Just Starting Out
While retirement may be decades away for educators just starting out, doing their homework today can set them on the right path for a secure financial future tomorrow. 403(b) plan sponsors can help by sharing the following tips:
Tip #1: Encourage Plan Enrollment
Encourage educators who haven’t yet enrolled in their 403(b) plan to so this year. People are living longer now than ever before. According to a 2011 report by the U.S. Census Bureau, the U.S. is projected to have 9 million people above the age of 90 by 2050—this is up from 1.9 million in 2010…and 720,000 in 1980. This means our nation’s 90-and-older population has nearly tripled over the past three decades…and is projected to quadruple over the next four decades. These longer life spans, coupled with spiraling healthcare costs, the uncertain future of Social Security and the decline of public pensions means individuals are increasingly responsible for funding their own retirement. Contributing to their 403(b) plan can put individuals on the right track to be able to fund their retirement years. The money contributed is tax-deferred from federal, and typically state, income taxes, which means investors don’t pay taxes on the contributions until they withdraw the funds, typically at retirement age. For example, if an individual is in the 25% federal income tax bracket and invests $5,000 a year, that’s $5,000 of their salary on which they are not paying federal income taxes. This reduces their annual tax bill on that $5,000 by one-quarter—$1,250 ($5,000 x .25). Furthermore, contributions to the plan are deducted automatically from their paycheck. By contributing even a small amount on a regular basis, they can build substantial wealth over the long-term. Even just one or two percent can make a big difference.
Tip #2: Leverage Both Pre-tax and Post-tax Contributions
If the plan allows for both traditional pre-tax and after-tax (Roth) contributions, encourage participants to study which is a better option for their individual situation. Participants may also have the option to split the deferral types. While pre-tax contributions allow contributions to the plan on a pre-tax basis, Roth contributions provide the opportunity to grow the earning on these contributions tax-free. This is a valuable feature if participants believe their tax bracket will be higher when they retire, since they will pay taxes on the contributions now based on a lower tax bracket and pay no taxes on the earnings when they retire.
Tip #3: Invest for the Long-TermOnce participants set their investment allocations, encourage them to be patient. It’s critical to remember that what is important is time in the market, not timing the market. After all, your focus is on saving for retirement in the long-term. Discipline participants to maintain their allocation through down markets as well as up markets. Having a properly diversified portfolio will help make any market swing easier to digest.
For seasoned educators, their 403(b) plan is a key component of their retirement savings. Taking advantage of additional retirement savings opportunities targeted for specific ages and career milestones can help them make the retirement grade.
Tip #1: Make Catch-Up Contributions
Participants who are age 50 or older (or will be by the end of the calendar year) can take advantage of the "catch-up" provision. In addition to the general deferral limit of $17,500 (or up to $20,500 for certain long-term employees eligible for the 15 years of service catch-up) for 2013, participants can contribute an additional $5,500 for a total of $23,000. This means participants who are 50 years old this year and haven’t started saving for retirement can contribute as much as $225,000 over the next ten years—tax-deferred—to their 403(b) plan. When you consider the potential of compound earnings, this can add up to significant savings.
Tip #2: Reconsider Borrowing Options
Even if the plan allows participants to borrow from the plan, it’s important for participants to think twice before doing so. While it may sound appealing, borrowing from a 403(b) reduces the benefit of tax-free compounding that is the key to building up savings. Although sometimes unavoidable, there a few considerations to take into account:
· Participants will pay interest on the loan with after-tax dollars, thereby losing the tax advantage.
· Participants will pay taxes a second time when they eventually withdraw the money in retirement.
· Interest on the loan is not tax-deductible, even if funds are used for a home purchase.
· Most loans must be paid back within five years. If a participant leaves their job before then, the plan may require that the loan be paid back in full immediately or the amount becomes a taxable withdrawal.
Tip #3: Conduct an Annual Review with a Financial Professional
Research suggests that those who spend time with a financial professional are saving more than their peers who do not, with greater investment knowledge and confidence in their ability to enjoy retirement. For participants who have never received help from a financial professional before, this is something to consider pursuing. An adviser will be able to guide participants to assess whether certain advancements in their career warrant an update to their savings strategy or if a raise in the past year warrants a contribution increase. By adjusting 403(b) contributions with each salary increase, participants can continue reducing their tax liability as they build up their nest egg.
Education is power. Knowing how to take advantage of these simple—but important —tips, can positively impact participants’ ability to stay at the head of the class so that they can retire with the dignity and financial security they expect and deserve.
Jamie Ohl is president of Tax-Exempt Markets for ING U.S. Retirement Solutions, a strategic business unit focused on guiding working Americans to greater retirement readiness through employer-sponsored 403(b) and 457 savings plans in the healthcare, education, government and non-profit markets. For more information, visit http://ing.us.
NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.