Capital Investment Advisors

What The Happiest Teachers Know About Retirement

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Teachers impact more lives than almost any other profession. Whether you are one or know one, it’s highly likely that you’ve been significantly impacted by the hard work and selfless passion of an educator.

In addition to being famously influential, teachers are also famously under-compensated. Why? That’s a question for someone else. What I can offer is advice for those fearless faculty members to maximize the unique retirement tools at their disposal so they can retire as soon and as happy as the students they mold.

Since I live in Atlanta, I’m going to focus on the Teachers Retirement System of Georgia (TRS). If you live in a different state, a lot of the same information may apply.

The TRS provides the primary and mandatory retirement vehicle for teachers. Known as the TRS Pension Plan, it’s a 401(a) defined benefit pension plan. Employer-sponsored retirement plans generally fall into two categories:

1. Defined contribution plans: This is similar to a typical 401(k), though it’s called a 403(b) in the world of education. The total amounts to retrieve at retirement are not guaranteed. This is by far the most widely used plan in today’s corporate world.

2. Defined benefit plans: This is akin to an old-school pension plan. The TRS Pension Plan falls into this category.

The basic difference is what each plan promises its participants. A defined contribution plan only specifies what each party—the employer and employee—contributes to an employee’s retirement account whereas a defined benefit plan specifies exactly how much retirement income employees will get once they retire. Teachers typically can utilize both.

Teachers in Georgia, and most other states, are required to use the TRS Pension Plan to save for retirement.

Georgia mandates that 6 percent of the annual salary be put into the plan and guarantees that the employer will contribute approximately 20 percent.

Teachers become vested in the TRS after ten years of service. Teachers can retire penalty-free after reaching the age of sixty or achieving thirty years of service, whichever comes first. I have also seen some teachers start taking their pension as early as age 55 after 25 years of service, but their retirement benefit would be subject to an early retirement penalty that they are willing to accept. Most corporate vesting requirements are much less stringent, which could contribute to the fact that nearly 70 percent of Georgia teachers leave before the state’s ten-year vesting requirement, and only 17 percent of Georgia teachers realize their full pension benefit after thirty years of service.

It’s an incredibly challenging job even under the best circumstances. The average student-to-teach ratio is 14.1, and the average starting salary for a teacher in Georgia is $44,000 with the overall average salary coming in at just over $60,000.

Those who exit before being vested have the option to leave their contributions with the TRS (accruing interest for four years), roll over their contributions to another qualified plan or IRA, or request a lump-sum distribution. Once vested, people have the option to withdraw funds or leave contributions with TRS. Withdrawal of funds will forfeit the lifetime monthly benefit and result in receiving a lump-sum payment of contributions and interest, which is subject to taxes and possible penalties.

Just how much will the TRS pay?

It varies. In Georgia, the annual retirement benefit is based upon a predetermined formula, using the length of service, the two highest earning salary years, and a 2 percent multiplier. Florida’s TRS pension uses a 1.6 percent multiplier and an average of the eight highest salary earning years. But, Florida only requires an eight-year vesting period. Arizona’s TRS pension uses various multipliers tied to years of service and averages the salary from the last five earning years heading into retirement but has no required vesting period.

TRS Limitations to Social Security

To be frank, the TRS is a really good perk of a really challenging career, but it does come with some limitations to Social Security for those who receive monthly pensions in retirement. As a general rule, that’s not unique to teachers, but I want to focus on specific areas that are.

The limitations, or offsets, are known as the Windfall Elimination Provision (WEP) and the Government Pension Offset (GPO).

Again, WEP and GPO can impact anyone receiving a pension who did not pay into Social Security while working. Some teachers pay into Social Security, but many don’t. Those are the folks who have to plan with extra caution.

Specifically, Georgia’s retired teachers may be eligible for Social Security under two conditions:

1. If they’ve paid into the Social Security program via payroll taxes throughout the earning years. This could be from the private sector, or from a county that pays into it. For example, Clarke County pays into Social Security but Gwinnett County does not.

2. Through the employment of a spouse who paid into Federal Payroll Tax (FICA)/Social Security.

But, those Social Security benefits can be reduced because of a TRS pension. Teachers who work in school districts that don’t collect Social Security via FICA taxes could see their benefits reduced by the Windfall Elimination Provision (WEP).

For the teachers who didn’t pay into Social Security hoping to be covered by spouses who did, the Government Pension Offset (GPO) can/will/likely reduce spousal benefits.

The GPO and the WEP were instituted in the early 1980s to “remedy” what some saw as the unfair advantage public workers had with their pensions. Social Security has a progressive formula. It weights benefits toward lower-income workers. Teachers with mixed coverage—working some years in a county that does pay into Social Security and some years in a county that doesn’t—would appear to be lower-income than they may be. I’m not saying I agree or disagree, but that’s the way the system is set up to work.

For non-covered teachers with covered spouses, the GPO reduces spousal benefits by an amount equal to two-thirds of their pension. For teachers with split coverage (who appear to be “low income” to Social Security), the WEP reduces Social Security benefits by up to one-half of the individual’s pension.

It should be noted that you don’t have to worry about WEP if you have thirty or more years of substantial earnings under Social Security.

How WEP and GPO Can Impact Social Security Benefits

To further illustrate how WEP and GPO can impact Social Security benefits let’s use the example of Caroline.

Caroline has been molding young minds for three decades. She spent the first fifteen teaching at Walton High School in Cobb County, Georgia, where she paid into Social Security and TRS. After her husband died, she moved, spending the last 15 years of her career at Roswell High School, where she only paid into TRS.

This is known as mixed coverage.

Caroline retired with a TRS pension of $3,000. She was eligible for Social Security benefits but was confused about the amount. She’d always heard that Social Security provisions would reduce an educator’s benefit amount, but everything she read seemed to say that the WEP and GPO only applied to individuals with a noncovered pension—one where no Social Security taxes were paid. Only half of her pension fit that description.

Since the GPO can reduce spousal or survivor Social Security benefits by two-thirds of the pension amount, it often completely wipes out all Social Security benefits. This can be terrible for anyone, but especially a widow like Caroline.

The good news is that Caroline does not have to enter the entire pension amount when calculating the two-thirds reduction! She only has to include years in which no Social Security taxes were paid. In her case, that was only half of the time. That means her $3,000 pension amount would be reduced by $1,000 instead of $2,000. A big difference!

How could the WEP impact Caroline?

Relevant to teachers who earned a pension without paying into Social Security, the WEP can reduce Social Security benefits by up to one-half of the total amount. After twenty years of substantial covered earnings, the impact of the WEP begins to diminish. At thirty years of substantial covered earnings, the WEP does not apply.

Since Caroline spent fifteen of her working years paying Social Security tax and the other fifteen not paying it, the portion of her $3,000 TRS pension from non-covered earnings would be $1,500. (Fifteen non-covered years divided by thirty total years multiplied by the total pension amount of $3,000).

In Caroline’s case, the maximum reduction would be $750 ($1,500 non-covered pension divided in half). So, if Caroline’s monthly Social Security benefits before accounting for the WEP are $1,500 per month, this amount would be reduced by $750, bringing the total to $750.

How many people out there are penalized by the GPO offsets?

In December of 2021, about 1 percent of Social Security beneficiaries had their benefits reduced by the GPO. Of those directly affected, 52 percent were spouses and 48 percent were widows or widowers. The GPO affected 17 percent of all spousal beneficiaries and 9 percent of all widow(er) beneficiaries. About 29 percent of all GPO-affected beneficiaries had their benefits partially offset and about 71 percent had them fully offset.

What about the WEP?

According to Social Security Administration data, as of December 2021, about 1.8 million Social Security beneficiaries were penalized by the WEP—roughly 3 percent of all Social Security beneficiaries.

Knowing more about the GPO and WEP offsets doesn’t exactly lower anxiety but what can is coming up with a plan to lessen the pain, protect purchasing power, and increase the chances of a happy retirement.

A great step in this direction is to contribute to a 403(b) defined contribution plan. Just like a 401(k), a 403(b) offers traditional (pre-tax) and Roth (after-tax) options and there is an annual maximum employee contribution. For 2022, the maximum is $20,500 with an additional catch-up provision of $6,500 for those fifty years and older.

A 403(b) can provide significant tax advantages since earnings on these amounts are not taxed until they are distributed from the plan (traditional) or not at all on after-tax contributions distributed from a Roth. Some school districts may even match a portion of the contribution.

It’s worth remembering that the TRS only requires teachers to contribute 6 percent, which is below the typical recommended savings rate during accumulation years. Supplementing that 6 percent with a 403(b) contribution of 5-10 percent of your salary, or even up to the full contribution amount if doable, can be a total game changer in helping teachers reach their retirement and happiness goals.

What’s the bottom line?

The best way for teachers to maximize earning potential is to stay on the job as long as possible. Not only does that mean they keep educating our children, but the end-of-career perks far exceed the relatively lower income during the working years.

Using the 4 Percent Rule as a guide, that my readers know I love, a teacher who earns a pension of $3,000 per month, or $36,000 per year, ends up being worth $900,000! Let me remind our readers of the 4% Rule’s Origin.  In 1994, William Bengen, an MIT aeronautics, and astronautics graduate turned Certified Financial Planner, made a historic discovery. Bengen, a number-cruncher by training, calculated actual stock returns and retirement scenarios over the last 75 years. What he found was that retirees who draw down 4% percent of their portfolio in their first year of retirement, and then adjust this amount every year for inflation, will very likely see their money outlive them, assuming a 50% to 75% allocation in stocks.

So let’s revisit that calculation from above.  It takes a little bit of “reverse math” to calculate what that $36,000 annual pension looks like:

$36,000 / 4% = $900,000.

Using the 4 Percent Rule as a guide, the $36,000 annual amount is basically equal to a $900,000 nest egg!

Not too shabby. All of a sudden it doesn’t sound quite as tedious to shake the chalk out of those erasers for all those years.

Teachers also need to use the 403(b) option to supplement the pension and guard against the potential whack of WEP and GOP offsets.

Finally, I encourage educators to take our new Teacher’s Only Money and Happiness Quiz.

Based on the HROB research my team and I have been doing for more than a decade, this new quiz has been adapted specifically for teachers. Teachers work so hard for so many years. If they follow these steps and stay vigilant, there’s a good chance their savings will return the favor.

This information is provided to you as a resource for informational purposes only and should not be viewed as investment advice or recommendations. Investing involves risk, including the possible loss of principal. There is no guarantee offered that investment return, yield, or performance will be achieved. There will be periods of performance fluctuations, including periods of negative returns. Past performance is not indicative of future results when considering any investment vehicle. This information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. This information is not intended to, and should not, form a primary basis for any investment decision that you may make. Always consult your own legal, tax, or investment advisor before making any investment/tax/estate/financial planning considerations or decisions.

 

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