By Chuck Yanikoski, Founder and President of StillRiver Retirement Planning Software, Inc.
There were an estimated 3.7 million full-time equivalent elementary and secondary schoolteachers in the United States as of the fall of 2011. About three quarters of these teachers are female. In this article, Chuck Yanikoski of Still River Retirement Planning Software, Inc. profiles two sisters with identical careers, retiring at the same age, receiving identical pensions and Social Security benefits. Chuck discusses how their actions and choices made for, up to and into retirement – regardless of their many similarities – can result in their experiencing very different outcomes.
This presentation was delivered in live webinar format in 2013. Chuck’s comments have been edited for clarity and length.
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What are the current practices in dealing with teachers when it comes to retirement? One is what happens before retirement, and the other is what happens when people are getting close to retirement. “Before retirement” means well before retirement – what we call the accumulation phase when people are accumulating funds, contributing to plans and saving for retirement. There is a standard approach, which we in the business call “gap analysis.” People estimate the income they are going to need when they do retire, estimate what they’ve already got covered through Social Security, pension plan and existing savings, and then figure what’s the gap between those two. How much less do they have than what they really need? That’s the gap that then one tries to fill one way or another, usually through persuading the teacher to save more through a plan; through their state-sponsored retirement defined contribution system if they have such a plan, which is increasingly common, through a 403(b) plan, or in some other way.
This kind of analysis is pretty simple. Timeframes are set in terms of the current age, the life expectancy and how many years from now until the teacher retires. We look at current income, and then usually apply some sort of inflation factor to estimate what their post-retirement income need is going to be.
Almost all teachers, public school teachers anyway, have a defined benefit/traditional pension plan. Some states have made this optional, especially for new teachers. Some have Social Security income. A lot of states basically disqualify teachers from receiving Social Security. Then there is income from other savings, particularly a 403(b) plan – but there could be other savings as well. This is a very simple way of estimating future needs.
Normally, I criticize things that are very simple, but in this case, I praise it. If the objective here was to actually determine what the need is and exactly how much the teacher should be saving, then no, this is not good enough. The real purpose of this exercise is almost 100 percent motivational. The idea is to show the teacher that there is a gap (if there is in fact one), between what they’re going to want to have when they retire, and what they’ve currently accounted for in terms of their pension plan and the savings they have already – so that they should be saving more. That is good advice for almost everyone. However, when the teacher gets close to retirement or is already retired, the traditional gap analysis produces a sketchier outcome.
Introducing Caroline and Sheri
Caroline and Sheri are twin sisters. They have nearly identical situations, at least in terms of the points of information that most software packages and most kind of casual advisors about retirement look at. They have the same number of years of service in the same retirement plan. They live in Indiana, which is one of the states that allow Social Security income as well as income from the state retirement plan.
Both sisters plan to retire next year with 37 years of service, and each is entitled to an annual pension of $2,464 a month under that plan’s maximum benefit. Both are highly qualified; they’re making a very good income, probably better than average for a lot of teachers. They’re anticipating a 1 percent increase next year.
Each also has $67,000 in a 403(b) plan, plus $25,000 in other savings. Since they’ve been doing the exact same work in the same state for the same amount of time, they both have the same Social Security benefit of $1,500 a month. So between Social Security and their pension from the Indiana plan, 65 percent of their pre-tax income is being replaced in retirement from guaranteed sources. Plus, they each have $92,000 in reserve. Both are non-smokers in excellent health.
How Prepared Are They?
The software we used shows results in the form of a report card, which happens to be particularly appropriate for teachers. Under normal circumstances, Caroline gets an A+, and an A+ in this software means that when she is expected to die, she will have a lot of money left over (see Figure 1 below). The other five scores of four A+ and an A without a plus indicate that she’s also in very good shape under various adverse circumstances.
Figure 1: Retirement preparedness report card for Caroline©2013, Chuck Yanikoski
For Sheri, everything is exactly the same, except that instead of getting As, she’s getting Fs. Her plan is a disaster.
Figure 2: Retirement preparedness report card for Sheri©2013, Chuck Yanikoski
How can this be? Obviously, there are some hidden differences.
The Hidden Differences
- Family. Sheri is single; Caroline has a husband and an adult daughter who happens to be living at home. There are other sources of income for Caroline. Her husband, Calvin, earns a better salary than Caroline does and is also entitled to Social Security. His Social Security is more than hers, so if he dies first, she’ll get to start collecting his instead of her own so her income will actually go up. Her personal income will go up; household income will go down because he won’t be collecting anymore.
- Home ownership. Caroline and Calvin own their own home; whereas, Sheri has always been a renter.
- Other assets. Sheri doesn’t really have any other significant assets, but Calvin has $125,000 in savings in a 401k plan through his own employer.
- Lifestyle differences. Caroline and Calvin live within their means, have always done so, and have been saving money for their own retirement since their daughter got out of college. Sheri, not so much – she likes to travel, and nothing wrong with that, but she’s kind of pushed it a little bit, and has pretty much spent most of what’s come in – and hasn’t been much of a saver. And that’s why she doesn’t have any assets other than what’s in her 403(b) plan and the $25,000 in the bank.
Retirement Planning Lessons
So there are some lessons from this kind of quick illustration. The pension plan, even supplemented with a 403(b), is not necessarily going to assure retirement solvency, even for people like Sheri who have been in the system for their entire careers. It depends on other things that are going on outside of their qualified plans. Teachers, and for that matter other people, need a much more detailed analysis when they’re approaching retirement. Years ahead of time, they don’t need that. They just need to be encouraged to save, and that’s a good thing. But once they get within a few years of retirement, and the closer they get, and then when they’re in retirement – you need to get into a lot more detail to find out whether you’re dealing with a Caroline or a Sheri.
If you’re dealing with a Sheri, you’re dealing with someone who’s going to have to make some serious adjustments either to their plans – and I don’t mean their retirement plans – I just mean their life plans – or their lifestyle, whereas, the Carolines of the world have extra money. I’m not saying you should encourage them to squander it, but when people retire, they are probably in the best health they’re every going to be in for the rest of their lives. I think we all know people in their 60s or early 70s or even in their 50s who develop really debilitating illnesses or have other problems. If they didn’t do the traveling they wanted to do, if they didn’t do that dream project that they always wanted to do – they maybe missed their opportunity.
For the people like Caroline, it’s good for them to know that they actually do have the means to pursue some of those extra dreams that they maybe have always had but weren’t really sure that they could afford. If you can demonstrate to them that they can afford it, then they’re better off too.
The other thing I wanted to point out from this is that with most middle-income people – and most teachers fall into that category – their long-term solvency in retirement is not usually asset driven. A lot of the tools and advice that comes out of the financial industry is really geared toward more affluent households. It’s focused on how they should invest their money and how much they can take out of their plan every year, as if that was something that was actually going to happen that they’d take the same amount every year. Those issues are not so important for teachers and other middle-income people because they don’t have a lot of assets.
The Importance of Spending in Retirement
They have to manage their finances using the factors that most dominate their finances. For most people, it would be their pension and Social Security on the one hand, which they don’t have a whole lot of control over – basically once you lock yourself in, you’re locked in. The other two main factors are when they retire and when they how much they spend on their household expenses.
Now, going back to Sheri; she was in trouble. She had Fs on her report card, so the software came up with Plan 2, and it calculated how long she’d have to postpone retirement in order to get decent grades.
Figure 3: Retirement preparedness report card
for Sheri: Delay retirement 5 years©2013, Chuck Yanikoski
You can see that these grades aren’t great, but under normal circumstances she’s got an A-minus, which means that by the time she dies she might have a little bit left. These are better, but five years is a long time, especially when you’re thinking you’re going to retire in one year.
Another alternative is that she cut her living expenses by 25 percent, and this provides even better grades – but 25 percent is a big cut. Most people can cut 5 or 10 percent without really impairing their lifestyle too much. They just have to be quite a bit more careful and maybe make a couple of significant compromises. But 25 percent is a big compromise, and because Sheri likes to be a little bit of a spender, this isn’t going to go down very well either. So let’s kind of mix and match these two things.
Figure 4: Retirement preparedness report card for Sheri:
Cut expenses 25%©2013, Chuck Yanikoski
We came up with a plan where she can retire in two years and reduce her expenses by only 10 percent; between those two changes together, she’s getting grades that are really quite acceptable.
Figure 5: Retirement preparedness report card for Sheri:
Cut expenses 10% and delay retirement 2 years©2013, Chuck Yanikoski
Other advice for Sheri:
- She should wait until 70 to begin collecting Social Security. This is particularly going to be easier for her if she delays her retirement, but she does have some savings she can fall back on, and she will have her pension. So she won’t have to use up necessarily all of her savings in order to do this. We’re not saying it’s a good idea for everybody to collect at age 70, but it is for Sheri because she is in excellent health. She doesn’t have a spouse benefit to rely on.
- Calculate what would happen at different ages. Choose the pension option that pays a benefit for her life only. In most states, this is the default. In Indiana, it is a lifetime income but with 60 payments guaranteed. So if the teacher dies a year after she retires, somebody else will get the benefit for another four years. Naturally, in order to pay that extra benefit, there is a reduction in Sheri’s benefit while she’s alive for the rest of her life. Since she doesn’t really have a beneficiary who needs that, the recommendation is for her to not choose the standard benefit but to choose the true-life annuity with no contingent benefit to anybody else.
- Pay off credit card debt. This is good advice for everybody, unless you’ve got a very low interest rate on your credit card.
- Don’t purchase long-term care insurance. This kind of insurance is good for a lot of people, but it’s not ideal for everybody. It is expensive; Sheri can’t afford anything expensive. She does have some family who might be able to help her in the early stages of some kind of disability that might develop over time. So she might have a little less need than some other people. The risk is not as great for her as it is for some other people because if she ends up in a nursing home that she can’t afford, Medicaid will pay for it. For a married couple this is more of an issue because the person who’s in the nursing home can drain all the finances out of a family, and then there’s nothing left for the other spouse.
- Invest more money into her 403(b) plan while she’s still working. Since she’s inclined to spend money, it might be easier for her not to spend it if it’s not in a place where she can’t get at it so easily.
- Sign a living will, healthcare proxy, durable power of attorney; as you get older they’re very important.
- Get ready for retirement non-financially. As we said before, there are lots of issues that are not strictly financial issues. A lot of people don’t think about these issues until retirement is very close, and that’s not wise. Find a way to help teachers to think about their retirement starting maybe two or three years ahead of time covering both financial and nonfinancial issues. Teachers have a little bit of an advantage because most of them get the summers off. They’re used to having extended periods of time when they’re on their own. They actually have a little bit of sort of retirement training built into their career. But when you’re used to going back to school in September, and when September comes you don’t go back – that can be a real shock for a lot of people. If they haven’t thought about it, if they haven’t prepared for it, if they haven’t found other ways to keep busy and to keep involved – it can be actually pretty devastating.
Advice that’s not included in Sheri’s plan is to:
- Reallocate her 403(b) plan to riskier investments so she can earn more money on them, even though she’s got a serious financial problem. There are different schools of thought in this. The Society of Actuaries has a list of 15 different risks that people face in retirement. Some of them you can’t do much about, but others you can. What you need to do is find ways to reduce your risk. By investing more aggressively to earn more money, you are actually increasing your risk. You’re taking on additional risk.
- Annuitize the 403(b) account. She already has a lot of guaranteed income. She already has Social Security, she has her pension; but what she doesn’t have is a lot of liquidity. If something goes wrong, she needs to have that money. She also needs it to cover her extra expenses. If she’s going to delay taking Social Security, she needs to use up a lot of that money to cover the fact that she’s not getting Social Security sooner. You could actually look at it as a way of purchasing an annuity in installments. The annuity, though, is not coming from an insurance company or from a 403(b) account. It’s coming from the federal government in terms of a higher Social Security benefit.
So every year she spends a little extra money out of her bank account or her 403(b) account to subsidize her expenses so she can delay taking Social Security, she will get a higher lifetime benefit when she does collect Social Security. So it’s like buying annuity on an installment plan, and the government’s rates are actually incredibly good, especially in the current market.
I happen to like annuities myself. But sadly, people are reluctant to look – especially in retirement, when they’ve already lost control of other aspects of their life because they’re not working anymore, they’re getting older; they want to hold onto whatever they can hold onto. If they’ve got a pot of money somewhere, they want to hold onto that. It represents freedom; it represents opportunity; it represents choice in the future.
The majority of teachers, especially older teachers, already have their money in an annuity. It’s a deferred annuity, meaning that while they’re working they’re paying money in. The payout, which guarantees lifetime income, is triggered only by their decision to do that. So they can actually keep the money just in a tax-deferred account until they die, or they can – within the product that they already have that’s their 403(b) and which they personally own – they can convert it to a lifetime income or a shared income with their spouse if they are married. All those things are usually easily available.
They also have the option of transferring it to another company and having another insurance company issue an annuity. They can do the same thing with private funds, except if you’ve got $100,000 in mutual funds, converting it to a lifetime income is not normally an automatic option. You would have to go to an insurance agent and purchase an individual contract for yourself. You have a lot of choices about how that would work.
Tips for Teachers
Lifelong saving and expense management are still the two most important factors in terms of what’s going to affect your financial situation in retirement. When you do get within a few years of retirement, don’t listen to people who are trying to do a very quick and dirty analysis. You’re better off just walking away.
If you’re married or have a life partner, do all your planning together. A lot of couples don’t do that. They don’t talk about retirement until one of them has actually left the job and is hanging around home. They say, okay, now what? A lot of couples have very different private attitudes and plans. It’s really important to discuss those ahead of time, preferably years ahead of time, and to continue to talk about them and refine them as you get closer so that when retirement comes, everybody’s on the same page.
Retirement is not about money – it’s about your life. Your first priority has to be to get a handle on what you want your life to be like when you retire, and then you see whether you can afford to have that life, and then if you can’t, what constraints your lack of financial means will impose and how you want to deal with those. If you’re only looking at the money, you’re missing the most important part.
Finally, in the last few years before retirement, it’s a good idea to revisit the financial analysis at those times. But even without those, it’s a good idea to do it every year because, if it’s starting to fall apart, as I mentioned before, you want to fix it right away. Because the older you get, the fewer options you’re going to have for fixing problems. The sooner you can find out what they are, the better.
About the author:
Chuck Yanikoski is the founder and president of Still River Retirement Planning Software, Inc. and its consumer subsidiary Retirement Works, Inc. He has been in the financial field and the financial software industry since 1976. He is also the principal founder of the Association for Integrative Financial and Life Planning and the co-president of the New England chapter of Life Planning Network. Chuck started his career at the home office of the New England Mutual Life Insurance Company where he worked in policyholders’ services, corporate planning, investment financial marketing areas from 1976 to 1994. He then became a systems developer for American Financial Systems from 1994 to 1999, and at the end of 1999 he founded Still River. Chuck attended Harvard College and the University of Chicago Divinity School and still retains an interest in research, scholarship and writing. His financial articles have appeared in Market Watch’s Retirement Weekly, the National Underwriter Income Planning E-Newsletter, Annuity Association News, Aging Well, and other publications.