically compared the fees you would pay for investing in PERA’s 401k/457 plan with those you would pay in the other vendor offered (TIAA for LPS, MetLife for DCSD). In this post I thought I’d take that a step further by showing the compounded effects of those fees over time, as well as throw in a comparison to an IRA at Vanguard.

Important note: IRA’s have much lower contribution limits than 401k/403b/457 ($6,000 vs. $19,500 if you are under the age of 50), so you can invest much more each year into your workplace plans. And there are also income limitations on whether you can contribute to an IRA, whereas there are no income limitations on 401k/403b/457 plans. And don’t forget the behavioral aspect – some folks need to have the money taken directly from their paycheck otherwise they won’t ever end up investing it.

So I created this spreadsheet to illustrate the impact of fees over time. Like all spreadsheets of this nature, it is based on many assumptions and those assumptions may be incorrect. Feel free to make a copy of the spreadsheet and change any of the assumptions you wish. For example, for the return on different asset classes, I put in the long-term compounded average return, but many folks think those will be lower in the future, so feel free to adjust. You also can adjust your asset mix between the different asset classes (I kept it fairly simple by limiting to US Large Cap Stocks, US Small/Mid Cap Stocks, International Stocks, US Bonds, and a Target Date fund choice.) Make sure the asset allocation mix adds up to 100%!

You can also change the initial amount you have invested (currently $0 in my examples) and the amount you are adding to your investment each year (currently $6,000 in my examples). You should not change the fees charged by Vanguard, PERA, TIAA or MetLife (unless you are reading this enough in the future that those have changed as well), nor the columns that keep track of your running totals with each vendor. Note that the fees for each are based on the lowest-cost fund offered within each asset class with each vendor.

You can change any of the numbers that are in cells with a purple outline, leave the rest alone.

So, let’s look at some selected results. First, what if you had an aggressive, all-equity allocation of 40% Large Cap, 30% Small/Mid Cap and 30% International? This is what it look like after 10 years:

As you can see, investing at Vanguard is going to get you the best overall return, and investing with PERA is going to be a better choice than either TIAA (LPS) or MetLife (DCSD).

How about after 30 years?

Wow. You’d have over $110,000 more in Vanguard than with MetLife, and over $90,000 more if you choose PERA over MetLife. And if you take it out to 50 years (think starting when you are 22 and not withdrawing until age 72 when you have to start taking Required Minimum Distributions):

Almost $1.5 million more in Vanguard than in MetLife, $1.2 million more with PERA than MetLife. (Note that these numbers get even further apart with contributions that are greater than $6,000 per year, although the percentage differences will be the same.)

Okay, well what if you just chose a Target Date fund (which is the default option in your 401k/403b/457 plans, and a good, simple choice for lots of folks) and put 100% of your money into that? Here’s after 10 years:

Note that here PERA is actually ahead of Vanguard due to the lower expense ratios on their Target Date funds, but both Vanguard and PERA are still doing much better than TIAA or MetLife.

30 years?

50 years?

Play around with the assumptions in the spreadsheet, including the asset mix that most closely reflects your desired asset allocation. But no matter what mix you choose, Vanguard and PERA will come out the best (usually Vanguard as the best, with PERA only if you go with just a Target Date fund). TIAA will come in a distant third, and MetLife a very distant last place. (And keep in mind that the negotiated fees with TIAA and MetLife are actually pretty good compared to many folks’ 403b choices around the country.)

And yet many employees in LPS and DCSD choose TIAA and MetLife. Why? Perhaps because a sales rep contacted them and was kind, concerned, and “helpful”. Perhaps because they think they can choose investments and “beat the market”. Or perhaps they just chose without much knowledge.

So, now that you know a bit more, what changes might you make with your investments? In general, if your adjusted gross income is not too high (varies depending on Traditional vs. Roth, and increases slightly each year), opening up an IRA at Vanguard is going to be your best choice to fund first (this is assuming you are disciplined enough to invest the money when it doesn’t come directly out of your paycheck).

If you max that out (remember, IRA’s have much lower contribution limits each year), then fund your PERA 401k or 457 next. In LPS, I would choose the 457 over the 401k, as it’s a bit easier to access the money before age 59.5 (unfortunately, DCSD has not chosen to offer the PERA 457), but otherwise the 401k and 457 are essentially the same.

If you are able to max out your personal IRA and your 401k or 457, then you can invest in the one you haven’t yet, as the 401k and 457 are different “buckets” and they each have their own, separate contribution limit (note that the 401k and 403b draw from the same contribution “bucket”). This means that in 2021 if you are under the age of 50 (if your income isn’t so high that you can’t contribute to an IRA), you can contribute up to $6,000 to an IRA, $19,500 to a 457, and another $19,500 to a 401k, for a total of $45,000. If you are 50 or older, you get “catch up” contributions, which gives you an extra $1,000 for your IRA and $6,500 for both the 401k and 457, for a total of $59,000. (And, depending your plan, there may be special catch up contribution provisions in your last 3 years of work that can let you contribute even more.) Keep in mind that for all of these you have the option of doing a Traditional (pre-tax) contribution or a Roth (post-tax) contribution, which is a complicated and entirely different conversation.

As always, feel free to reach out with questions (or comment below).

Financial Independence for Colorado Teachers Part 1: The Concept

TL; DR: This is the first in a series of posts that will lay out a possible path for Colorado teachers to achieve Financial Independence and retire* early. This post looks at the concept of Financial Independence and discusses a little bit of the “what” and the “why”.

*Retire only if you want to, but certainly achieve a “work optional” stage of life much earlier.

This is the first in what will be a series of posts discussing how Colorado teachers can achieve financial independence. (Actually applies to any Colorado public school employee, not just teachers, but will focus on teachers.) This post will focus on the concept of financial independence: what it is, why you might want to achieve it, and the basic outline of what it takes to get there.

There are many, many, many excellent resources online (some of which I’ll link to at the bottom of this post) that are better written, broader in scope, and more in-depth. But I decided to write this series because, as far as I know, there is not any that are devoted specifically to Financial Independence for Colorado teachers. The path to Financial Independence is different for everyone, but there are certain aspects of being a teacher in Colorado that make this an easier path and are worth exploring in detail (notably Colorado PERA and the specifics of the Colorado state tax code). My hope is that this can be a resource for Colorado educators to adapt some of the terrific information that is available elsewhere online in light of the added options that PERA and the state tax code give you.

If you’ve ever explored anything financially related online, you have probably come across the acronym FIRE, which stands for Financially Independent Retire Early. (I will include some links to resources at the bottom of this post you might want to investigate.) While the FIRE concept may seem to be pretty well defined, there are many different approaches, definitions, and opinions about exactly what it means, so let me give you my take as a frame of reference for this series of posts. (Not that you have to agree with my take, but just as a common understanding for these posts.)

It seems to me that there is often a misconception of financial independence that it’s all about money. In my view, it’s not. Money is the means but not the end. Financial independence is, at its essence, exactly that – meaning that you don’t have to be employed and earning income in order to meet your financial needs. When you “achieve FI”, that means you have enough savings and investments to live off of even if you never earn another dollar at a job. That doesn’t mean you have to retire, the ‘RE’ part of FIRE, but it means you can if you want to (or circumstances dictate that you have to). Some people refer to this as a “work optional” stage.

So if FI is not about money, what is it about? I think it’s about living your best life and the life you want to live. It’s about making the most of your limited years (time is not a renewable resource) and about maximizing the time you have to do what you want. It’s about being intentional about life and not just letting life happen to you, but taking a little bit of time to plan the life you want to lead, one that aligns with your values, and then take the steps to allow that to happen. Perhaps that doesn’t seem all that different than what most people do, plan for the future. But this is taking it one (or two) steps further than most people do and being much more granular about the financial aspects of your future in order to achieve the life you want to live.

One of the unfortunate things about American society (I’m focusing on the United States in these posts) is the lack of knowledge and open discussion about money and finances. In many families, money is a taboo subject, and most schools do little or no real financial education. As a lifelong educator, it saddens me that we don’t make an effort to really educate our students about money and finances. Not because money or wealth is important in and of itself, but because of the tremendous impact finances and financial decisions have on everyone’s life. (If I was pressed to name the two most important subjects we should teach in K-12 education, it would be Physical Education and Financial Education, as those are so important throughout everyone’s life, yet we devote very little resources to teaching them.)

That doesn’t mean society doesn’t talk about “Money” with a capital ‘M’. We are inundated with stories about making money and wealthy people, bombarded with marketing encouraging us to buy things, and often social pressures to look and dress and own the correct things to fit in. But that’s as far as it goes for most folks, we get the pitch for all these things that are “desirable”, but not the knowledge and resources to manage our financial lives in a way that matches up with our goals and our values. FI is about achieving your goals and living your values. That may include retiring early or it may not – it’s about making decisions that optimize meaning and happiness. Once you achieve FI you may still continue to work, but you’ll continue because you want to do the work, not because you need the paycheck. And if at that point in your life you are ready to do something else, you won’t be restricted from making a change because of the need for that paycheck.

I think most folks would think that my family has done really well financially along the way, and we have, but if I knew what I know now back when we were first starting our careers, we would have achieved financial independence much earlier. So this series is intended to help some of you, if you decide this is the path for you, to do it better than we did. So what does it take to get there? Future posts will go into more detail, but it generally boils down to spending less than you make, and then saving and investing the rest. It’s also about making smart lifestyle choices (living within and actually below your means), and understanding the math of things like compound interest and how your taxes work.

Below you will find links to subsequent posts in this series (as the posts are written, the links will become active), as well as links to some excellent FI(RE) bloggers and other resources that you may want to investigate if you want to go down the rabbit hole and learn much, much more about this idea.

  • Part 2: The Process
  • Part 3: The “What ifs?” and the “Yeah, buts”
  • Part 4: Tax optimizing/401k/403b/457/Section 125
  • Part 5: Case Study: Teacher Married to Another Teacher
  • Part 6: Case Study: Teacher Married to a Non-Teacher
  • Part 7: Single Teacher

Some excellent resources to learn more about FI(RE)

PERA Transition Year (aka, 93/93 or 110/110)

Summary: For many public school employees, a transition year is a fantastic benefit that can make a huge difference in your retirement finances. It’s definitely worth finding out if your school district offers it, under what conditions, and then investigating whether it might be right for you.

transition

The working after retirement rules for PERA specify that retires can work up to 110 days in a calendar year for a PERA-covered employer after they retire (there’s no limit on non-PERA covered employment). While any PERA-covered employee can possibly take advantage of this, it works especially well for public school employees because our contract year naturally occurs half in one calendar year and half in the next, meaning you won’t exceed the 110-day limit in either year. Some – but not all – school districts offer this transition year benefit (sometimes referred to as 93/93 or 110/110), but often with special conditions. For example, in Littleton Public Schools you must have been continuously employed by the district for the previous 10 years in order to qualify, and the district does not pay benefits during the transition year. Check with your district to see if it’s offered and what conditions there may be. (In Douglas County Public Schools it is also working in the district the previous 10 years plus the permission of your supervisor.)

Despite this being around for a while, lots of folks are a bit unclear on the details (or unaware of it altogether), so I thought I’d use my experience as an example. I officially retired on June 1, 2017 and am now working a transition year with LPS. I currently have 29 years of teaching experience under PERA, plus I purchased 6 years of service credit, giving me 35 years of service credit that my retirement benefit is based on. Thirty-five years translates to 87.5% of my Highest Average Salary (HAS) if I choose option 1 under PERA (full benefit comes to me, but when I die the benefit stops). Since I chose option 3 (I get a reduced benefit, but when I die my spouse gets the exact same benefit until she dies), I’m getting about 91.5% of that which comes out to about 80.1% of my HAS. It’s important to understand that the factor that determines that reduction percentage changes, both according to your age and your spouse’s age and due to PERA’s current actuarial assumptions, but the changes are relatively small from year to year.

What this means is that during this transition year, I’m effectively getting 180% of the pay I would normally get, minus the amount I have to pay for my own insurance coverage. I’m adding on to my wife’s insurance (as is our daughter) so that comes out to approximately 5% of my salary, so I’m making about 175% of what I normally would. (Also, in LPS your pay for the transition year is “frozen” at what you made the previous year, so I do not receive the small cost-of-living raise I would’ve normally received.)

The other thing to keep in mind is that in addition to losing benefits, I’m “giving up” the service credit I would earn with PERA by working this transition year. I (and LPS) still contribute to PERA during this year, but I do not earn any service credit, which is effectively giving up 2.5% of my HAS. Because I’m 75% “ahead” from getting the benefit during my transition year, that’s equivalent to roughly 30 years of retirement. (Not exactly because of the time-weighted value of money, it is actually much longer than that because I can earn money by investing that 75% over those thirty years, but good enough for our purposes). So, with that back-of-the-envelope calculation, the “break-even” point is 30 years. If I live longer than that (which I have decent chance of), then theoretically not taking the transition year would work out better. In reality, because of the compounded investment returns that I can make on that 75%, it’s likely to be 40 years to break-even or perhaps a lot more, so for me the (financial) decision was pretty easy. (The fewer years of service credit you have, however, the closer you need to look at that calculation.)

There are other things to consider in addition to the “break-even” point when looking at the transition year option.

  • Because you have to retire from PERA and keep working for your employer, you have to know you are going to retire (and commit to it) about 16 months before you will actually stop working for your current employer. For some folks, that’s difficult to do.
  • As mentioned above, in many districts you’ll lose your benefits, which includes not only health, dental and vision, but things like life insurance and sick days (in LPS you get 5 sicks days for use during the transition year). So you have to figure out where you are going to get coverage (from a spouse, from LPS via COBRA where you pay the full premium, from PERACare, or on the individual market).
  • During the two calendar years that the transition year affects, your taxable income will increase (both your regular income and your PERA distribution are taxable), and there’s a decent chance it will move you into a higher tax bracket. (In LPS you get two “paychecks” – one from LPS, one from PERA – for a total of 14 months, 7 in each calendar year.) This is especially true in LPS if you have a lot of accrued sick days, as LPS gives you a payout on those as well, for me that’s over $9000 additional taxable dollars for 2017 (this is not PERA-includable salary). This is why many folks increase their contributions to 401k/403b/457 plans during these two years.
  • And it depends a lot, of course, on your personal financial circumstances and needs. There’s no one-size-fits-all when it comes to retirement planning.

So, should you take a transition year (assuming your district offers it and you’re eligible)? It depends, and if you choose to work with me we will look at this very carefully, but it’s definitely something to know about, investigate, and perhaps even make some financial decisions prior to retiring based on the knowledge that you will be receiving this benefit.

photo credit

Focus On: LPS Retirement Plans (401k/403b/457 Plans)

Summary: Choose the PERA 401k plan and invest as much as you can.

lpsretirement

The idea of retirement is a fairly new one. It wasn’t until early in the 20th century that the concept of retiring from work and “living a life of leisure” was even a concept. Many employers started offering pension plans and then Social Security came along in 1937. Then in 1978, the idea of a tax-deferred savings plan (401k) was created, although it’s original intent was not the way we’ve ended up using it.

Social Security was really designed to be part of a “3-legged stool” concept of retirement, that retirees would draw from their company pension, from social security and from their personal savings. As pension plans have gone out of favor and 401ks have taken their place (particularly in the private sector), it has really become a two-legged stool (which is somewhat problematic). For public school employees in Colorado, PERA is a social security replacement plan, so basically covers those two legs, leaving the personal savings leg for you to figure out on your own. That’s where employer-offered tax-deferred savings plans come in.

All PERA employers offer the PERA 401k plan to their employees, and some employers also offer access to the PERA 457 and the newly created PERA Roth 401k/457 plans. Many school districts also offer additional, non-PERA options for tax-deferred accounts. This post will focus on what’s offered in Littleton Public Schools, but you should check with your employer to see what options they offer.

LPS allows you to choose between PERA and TIAA for retirement savings vehicles, offering the PERA 401k, 457, Roth 401k and Roth 457 plans, and the TIAA 403b, 457, Roth 403b and Roth 457 plans. There are subtle differences between 401k, 403b and 457 plans that can be important but, for the purposes of this discussion, we’ll treat them as roughly the same, with the important exception that you have separate contribution limits for 401k/403b and 457 plans which gives you the ability to save more if you have the cash flow to do that.

This post is not intended to be an in-depth explanation of 401k/403b/457 plans (or their Roth versions), but let me try to briefly describe them (if you decide to work with me we can dive deeper if need be). The idea behind 401k/403b/457 plans is to save money in a tax-deferred account, which means that you are not taxed on your income that you place into those accounts now, nor are you taxed on the earnings in those accounts as they accumulate, but you are only taxed when you make withdrawals which will hopefully be when you are retired. The traditional thinking is that most folks will be in a lower tax bracket when they are retired, so not only do you reap the benefits of saving “extra” all those years by not paying taxes up front, but when you do pay taxes upon withdrawal you will pay a smaller amount.

More recently Roth 401k/403b/457 plans have been created (along with Roth IRAs, which don’t flow through your employer) that take a different approach. For these plans you do pay taxes on any income you invest, but the earnings grow tax free and all withdrawals in retirement are tax free as well. In other words, pay the tax up front, never have to worry about taxes on this money again. For folks who think their tax bracket might actually be higher in retirement, this is a better option.

The obvious conundrum is how do you know for sure whether your tax bracket will be higher or lower in retirement? You don’t, which is why many folks choose to put money into both types of accounts to hedge their bets and give themselves more flexibility in retirement by giving them the option to withdraw from whichever account makes the most sense based on their current tax situation. (There are also some really nice benefits of a Roth if you are trying to leave an inheritance.)

Many employees, especially younger ones, kind of throw up their hands at all this. Retirement seems like a long way off, the choices can be complicated, and of course choosing not to spend money right now can be difficult for some folks. But the beauty and power of investing is compound interest, and it’s most effective the more time you give your money to grow, so the sooner you start, the better (and easier) it is to generate the retirement savings you want.

Many folks thinking about 401k/403b/457 plans also don’t take into account the effect on the tax-deferral on their current income. They think about putting say $100 a month into a 401k, but then worry they can’t do without that $100 a month. But they’re missing that their actual paycheck won’t go down by $100, but more like $70 (if you are in the 25% federal bracket, plus 4.65% for Colorado taxes). The government is basically saying, “invest $70 and we’ll give you $30” (always remembering that eventually they are going to tax you on that when you withdraw it). If you choose the Roth options, you don’t get that tax break up front, so your paycheck will decrease by $100 (but the potential for tax-free growth over time is tremendous).

So, with that overview, if you are an LPS employee, should you choose PERA or TIAA? Well, again, that depends on your individual circumstances and I’d be happy to discuss those with you, but for most people PERA is the better choice because of lower fees.

PERA offers a choice of several funds or a self-directed brokerage account if you want more control. For most folks, the funds are the better choice. In 2011 PERA chose to go with a “white-label” approach to investments. Research has shown that many folks make poor investment choices when given too many choices so, instead, a “white-label” approach has you choose among asset allocation choices instead of picking individual funds.

whitelabel

I’ll write more in future posts, but there are basically three things you can control when saving for retirement:

  1. How much you save.
  2. What asset allocation you choose.
  3. How much in fees you pay.

By going with a white-label approach and trying to keep fees low, PERA has tried to simplify the second and third choices for you. For each of their asset classes, PERA has typically gone with a combination of a passive (index) approach and an active (managed) approach. This combination gives you lower fees than a fully active approach, but higher fees than a strictly indexed approach. PERA thinks that they can achieve higher returns than the index this way. I’m a big fan of index funds, so I’m not totally convinced of this approach but, so far in their short lifespan (since 2011), they have mostly achieved this to  a small extent.

perafees

PERA does also give you a self-directed brokerage option (for an additional fee), which allows you almost unlimited choices in investments. For most folks, the additional complication of choices and fees make this sub-optimal, but it’s there if you want it.

selfdirected

TIAA is more like the self-directed brokerage option, which is one of the reasons the fees tend to be a bit higher (although still not bad compared to many other companies, 0.42% plus the underlying fund fees). Here’s a comparison of fees for a large-cap investment in the PERA white-label fund, the PERA self-directed brokerage option invested in a large-cap index fund (they require you to keep $500 in PERAdvantage funds), and the TIAA option invested in the same index fund. (You can view comparisons for other asset classes here.)

401kfees

If you look carefully, you’ll notice that the cheapest option is the PERA self-directed brokerage option (as soon as you pass about $20,000 in your account), with the PERAdvantage funds coming in second, and TIAA coming in last. Since the middle and third columns are essentially the same choice in terms of what you’re investing in, there’s no reason to choose the higher fee TIAA option over the PERA option. If you are investing a lot, you can save in fees by going the self-directed brokerage option, but this is where PERA would argue that they think they will outperform the index and make up those fee differences. The differences are small enough between the first two columns that, for most folks, it’s probably best to stick with the PERAdvantage options.

In future posts I’ll write more regarding possible asset allocations (which fund(s) should you choose), contribution limits (and the fact that you get separate limits for 401k/403b vs. 457, allowing you to save much more if you can), and the power of compounding. But, for now, this gives you an idea of where to start. The key thing is to start now and put as much as you can into one or more of these vehicles so that your “stool” will be sturdy enough to support you in retirement.

PERA: It’s Even Better Than You Think

pera

Most Colorado (public school) educators know that Colorado PERA is a “good” retirement program, especially compared to Social Security, but often they don’t know just how good it is. Fully exploring this topic is beyond the scope of this blog post, but let me briefly hit some of the highlights.

As part of SB 14-214, the the state of Colorado commissioned three independent studies of Colorado PERA, two of which are particularly relevant to this discussion. The Milliman Retirement Benefits Study, released in January of 2015, looked at how Colorado PERA’s benefits fit into the larger picture of total compensation, and was designed to evaluate the value of PERA compared to other retirement packages offered by other states and by private companies. The executive summary states,

The state’s total retirement compensation package is equivalent to 15.7% of pay (15.4% defined benefit and 0.3% retiree health), relative to the market median of 14.7% (combined sources: defined contribution, defined benefit, social security, and retiree health)

Basically, this says that as part of a total compensation package, Colorado PERA is just above the median benefit paid by states and private companies.

The second study, the Gabriel, Roeder, Smith & Company Plan Design Study is a bit more in-depth and relevant to this discussion. The purpose of this study was to compare Colorado PERA’s plan design and, specifically, the costs and effectiveness of PERA, as compared to other retirement plans offered in the public and private sectors (including the one that affects the most people, Social Security). Again, from the executive summary,

This study found that the current PERA Hybrid Plan is more efficient and uses dollars more effectively than the other types of plans in use today.

When the study was presented to the State of Colorado’s Legislative Audit Committee, GRS officials told members,

Colorado’s largest public employee pension system is the most efficient and effective a state could have.

Those are important pieces of background to know, especially when the legislature is in session and various bills are offered regarding PERA. But I want to point out some specific features of Colorado PERA that are particularly relevant to you from an investment and financial planning perspective.

Colorado PERA represents over 500,000 members which provides some significant advantages to you in terms of economies of scale and in terms of investment returns. Because PERA is so large, it is able to both invest at low cost and to invest in areas that are not available to you as an individual investor. Because they are a large, institutional investor, they are able to negotiate investment fees that are lower than what you can typically achieve on your own. They can also invest in areas such as real estate and private equity that are not available to you as an individual investor. Both of these help PERA achieve higher returns (at the same level of risk) than most individual investors.

Perhaps even more importantly, however, is the fact that PERA is the ultimate long-term investor. As an individual, you have a “life-cycle” to your investments. Typically as you get older and then eventually when you are retired, conventional wisdom indicates that you should get more conservative with your investments because you don’t have time to “recover” from a market downturn. But because PERA pools money from over 500,000 members, and because they are essentially investing in perpetuity, in many ways PERA can invest like each one of those investors is an unchanging 35-year old.

While PERA does have to deal with cash flow issues in order to pay benefits, and they certainly have to manage risk and particularly be concerned with sequence-of-returns risk, overall they can truly invest for the long term. Which means that even as you get older, PERA doesn’t have to adjust its investments based on your age, they continue to invest as if you were 35. This allows them to stay fully invested for the long-term at an appropriate level of risk that will generate good long-term returns.

In addition, once you do retire and start drawing your PERA benefits, those benefits are guaranteed for life, including a 2% annual increase to help cover inflation. (Note: that 2% applies to those hired before 2007, and can temporarily decrease following calendar years that PERA investments lose money, which does happen, but not that frequently. For those hired after 2007, it could also be 2%, but it’s a bit more complicated.) Let’s use a specific example to put that into perspective.

The median PERA retiree earns about $35,000 per year in benefits. There’s a rule-of-thumb in financial planning circles called the 4% rule which says that, based on historical results, people can typically withdraw 4% of their investment balance each year to live on and still expect their money to last until they die. While not perfect, the 4% rule is pretty robust, which means that the $35,000 per year in our example equates to about $875,000 in savings. Many career educators will likely qualify for a much higher benefit, maybe $55,000 a year or more, which equates to $1.375 million in savings.

Now, this is a very rough equivalency, as an investment balance using the 4% withdrawal rule has a decent chance of actually growing over time, which means you could leave a healthy inheritance, while your pension income ends when you die (or when your beneficiary dies if you take Option 2 or 3). But I think it still gives you a rough idea of the incredible value of your PERA pension. It really does allow teachers to become millionaires by the time they retire (and multi-millionaires if you invest your own savings wisely).

There’s one other important aspect of this that I think many Colorado educators may not notice. Because this pension income is guaranteed, in many ways you can think of your PERA pension as the fixed income (bonds) portion of your portfolio. This means you can invest your other retirement savings (401k/403b/457 – I’ll write a post soon on retirement savings plans) more aggressively than folks who don’t have a pension plan like PERA, which can ultimately generate a lot of increased wealth and therefore financial security. (I will write a post soon on investment “risk” and how “aggressive” investments are not necessarily more risky for the long-term investor.)

This is one of the main reasons why I think it’s unfortunate that many Colorado educators don’t really start thinking about PERA until they are close to retirement. In reality, the fact that you have PERA as your retirement plan should affect your financial planning from the first day you begin PERA-covered employment. (This is also one of the reasons I decided to start Fisch Financial – after talking with colleagues over the years about PERA, I realized how little many of them have thought about how PERA should affect their financial planning.)

So, how good is PERA? It’s great in-and-of-itself, but it also allows you to be more successful with the rest of your investments as well. Please consider incorporating the affordances that your PERA benefit allows you in the rest of your financial planning.