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403b Plans

403b Plan Financial Advisor for Public Employees

Since 1990, I’ve been a financial advisor specializing in helping educators set up, invest in, and service their 403(b) plans.

I have accumulated a reservoir of knowledge on the retirement system, the social security offset/windfall elimination, 403(b) plans, and other financial issues specific to public employees.

Because I am an independent financial advisor who provides flexible payment options (fee-only, hourly rate, or commission), I can work with most companies in your school system’s 403(b) plan. A partial list of companies I work with includes Fidelity, American Funds, Putnam, MFS, Aspire, Security Benefit, Axa, and Oppenheimer.

Read More: Diversification and Rebalancing Your Portfolio

403b Plan Advisor
403b Plan Financial Advisor

1. How Much Can You Contribute to a 403b?

Public school educators, including university professors and administrators, can save more pre-tax than any other public or private-sector employee.

Educators are eligible for two retirement plans, both with unique catch-up options.

In 2021, educators can save $19,500 into a 403(b) and a 457 plan. Those fifty years or older can also contribute an additional $6,500 into one of the two.

The 403(b) catch-up allows educators who have low 403(b) savings and have worked fifteen years with the same employer to save an additional $3,000 per year for five years.

One problem with this catch-up is that any contributions over $19,500 are credited first against the 15-year rule. A teacher aged fifty or above could use up their 15-year catch-up without knowing it.

The 457 plan has a more considerable catch-up. It allows eligible employees to contribute $37,000 per year for three years before their “regular retirement date.”

The 403(b) catch-up can be used in conjunction with the age fifty catch-up and 457 plan. However, the 457 plan catch-up cannot be used with the age fifty catch-up, although the employee could still contribute to a 403(b).

Putting large amounts of your savings into a 403(b) and 457 plan does not reduce your income for the State Retirement System calculations.

Not everyone can afford to save the maximum; however, it is good to know that educators have a well-deserved potential benefit.

Your school system provides you with a list of 403(b) companies. The 457 plan is different. The city/town usually provides one company. Both typically give you a broad range of investment options.

Massachusetts Public Employees & Social Security Eligibility
403b Plan Financial Advisor

2. Public Employees and Social Security

Public employees in Massachusetts do not contribute to the Social Security system, but many of them contribute through other jobs. Some also have spouses who take part in the Social Security system. Both scenarios are affected by two federal laws.

  • The Windfall Elimination provision can reduce any Social Security benefits that a public employee earns by as much as 55%. For example, a retired teacher who receives a pension from MTRS and also qualifies for a monthly Social Security benefit of $1,000 might only receive $450 a month.
  • The Government Pension Offset provision affects the Social Security benefits of a spouse, widow, or widower. For example, if a married teacher receives a monthly pension from MTRS of $6,000, two-thirds of that amount ($4,000) will be credited against any benefit from their spouse’s Social Security.
    • Thus, if the spouse dies and the retired teacher is eligible for a $2,000 survivor benefit from Social Security, that teacher would receive none of it because the $4,000 would eat into all of it.
    • Very few married people who retire with a pension from MTRS will receive anything from their spouse’s Social Security.

Are There Any Workarounds?

There is a workaround for the Windfall Elimination Provision. Any public employee in Massachusetts with 30 or more years of ‘substantial earnings’ in a job where they paid into Social Security will receive their full benefits. In fact, after 25 years of such substantial earnings, any reduction in Social Security benefits begins to shrink.

Public Employee Pensions Maybe Rhode Island Figured It Out
403b Plan Financial Advisor

3. Public Employee Pensions

Back in the day before private employers dismantled their pensions and replaced them with 401(k)s, if someone told you that they had a pension, you would not know whether they worked for the public or private sector. Today, however, if someone says, ‘I have a pension,’ that usually means they work in the public sector.

Public employees make up 14% of the total workforce. Fifty-two percent of them have college degrees, higher than in the private sector, where only 35% do. Fifty-seven percent of public employees are female, compared to 42% in the private sector, and 30% of public employees, roughly six million workers, are not covered by Social Security.[i]

Some of the states that have poorly funded their public pensions (e.g., Illinois, which has a funding ratio of just 39%) are also some of the thirteen states where Social Security doesn’t cover public employees. Colorado is one of these states, and its 59% funding ratio is not much better than Connecticut’s at 47%.[ii]

A Pew Research Report puts the funding gap for all public employee pensions at $1.24 trillion. Every state is different, though. For instance, Washington, South Dakota, New York, Nebraska, Idaho, Wisconsin, and Tennessee are in great shape, with 90% or better funding ratios. Others, such as Illinois, Kentucky, New Jersey, and Connecticut, are in big trouble, with funding ratios of only 40% to 50%.[iii]

Public employee pensions are funded in three ways: (1) The states contribute; (2) Employees put in a percentage of their salary; and (3) The pool of money grows. In states where Social Security covers employees, the median employee contribution rate is 5%. In states without Social Security, the median employee contribution rate is 8%.[iv]

Some states, including Rhode Island, which at one point had the nation’s highest underfunding on a per-capita basis, shifted their public employees to a hybrid program that combines a less generous traditional pension with a 401(k).[v]

With 401k(s), employers contribute money for their employees’ retirements while they are working. Employees can also set aside a portion of their pay. (The government provides the tax incentives to do so.) However, it is up to the worker to set aside enough for a comfortable retirement.

The painless way for states to make up for funding gaps is to hope that the $3 trillion already in these plans grows fast. That way, neither the state nor the public employee is required to contribute additional funds. However, growing a portfolio when interest rates are this low requires plans to reduce holdings of safer investments, such as bonds, and increase holdings of riskier assets such as stocks, hedge funds, real estate, and private equity.

According to Alicia Munnell, Peter F. Drucker Professor of Management Sciences at Boston College’s Carroll School of Management and director of BC’s Center for Retirement Research, two-thirds of public pension plan assets are invested in stocks, hedge funds, real estate, and other alternative investments.[vi]

Joshua D. Rauh, Professor of Finance at Stanford Graduate School of Business and a senior fellow at the Hoover Institution, adds, ‘US Public pension funds have $315 billion of commitments to private equity, venture capital, and private real estate funds. This is compared to $89 billion for all university endowment funds combined and $98 billion for all sovereign wealth funds.’[vii]

This April, at the height of the stock market carnage, famed reporter Bethany McLean penned a piece for Vanity Fair that discussed the large investments public employee pensions made in private equity, making private equity-like the big banks—too big to fail and in need of a bailout from the federal government.[viii]

The good news for public employees is that it is extremely hard for states to get out of their pension commitments no matter how poorly they are funded or how much they have invested in private equity. The bad news is, unlike the federal government, states don’t own a printing press.

Maybe the Rhode Island solution of a combination of a traditional pension along with a 401(k) ends up being the way forward that allows states to continue to provide smaller but well-funded pension benefits to their public employees. [ix]

These are the opinions of Tim Hayes and not necessarily those of Cambridge Investment Research. They are for informational purposes only and should not be construed or acted on as individualized investment advice.

[i] Alicia H. Munnell, State and Local Pensions What Now? (Kindle Version)

[ii] The State Pensions Funding Gap: 2018, https://www.pewtrusts.org/en/research-and-analysis/issue-briefs/2020/06/the-state-pension-funding-gap-2018#:~:text=At%20%241.24%20trillion%2C%20the%2050,due%20to%20strong%20investment%20performance.

[iii] The State Pensions Funding Gap: 2018, https://www.pewtrusts.org/en/research-and-analysis/issue-briefs/2020/06/the-state-pension-funding-gap-2018#:~:text=At%20%241.24%20trillion%2C%20the%2050,due%20to%20strong%20investment%20performance.

[iv] Alicia H. Munnell, State and Local Pensions What Now? (Kindle Version)

[v] Alicia H. Munnell, State and Local Pensions What Now? (Kindle Version)

[vi] Alicia H. Munnell, State and Local Pensions What Now? (Kindle Version)

[vii] J.D. Rauh (personal communication, July 14, 2015)

[viii] McLean Bethany, Too Big to Fail, Covid-19 Edition: How Private Equity Is Winning the Coronavirus Crisis, Vanity Fair, April 9, 2020, https://www.vanityfair.com/news/2020/04/how-private-equity-is-winning-the-coronavirus-crisis

How the Federal Tax Cuts and Jobs Act Can Help Solve the Public Pensions Problem
403b Plan Financial Advisor

How the 2017 Federal Tax Cuts and Jobs Act Can Help Solve the Public Pension Problem

Some politicians want public employees to change their traditional pensions to 401(k)-type plans,[1] pointing out that private-sector workers have already done so.

This change of retirement contribution plans has had a mixed record. It benefits those workers who often change employers because they receive employer contributions while they are working. However, it hurts workers who stay with the same employers, as those workers miss out on the employer contributions during retirement.

Also, many private-sector workers struggle with saving and investing their 401(k) retirement money. According to a 2015 Wells Fargo study, the median savings of working Americans aged 60 or older is $50,000 against a retirement savings goal of $300,000.[2]

Ted Benna, credited with inventing the 401(k) retirement plan in the late 1970s, says he never fathomed that the plan would be a substitute for traditional pensions. In light of that, he said he would conceive the 401(k) plan differently were he doing so for the first time today.[3]

How Are Public Employee Pensions Doing?

Some states have severely underfunded their public employee pensions. This puts pressure on the politicians, as they need to either (1) go to the taxpayers to increase their taxes to make right on the pension promises, or (2) ask the public employees to give up an accrued pension benefit.

On October 23, 2018, the PBS documentary series Frontline devoted an entire episode to the multi-trillion-dollar public pension hole, focusing on the Commonwealth of Kentucky,[4] which has systemically underfunded its pension plans by $37 billion and has tried to make up for that with aggressive investing strategies. Some of its pension systems went from fully funded in 2000 to possibly running out of money in the next three years.

The 2017 Federal Tax Act

In 2017 the US Congress passed the Tax Cuts and Jobs Act, the most significant change to the federal tax code since the 1986 tax overhaul. The Act reduces or eliminates many deductions, such as putting a $10,000 cap on state and local income and property taxes, no longer allowing for a deduction for home equity or moving expenses. It also eliminated the $4,050 per-person personal exemption.

To offset those losses, the Act increases the standard deduction from $6,500 to $12,000 per single filer (double for joint filers) and lowers overall tax rates. Thus more people will use the new larger standard deduction and pay less in federal income taxes. However, some wealthy and upper-middle-class people will end up paying more in federal taxes, because of the decrease in deductions and exemptions.

What Does All That Have to Do with Public Pensions?

Most of the 41 states with state income taxes conform in some way to the Federal Tax Code. For example, Colorado uses the federal definition of taxable income to figure state taxes owed, and taxable income is one’s income after all deductions.[5] This means any Colorado taxpayer who loses deductions and exemptions at the Federal level also loses them at the state level. And, unlike the feds, neither Colorado nor any other state has reduced its tax rates to reflect the broader tax base.

Kentucky also has a state income tax, so it, too, could see an increase in tax revenue as taxpayers there lose mortgage-interest and property-tax deductions, as well as personal exemptions, leaving some taxpayers with a much higher state income to be taxed.

Almost all income-taxed states could see more revenue as a result of the 2017 Federal Tax Cuts and Jobs Act. This gives the politicians once-in-a-lifetime opportunities to shore up their public pensions with tax revenues from higher taxes they didn’t impose.  

Why Public Employee Pensions Are Worth Saving

Interestingly, public employees’ pensions are precisely what Ted Benna envisioned when he created the 401(k): a traditional pension, supplemented by a 401(k) plan. (Public employees use 403(b) or 457 plans.)[6]    


Notes

[1] Loftus, Tom, and Morgan Watkins, “Kentucky Supreme Court: How Does a Sewer Bill Become Pension Reform?” Courier Journal, September 20, 2018, https://www.courier-journal.com/story/news/politics/2018/09/20/kentucky-pension-reform-supreme-court-hears-arguments/1344378002/

[2] MarketWatch, Wells Fargo Retirement Study: A Few Years Make a Big Difference, October 22, 2015, https://www.marketwatch.com/press-release/wells-fargo-retirement-study-a-few-years-makes-a-big-difference-2015-10-22?TB_iframe=true&width=370.8&height=658.8

[3] Ambrose, Eileen, “The 401(k) Turns 30,” Baltimore Sun, March 6, 2011, http://articles.baltimoresun.com/2011-03-06/business/bs-bz-ambrose-401k-20110306_1_ted-benna-savings-plan-retirement

[4] Taddonio, Patrice, “Watch: In Kentucky, Sewers, Pensions and Protests, Frontline, October 23, 2018, https://www.pbs.org/wgbh/frontline/article/watch-in-kentucky-sewers-pensions-and-protests/

[5] Walczak, Jared, “Tax Reform Moves to the States: State Revenue Implications and Reform Opportunities Following Federal Tax Reform,” Tax Foundation, https://taxfoundation.org/state-conformity-federal-tax-reform/

[6] Tong, Scott, “Father of Modern 401(k) Says it Fails Many Americans,” Marketplace, June 13, 2013, https://www.marketplace.org/2013/06/13/sustainability/consumed/father-modern-401k-says-it-fails-many-americans

How the 2017 Federal Tax Cuts and Jobs Act
Can Help Solve the Public Pension Problem

Who's Looking at Your 403b?
403b Plan Financial Advisor

4. 403b Plan Financial Advisor Masssachsuestts School System’s

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