Most states offer defined benefit plans to public school teachers through different retirement programs. However, the monthly payments that teachers receive after retirement are usually not sufficient and, in most cases, are significantly lower than their last drawn salary. In such a situation, educators need to invest their earnings to accumulate sizable funds at the time of retirement to lead a comfortable post-retirement life. As an educator, you can consider the following options to boost your retirement income.
1- Invest in Defined Contribution Plans
In addition to your defined benefit pension plan, you can opt for defined contribution plans, such as a 403(b) or 457 plan. In defined contribution plans, contributions can be tax-deductible while investment earnings are tax-deferred, which means that you can reduce your taxable income while making contributions to the plan and can defer your tax on earnings when you withdraw funds from your plan after your retirement.
Teachers can also consider investing in a 403(b) plan that is usually offered by most public schools and tax-exempt organizations, unlike 401(k) plans that are mostly offered by for-profit organizations. 403(b) plans are similar to 401(k) plans as the contributions are tax-deductible and investment earnings are tax-deferred. However, employer matching is less common in 403(b) plans as compared to 401(k) plans. If your employer offers a 403(b) plan with matching contributions, you should make enough contribution so that you become eligible to reap the benefit of the maximum matching contributions from your employer.
A 457 plan is also a type of defined contribution plan similar to 401(k) and 403(b) plans. Although you don’t get matching contributions from employers in a 457 plan, you can take distributions from your plan after you leave your job even before your retirement age without penalty. The maximum contribution you can make to the plan is fixed at $19,500 per year for 2021, with an additional catch-up contribution of $6,500 for employees above 50 years of age. In most cases, employees with both a 403(b) and 457 plan through the workplace are allowed to contribute to both.
In the state of California, the public school system does not offer a 401(k) plan, but in case you're planning a future with someone who has a 401(k), here are some basics to know about it. If you opt for a 401(k) plan, you and your employer can jointly contribute to the fund. As of 2021, the annual limit to your contributions is $19,500 if you are age 49 or younger. 50 and older educators are allowed an optional catch-up contribution of $6,500 per year. Any employer contribution does not count against the $19,500, or $26,000 annual limit. The contributions from employees are deducted from their salary.
Most employers that offer 401(k) plans match the contributions of their employees. Suppose your employer matches 100% of your annual contributions, up to 6% of your annual compensation. If you earn $100,000 per year, your employer will contribute a maximum of $6,000. If you contribute more than $6,000, the excess amount will not be matched by your employer. On the other hand, if you contribute $4,000 annually, your employer will also contribute 4% or $4,000, you will lose out on $2,000 because you failed to make the maximum contributions required for matching.
Contribution from the employer is free money, and to benefit from it, you must make the required contributions to allow your employer to match your contributions.
2- Invest in Individual Retirement Accounts
Investing in individual retirement accounts, in addition to your regular defined benefit plan, can boost your retirement income. Individual retirement accounts (IRAs) are tax-advantaged accounts and can help you lower your taxable income or tax payable. Depending on your adjusted gross income (AGI) for the year, here are some options to choose from:
Traditional IRAs can be opened at any bank or a brokerage house. The funds deposited in individual retirement accounts are invested in stocks, bonds, money market, or certificates of deposits. Like employer-sponsored retirement plans, contributions made to traditional IRAs are also tax-deductible, allowing you to lower your taxable income. The maximum limit on contributions to IRAs is fixed at $6,000 per year for 2021, with an additional $1,000 contribution allowed for anyone 50 or older.
Contributions made to Roth IRAs are not tax-deductible, but you get tax-free withdrawals when you withdraw your funds after the age of 59 1/2 or five years since the start of your first contribution. If you expect to fall under a higher tax bracket at the time of retirement, Roth IRAs can provide you with a significant advantage as you will be withdrawing your funds tax-free. Like traditional IRAs, the maximum limit on contributions to Roth IRAs is also fixed at $6,000 per year for 2021, and also enjoys an optional catch-up contribution of $1,000 per year at age 50 or older.
3- Invest in Health Savings Accounts
To contribute to an HSA, you must be covered under a high deductible health plan (HDHP). For 2021, the health plan must have a deductible of at least $1,400 for self-only coverage or $2,800 for family coverage. Contributions to health savings accounts are tax-deductible if you are enrolled in a high deductible health plan, and the withdrawals for eligible healthcare expenses are also tax-free. Which means you are able to lower your taxes while allowing money in a health savings accounts to grow and potentially boost your retirement savings.
The health plan must also have a limit on out-of-pocket medical expenses that you are required to pay. Out-of-pocket expenses include deductibles, copayments and other amounts, but don't include premiums. For 2021, the out-of-pocket limit for self-only coverage is $7,000 or $14,000 for family coverage.
Contributions to health savings accounts are capped at $3,600 per year for single coverage and $7,200 for family coverage. Assuming that you make a maximum contribution of $3,600 each year to your health savings account annually while incurring healthcare expenses of $600 per year, you would have approximately $209,000 after 30 years if you earn a 5% average rate of return by investing the money. After age 65, you can withdraw funds from the health savings account for any purpose other than healthcare expenses by paying normal income tax. The health savings account can not only help you in meeting your healthcare expenses but also help you lower your taxable income while contributing to the account.
Teachers need to take proactive steps and start investing as early as possible to amplify their retirement savings. Defined benefit plans can fall short of adequately replacing the income of teachers during retirement. By actively investing in secondary retirement plans, such as defined contribution plans, individual retirement plans, and other investment accounts, it can help bridge the shortfall, allowing teachers to retire more comfortably.