Your pension plan shouldn’t be your only retirement plan
Improve the odds of retiring on your terms by taking advantage of other account and employment options
By Christopher Bluem
Law enforcement officers are in a unique situation in that policing is one of the few professions that still provides a defined benefit pension plan. A defined benefit pension plan is what we normally think of when the term “pension” is used. Although these plans are great for the employee, there are still risks.
Everyone’s financial situation is different. The universal objective here is to improve your financial situation, whatever it may be.
This article outlines options for awareness purposes only. Always consult a financial advisor before making financial decisions. The examples provided here are simplified to help you understand some core concepts.
DEFINED BENEFIT PENSION PLAN RISKS
Defined benefit pension plans are not without risks. The plans are generally far superior for the employee than the standard 401(k) but may not be a one-size-fits-all solution.
Note, pension terms differ wildly between jurisdictions, regions and states. Consult your pension plan documents and reports to determine the risk of your pension.
The number one risk is that your defined benefit pension may not be enough.
Some pension plans provide 50% of your salary based on your last three years of service. If you are accustomed to making $100,000, can you live on $50,000? Maybe, probably not. Think about it, as police officers, we typically retire between age 50 to 55. At those ages, there is a very good chance you will still have children in college, a home mortgage, and other major financial obligations.
Here are some other risks.
Many law enforcement pension plans do not provide a cost-of-living adjustment for inflation. Simply put, inflation is the increase in the prices of goods over time. As goods [prices] increase, the purchasing power you have with the same amount of money declines.
Let’s take a hypothetical case study: You worked hard for your entire career. You just hit 25 years and 55 years old, which is your minimum age and time in service for retirement. Your average salary used to compute your pension calculation was $100,000. Your pension plan allows you to begin collecting 50% of your salary from the time you retire until the day you die. Your pension plan, like many these days, has no cost-of-living adjustment. Hypothetically, we continue to experience moderate inflation (2.5%) for the next 20 years. By 2040, your $50,000 would only have the same purchasing power as $30,514 in 2020.
The bottom line is you need to have other sources of income.
PENSION FUND HARDSHIP
State and local pension funds are notoriously underfunded and mismanaged. Although the courts and legislatures make it difficult for government pension funds to default on obligations, it is still possible. We must always consider this a possibility when planning for our future.
The theory and reasoning behind this are quite complex. Be cognizant that it is theoretically possible for these pension funds to fail to meet the future pension obligations you were promised.
Because of political pressure, it is much more likely that a generation of law enforcement in the future will not have the benefit of a defined benefit pension plan. We are starting to see local jurisdictions move toward this already.
HOW TO SUPPLEMENT RETIREMENT SAVINGS
Thankfully, you have other options to supplement your retirement savings. As far as saving for retirement, let’s establish a few principles:
- It is never too late to start, but it is best to start early. The earlier you start, the better. Wealth building is amplified by a financial concept known as compound interest. It’s essentially earning interest on your interest.
- A little bit is better than none. You can always contribute to retirement accounts. Even $50 is better than $0. You are investing in yourself. Nothing is more important.
- Have multiple options. A pension is a great place to start with retirement planning. However, you might need to employ some of the means discussed below. Your objective is to retire on your terms.
First, let’s get a brief understanding of compound interest. It’s probably the most important financial concept you will ever learn.
When reviewing the chart below, consider these assumptions:
- Salary: $100,000
- Contribution percentage: 7% (at year-end)
- Retirement age: 55
- Yearly return: 6.5%
As you can see, the impact of starting at 25 rather than waiting until 30 is nearly $200,000. Compound interest is the core concept of any wealth-building strategy. If you want to run hypothetical numbers for your savings, check out the 457(b) savings calculator.
Here are several ways you can supplement your pension income. These are by no means the only ways to supplement pension income.
Utilizing retirement plans through your employer and other retirement account options can help you save for retirement.
Employer-sponsored 457(b) plan
A 457(b) plan is essentially the government employee version of a 401(k) except most government employers don’t match the contributions. The 457(b) allows you to save money out of each paycheck to increase your retirement savings. Employers may offer a traditional 457(b) plan and/or a Roth 457(b) plan. These plans offer significant tax benefits as well as allow you to save more.
A traditional 457(b) plan involves a paycheck withdraw of pretax dollars, meaning you don’t pay taxes on this money in your paycheck. The money is then placed into your investment account and grows tax-free. Upon separation or retirement, you can then elect to withdraw your funds from this account every month or as a lump sum. You only pay taxes on the withdraw.
A Roth 457(b) plan allows you to contribute post-tax dollars to grow tax-free. You pay the taxes on the deposits as regular income. When you separate or retire from your employer, you can then withdraw the money (and earnings) tax-free. Upon separation or retirement, you can then elect to withdraw your funds from this account every month or as a lump sum.
If you don’t have a 457(b) plan at your employer, you should certainly ask for it at your union negotiations. If you don’t have a bargaining unit, try just asking your employer.
One additional benefit of the 457(b) plan is you don’t get penalized for withdrawal before age 59½ as you do with other retirement plans. In a career where we often retire before age 59½, this can be a great benefit.
Individual Retirement Account (Traditional IRA) or Roth IRA
Even if you contribute to a 457(b) plan, you can still contribute to an IRA plan. The main difference between the traditional and Roth plans is the tax treatment of the deposits. For the tax year 2020, you can contribute up to $6,000 ($7,000 if you are over age 50).
The main benefit of a traditional IRA is up-front tax advantages. If you are single, covered by a retirement plan at work, and your modified adjusted gross income (MAGI) is under $64,000, you can deduct up to $6,000. A phase-out for the tax deduction begins at $64,000, and if your MAGI is over $75,000 you are not eligible for the tax deduction.
With a Roth IRA, you contribute funds you have already paid taxes on. When you hit age 59½, you can withdraw the funds tax-free. There are a significant number of rules with a Roth IRA, but there are circumstances in which you can withdraw your contributions without penalty before age 59½.
Yes, depending on where you work, you might need to work overtime to even make a respectable wage. If overtime is a luxury and not a necessity, you can get creative with saving overtime earnings. The availability of overtime is dependent on your employer; some officers rarely get overtime, but others can easily double their salary.
Here are some creative ways to manage overtime earnings to improve your financial future:
- For your first $6,000 in overtime, deposit it in your Roth IRA.
- Put all of your overtime earnings into a brokerage account for other investments.
- If you have a heavy debt burden, use overtime to pay down all of your debt. Use overtime earnings to save and start a business outside of police work.
- Get creative. The key is, don’t spend the money just because you have it. Invest in yourself.
One of the worst parts about shift work is the time away from family. Since we are often at work when our families are at home, we end up at home when our family is away too. This provides the time you could use to make additional money. Find a part-time job that allows you flexibility in the hours you work. Some examples might be becoming a real estate agent, consultant, or even a sports official. Take part-time job income and place it in an investment account. Make sure your part-time job doesn’t violate any department policies.
Real estate investing
Investing in real estate is probably the single best wealth-generation tool available. It won’t make you rich overnight, but a sustained strategy can be an outstanding wealth-building strategy. There are many opportunities such as flipping houses, rental properties, or investing in real estate funds.
We want to retire on our terms. Unfortunately, sometimes we encounter circumstances beyond our control. Nobody knows when the economy may go down or if you might experience a work-related disability. Having a strong network of people can help you quickly get a new job to continue providing for your family.
The earlier you plan, the better. The more opportunities you create, the better. Start planning early in your career, so you can retire on your terms. It’s all up to you.
About the author
Christopher Bluem is a law enforcement officer in Pennsylvania. He holds the Certified Fraud Examiner (CFE) credential and is an active real estate investor. Prior to entering law enforcement, Chris worked for a regional accounting firm in New York City. He holds a bachelor's degree in accounting and finance from Rider University.