New Job with 401A, uncertain on selection of 2 options - 4% vs. %5.33%

[prototype]

My DD just graduated college (Dec) and started working for a large, reasonably financially stable county that has a 401(a) retirement plan. She has 2 options as shown below and 28 days left to make her decision. Once the decision is made it CAN NOT be changed during her employment. There is no defined benefit pension plan in addition to the 401A. She asked me which I would select and I told her I really don’t know, but that I would probably go with the 4% and invest separately on the side, but my gut tells me the 5.33% is the way to go. She has talked to acquaintances that work there and they are pretty much split on what they selected.
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Plan C--

• • Employee: 4% of salary (no overtime) up to the Social Security Wage Base; 5.333% of salary over the Social Security Wage Base
  • Employer: Amount required to fund the plan based on actuarial calculations: Varies. (As of July 1, 2013 - 19.30%.)

Plan D--

• • Employee: 5.333% of salary
  • Employer: Amount required to fund the plan based on actuarial calculations: Varies. (As of July 1, 2013 - 19.30%.)

Employee contributions earn 5% interest annually.
-------------------------------

The employee contribution (plus the 5% interest) is hers if she leaves before retirement (and subject to taxes and penalties like a 401K I believe). She doesn't have (and I haven't tried to compute) the details yet on what the actual pension/payout difference would be between the 4% plan and 5.3% plan. The employer contribution has varied all over the place the last few years with the 19.3 % from last year being a bit on the high side, and that is not her money anyway to take if she leaves before retirement age is met).

Logically it is seems the 5.33% plan is the way to go, but she will be on tight budget for her first few years and is trying minimize her paycheck deductions. She is leaning towards the 4% option. I did explain to her that if she took the 4% route and she could/should invest money separately in a Roth IRA, or just start building a regular after tax portfolio (or preferably both) starting in a year when she is scheduled for her first promotion and associated raise (5% I think, plus whatever COLA adjustment is provided).

I don’t have a crystal ball, so it is hard to say where her career will go but I would say there is at least a 50% chance she won’t be working for this local Govt. until retirement (even though her degree is a BS in Public Administration).

Any comments or additional factors to consider would be greatly appreciated, especially from anyone who has had a similar irreversible 401A option/decision placed in front of them (or someone they know) at a young age.

Thank You in Advance

 

[RetireAge50]

My wife has a 401A as a school teacher. We decided to go with the maximum level just because we wanted to max out all retirement options available.

Looking back we are very glad we did as the annuity/pension payout is extremely generous and is based on the amount in the 401a.

Normally I would never even think of pensions/annuities and would just take lump sums or plan on investing on my own. However, for teachers and some public workers the retirement benefit is a big part of their overall pay. I would encourage her to do some calculations on the payouts, it should help with the decision.

 

[prototype]

My wife has a 401A as a school teacher. We decided to go with the maximum level just because we wanted to max out all retirement options available.

Looking back we are very glad we did as the annuity/pension payout is extremely generous and is based on the amount in the 401a.

Normally I would never even think of pensions/annuities and would just take lump sums or plan on investing on my own. However, for teachers and some public workers the retirement benefit is a big part of their overall pay. I would encourage her to do some calculations on the payouts, it should help with the decision.

Makes sense to me, I'll probably have to do the calculations. I'll share your post (and any others that might appear) with her so she has some data points to help her make her decision.

Thanks

 

[Bestwifeever]

If she goes with the 5.33 percent level, it also reduces her current taxable income by another 1.33 percent so her take home pay will be only about 1 percent less than the 4 percent option, right? She could probably still put the same amount in other savings. I vote plan D.

She is lucky to have your advice in deciding.

 

[Animorph]

It definitely depends on the end result. I assume that the ratio of employee to employer contributions means that this is a good deal for the employee, and the 5.333% deduction would be worth it.

On the other hand, if there is no intention of staying there to pick up the annuity, 5% interest is a bit lower than I would like to have for investment gains. Good to get money into a retirement account (maybe rollover into something better in the future), good to have a guaranteed return, but I'd probably split with a taxable account.

And last, I'd like to see anyone saving 15% of gross, so in that case 5.333% into the retirement account and 10% into a taxable account (and a Roth) would be OK with me.

Given the one time choice, I'd go with the higher percentage.

 

[prototype]

If she goes with the 5.33 percent level, it also reduces her current taxable income by another 1.33 percent so her take home pay will be only about 1 percent less than the 4 percent option, right? She could probably still put the same amount in other savings. I vote plan D.
....

In her case it will be about a 21% tax savings. - 15% Fed (maybe for 2 years) and 5.75% for State (~21% total). So yes, just over 1% reduction in take home pay. It will be interesting to see what she picks. Hopefully she can get some "financially sound" advice on this matter from co-workers over the next week or two.

It definitely depends on the end result. I assume that the ratio of employee to employer contributions means that this is a good deal for the employee, and the 5.333% deduction would be worth it.

On the other hand, if there is no intention of staying there to pick up the annuity, 5% interest is a bit lower than I would like to have for investment gains. Good to get money into a retirement account (maybe rollover into something better in the future), good to have a guaranteed return, but I'd probably split with a taxable account.

And last, I'd like to see anyone saving 15% of gross, so in that case 5.333% into the retirement account and 10% into a taxable account (and a Roth) would be OK with me.

Given the one time choice, I'd go with the higher percentage.

Just getting started in life, I don't think she'll be able to save/invest much ,certainly not 15% total, over and above the 5.33% or even the 4% for at least a couple of years. Sounds like everyone agrees Plan D (5.33%) agrees is way to go.

 

[Spudd]

What I'm curious about is what Plans A & B are!

 

[prototype]

What I'm curious about is what Plans A & B are!

Those are the older, better plans, they were replaced a year ago (or so) by Plans C and D for new employees. I guess they want to keep the pension plan solvent.

 

[clifp]

I am not sure I entirely understand the difference between the two options are so let me put some numbers out there and see I'm getting it right.
Assume DD salary = 50K for ease calculation
Option C she contributes $2,000/year
After 4 years (probably before she vest in the pension) she quits she gets back her $8,000 back
Option D she contributes $2,665
After 4 years she quits and get her $10,660 contributions and additional $1,113 interest back.
In this case I'd say contributing an extra $665 a year (tax deductible) to get an additional $1,113 in interest in a tax deferred account is an absolute no brainer.
What is unclear is what happens if she make a career and works 33 more years and retires at say 55.
Does her pension increase?
What is the compensation for contributing an additional $665.
Will she get all the interest back as lump sum or...

 

[leftbucket]

D!!!

My father and I both work for this county (I am not in the Employee's plan at all, but am familiar with it). If there is even the most remote possibility she will stick around, go with plan D. Dad is in plan B (equivalent of D for those prior to 2013). With the extra ~1% contribution earning 5% interest, there is little downside (and tremendous upside). Dad calls plans A/C the "sucker's bet." Tell DD to hit the TRowe hard now, too; it is excellent. Even if bills are tight, tell her to find a way to hit that 457. All are supposedly getting a 1-2% raise in July, tell her to put all that in the TRowe.

(Show her this post if you have to).

R/
LB

 

[prototype]

.......... With the extra ~1% contribution earning 5% interest, there is little downside (and tremendous upside). Dad calls plans A/C the "sucker's bet." Tell DD to hit the TRowe hard now, too; it is excellent. Even if bills are tight, tell her to find a way to hit that 457. All are supposedly getting a 1-2% raise in July, tell her to put all that in the TRowe.

(Show her this post if you have to).

R/
LB

I am not sure I entirely understand the difference between the two options are so let me put some numbers out there and see I'm getting it right.
Assume DD salary = 50K for ease calculation
Option C she contributes $2,000/year
After 4 years (probably before she vest in the pension) she quits she gets back her $8,000 back
Option D she contributes $2,665
After 4 years she quits and get her $10,660 contributions and additional $1,113 interest back.
In this case I'd say contributing an extra $665 a year (tax deductible) to get an additional $1,113 in interest in a tax deferred account is an absolute no brainer.
What is unclear is what happens if she make a career and works 33 more years and retires at say 55.
Does her pension increase?
What is the compensation for contributing an additional $665.
Will she get all the interest back as lump sum or...

Clifp, I am not really sure myself what the difference would be as far as what the actual "Pension" would be if she stays there until retirement. I don't have the full set of info/paperwork in my hands. I guess it is just the extra % (19% last year, as shown in my OP) applied to higher value of the employee "bucket of funds" each year.

Anyway, I'll show her these two posts tonight. Showed her the posts from yesterday last night and talked to her just a bit (she did mention something about a 457). I think (hope) she is now leaning towards Plan D now. Hopefully these two posts solidify her decision to take that route (Plan D).

Leftbucket, I love that term "Sucker's Bet"

Thanks to all who provided input.

 

[Texas Proud]

I am not sure I entirely understand the difference between the two options are so let me put some numbers out there and see I'm getting it right.
Assume DD salary = 50K for ease calculation
Option C she contributes $2,000/year
After 4 years (probably before she vest in the pension) she quits she gets back her $8,000 back
Option D she contributes $2,665
After 4 years she quits and get her $10,660 contributions and additional $1,113 interest back.
In this case I'd say contributing an extra $665 a year (tax deductible) to get an additional $1,113 in interest in a tax deferred account is an absolute no brainer.
What is unclear is what happens if she make a career and works 33 more years and retires at say 55.
Does her pension increase?
What is the compensation for contributing an additional $665.
Will she get all the interest back as lump sum or...

I think that the 5% is earned on either fund.... it is not under D, but back to the first level of points...

 

[Texas Proud]

Just my thinking.....

It appears that the only difference is the rate that the employee pays.... the county pays the same amount no matter which plan you are in...

You earn 5% no matter what plan you are in.... no matter what interest rates or inflation is doing... sounds good today, but not if inflation takes off...


At the end, when she retires.... they calculate an annuity based on how many dollars is in your account...




With this being my understanding.... I would go with C... I would take the extra money and invest in a ROTH and put it in stocks.... when it comes time to retire in 30 or so years.... I would more than likely have a lot more money than someone who choose D.... and I would not be paying taxes on the part that is in my ROTH....


I think D is the suckers bet as you lock yourself into a return for your lifetime....

 

[prototype]

..... She is leaning towards the 4% option. I did explain to her that if she took the 4% route and she could/should invest money separately in a Roth IRA, or just start building a regular after tax portfolio (or preferably both) starting in a year when she is scheduled for her first promotion and associated raise (5% I think, plus whatever COLA adjustment is provided).

Just my thinking.....

It appears that the only difference is the rate that the employee pays.... the county pays the same amount no matter which plan you are in...

You earn 5% no matter what plan you are in.... no matter what interest rates or inflation is doing... sounds good today, but not if inflation takes off...

At the end, when she retires.... they calculate an annuity based on how many dollars is in your account...

With this being my understanding.... I would go with C... I would take the extra money and invest in a ROTH and put it in stocks.... when it comes time to retire in 30 or so years.... I would more than likely have a lot more money than someone who choose D.... and I would not be paying taxes on the part that is in my ROTH....

Texas, Your "thinking" is similar to my initial thoughts in my OP. I'll have get her to check on whether or not they ever "adjust" the 5% (i.e. for cases like the early 1980's when inflation skyrocketed). I'll pass your assessment along to DD. (Actually I need to get her to just join this forum and get in the habit of doing her own "financial planning" leg-work, I'm missing my morning cable news "fix" .)

 

[RetireAge50]

Be sure to calculate the payouts. I agree option C will likely have a higher lump sum value at retirement (assuming you invest the difference in a Roth).

However, the highly subsidized annuity under plan D will probably provide higher annual income from that point forward.

 

[Texas Proud]

Be sure to calculate the payouts. I agree option C will likely have a higher lump sum value at retirement (assuming you invest the difference in a Roth).

However, the highly subsidized annuity under plan D will probably provide higher annual income from that point forward.

Red herring here IMO... the only difference in option C and option D is the amount the employee pays... sure, option D will have a higher payout because more money was put into it and it grew at 5%.... but, if you put that extra money into a ROTH and it grew at 7%.... then option C is better...



BTW, with option C, you actually have an account balance that you might be able to pass on when you die... option D becomes an annuity and it will be gone....

 

[clifp]

Just my thinking.....

It appears that the only difference is the rate that the employee pays.... the county pays the same amount no matter which plan you are in...

You earn 5% no matter what plan you are in.... no matter what interest rates or inflation is doing... sounds good today, but not if inflation takes off...


At the end, when she retires.... they calculate an annuity based on how many dollars is in your account...




With this being my understanding.... I would go with C... I would take the extra money and invest in a ROTH and put it in stocks.... when it comes time to retire in 30 or so years.... I would more than likely have a lot more money than someone who choose D.... and I would not be paying taxes on the part that is in my ROTH....


I think D is the suckers bet as you lock yourself into a return for your lifetime....

Ah if both plans earn 5% on employee contributions than I agree plan C is the way to go. You should ignore my calculation. I'd invest the additional money separately. The opportunity to invest an additional 1.33% of your salary at 5% is not very exciting even under todays low interest rate environment in a normal interest rate it is even less exciting.

 

[prototype]

Be sure to calculate the payouts. I agree option C will likely have a higher lump sum value at retirement (assuming you invest the difference in a Roth).

However, the highly subsidized annuity under plan D will probably provide higher annual income from that point forward.

Red herring here IMO... the only difference in option C and option D is the amount the employee pays... sure, option D will have a higher payout because more money was put into it and it grew at 5%.... but, if you put that extra money into a ROTH and it grew at 7%.... then option C is better...

BTW, with option C, you actually have an account balance that you might be able to pass on when you die... option D becomes an annuity and it will be gone....

Ah if both plans earn 5% on employee contributions than I agree plan C is the way to go. You should ignore my calculation. I'd invest the additional money separately. The opportunity to invest an additional 1.33% of your salary at 5% is not very exciting even under todays low interest rate environment in a normal interest rate it is even less exciting.

You folks are bring up excellent points that require clarification. So I will try to get a hold of and read the actual Plan Descriptions from DD. I also need to understand what the 457B aspects are that Leftbucket mentioned (confirmed they exists after talking to DD today).

Texas - as far as I know the employee contribution for both C and D (plus the 5% compounding interest) go to whatever beneficiary(s) are named. I'll confirm with DD.

 

[RetireAge50]

I was not trying to do a “Red Herring”. My main point is to calculate the payouts before deciding!! There is no way to know which is likely to be better until we know the terms of the annuity. Currently we know the inputs but not the payouts.
As an example, the payout for my wife’s 401A will be 6% of the initial lump sum and then increased 3% each year with at least the principal guaranteed to beneficiaries. In our case this was a good deal unique to being a teacher, the more in this plan the better.
I would also encourage her to open a Roth IRA anyway regardless of any of this.

 

[Texas Proud]

You folks are bring up excellent points that require clarification. So I will try to get a hold of and read the actual Plan Descriptions from DD. I also need to understand what the 457B aspects are that Leftbucket mentioned (confirmed they exists after talking to DD today).

Texas - as far as I know the employee contribution for both C and D (plus the 5% compounding interest) go to whatever beneficiary(s) are named. I'll confirm with DD.

Also check out what happens when she starts an annuity.... there is probably a beneficiary in case she dies before starting the annuity, but I would doubt there is anything afterwards.... but I have been proven wrong many times before....

 

[Texas Proud]

I was not trying to do a “Red Herring”. My main point is to calculate the payouts before deciding!! There is no way to know which is likely to be better until we know the terms of the annuity. Currently we know the inputs but not the payouts.
As an example, the payout for my wife’s 401A will be 6% of the initial lump sum and then increased 3% each year with at least the principal guaranteed to beneficiaries. In our case this was a good deal unique to being a teacher, the more in this plan the better.
I would also encourage her to open a Roth IRA anyway regardless of any of this.

I agree that the point is the payout.... but I cannot see how they would have a payout that was not based on standard annuity calculations... therefore, the main component to what you get out is what you have on the day that amount is calculated...


Also, remember taxes.... there will be no tax savings today for what you put in a ROTH, but huge tax savings when you start to spend that money...

 

[prototype]

Also check out what happens when she starts an annuity.... there is a beneficiprobablyary in case she dies before starting the annuity, but I would doubt there is anything afterwards.... but I have been proven wrong many times before....

.... There is no way to know which is likely to be better until we know the terms of the annuity. Currently we know the inputs but not the payouts..........

The retirement plan handbook is about 50 pages long, plus it references some other documents. I just took a quick look at it this morning. Based on the examples in the handbook (I’ll keep the post short and not screen shot them in), it does look like Plan D is the way to go unless you are at least 98+%? Certain you will be leaving before 5 years. There is some sort of calculator, but I am not sure DD has access to it yet (county computer accounts being set up). Here are some of the items that I hope answer some questions.


1. Yes there are spousal (and SO?) survivor beneficiary options (100%, 75%, 66.7%, 50%). Before and after death payouts are adjusted based on what is selected. (Looks like standard pension plan approach/schedule).

2. For Plans C & D full retirement eligibility is when you are age 55 or older and your age plus years of eligibility service total 85 or more, there is also an early retirement options, disability…., but benefits are reduced (except for disability I think) accordingly by some formula.

3. If you make it to the point you are collecting the pension/annuity it is COLA’ed, the standard annual COLA is the lesser of 4% or the percentage increase in the Consumer Price Index.

4. One is vested after 5 years if they don’t pull their money out (they do have that option). You do have to wait until 65 to receive benefits if you leave before early or normal retirement age and have left you leave your contributions in.

5. She will still be paying into social security and building that up. Both Plans C/D, do adjust monthly payouts down at FRA.

6. They had a C vs. D example, for the same scenario (retiring at 61, 30 years of service, average final compensation of $84K (high 5 year average?),FRA of 66, (DD FRA is 67). If I read it all correctly, this is the summary.
Plan C – 47K/yr for life
Plan D – 76K/yr until FRA, 52K/yr after FRA

Bottom line -- 1) From what little I understand of the current Federal Government retirement system, this seems similar. 2) Need to get DD to do some calculator runs for various scenarios (I think I,…. , I mean DD will be able to access it from home by next week..

PS - IMHO looks like a great place to work until 55, gain FI and RE!!!!!

 

[Texas Proud]

Prototype....


Keep in mind that if you only look at C vs D.... of course D is 'better'... you put more money into it...


But, add to that $47K for life whatever is earned by the ROTH... also you need to take taxes into consideration...



I wills say that a COLAed annuity is better than one that is not... but we would have to figure out the payment amount.... IOW, your example says ending salary of $85K.... so, is payout based on ending salary OR how much money you put into the account That is what RetireAge50 was pointing out that I dismissed... I was thinking the annuity would be based on cash in the account and NOT final salary...


So much more to think about... and so much more info needed to make a good decision....

 

[prototype]

....

So much more to think about... and so much more info needed to make a good decision....

Agreed, need some calculator runs, and I/she need to read through the plan. Appreciate all your input to date. 26 or so days left for her to make a decision (otherwise I believe they just enroll you in the 4%/Plan C). I'm just swamped trying to get my home ready for sale (by June?). DD is swamped with new job and prepping to leave the nest so to speak.

 

[leftbucket]

proto,

PM'ed you with link to county retirement webpage. DD is in the "Employee's" plan. All the documents, summaries, and calculators are there.

For the rest of you wondering the payout difference: the multiplier for the C plan is 1.8x yrs service x avg final salary. The multiplier for the D plan is 2.0x yrs service. She's fortunate someone's looking out for her. I remember being overwhelmed with benefit paperwork when I started out too.
Good old dad came through for me, too.

All the best,

R/
LB