September 30, 2007
Q. I have only $20,000 saved for retirement and am 50 years old. I know I have to get going, but my head is swimming with things I have heard about a deferred compensation plan and a 403(b) variable annuity at work. I'm a teacher, and can use either of the plans. But some people at work say the annuity isn't good and the deferred compensation plan is better. I tried to get help from a person in benefits, but they sounded like they were talking in code. So I haven't been doing anything, although I did pay off my house. What should I do?
A. You are right: You have to get going.
Rather than being afraid of choosing the wrong retirement savings plan, you should be more worried about the dismal future you could face if you keep spinning your wheels.
Say you leave $20,000 invested in a strong mixture of stocks and bonds. If you had an 8 percent annual return in the next 15 years, you would end up with about $63,400. If the money is simply in a savings account, you will probably end up with less than $27,000.
Either way, your savings aren't going to carry you far in retirement.
There's a rule of thumb that if you want your savings to last through 30 years of retirement, you cannot remove more than 4 percent each year, then adjust it each year for inflation. Under that formula, if you accumulated $63,400 by the time your retire, you would have $2,536 for living expenses the first year away from work -- about $211 a month.
To put it into perspective, consider that Medicare doesn't cover all medical expenses during retirement. So retirees typically buy extra medical insurance. That alone runs about $150 a month now per person, depending on where you live.
Although some teachers may not receive Social Security benefits, most people who do overestimate what that amount will be. The average is about $1,011 a month.
The good news for you is that your home is paid off. Still, there will be property taxes, utilities and upkeep.
The better news might be that you are a teacher. Typically, public school teachers receive rather nice pensions, which is becoming more unusual for other workers. If you happen to have a pension, and have been in your job for many years, it might provide a nice sum -- perhaps about 60 percent of your annual income on the job.
If that's the case, you won't have a luxurious retirement, but you will probably get by. Financial planners frequently recommend that people have at least enough money from savings, pensions and Social Security to give them about 70 percent of what they were used to during their last year of work.
But do not take the prospect of a pension for granted: Even as a teacher, you might not have one. And because pensions are based on the years of service, your benefit could be small if you are relatively new to your job. Contact your benefits office, and find out what to expect. If your pension income turns out to be disappointing, you need to start saving quickly.
Luckily, the two retirement savings plans that have been confusing you might be just what you need to help catch up. Under provisions for 403(b) plans, you might be able to save as much as $23,500 a year, and in the deferred compensation plan, or what's known as a 457 plan, you might be able to save as much as $31,000, said Melanie Walker, an attorney with Segal Co., a benefits firm.
Although the usual maximum limit on savings in each plan is $15,500 for the year, there are provisions for people to save $5,000 more a year if they are 50 or older. On top of that, some additional amounts are possible if you meet certain criteria, such as 15 years of employment where the 403(b) is offered. Ask your human resources offices about the rules for your plan.
The benefit of using either a 403(b) plan or deferred compensation plan, or both, is that you insulate your savings from taxes. Each year you put money away for retirement, you reduce your income taxes because you are not taking the income home with you. And while the money is in the retirement plans, you aren't taxed on it either. That's different than a savings account, where the interest you have earned is taxed each year.
With either a deferred compensation plan or 403(b) you will be required to pay taxes when you remove money.
As for your friends' concerns, my guess is that they either don't like the quality of the mutual fund choices in one of the plans or the fees you must pay. Walker said that deferred compensation plans often offer a wider range of mutual fund choices and charge lower fees than the variable annuity in your 403(b).
Some 403(b) plans have charged such high fees that the Securities and Exchange Commission has run an alert on its Web site to help people avoid expensive investments. You could be charged loads, surrender fees and redemption fees, plus the fees to operate your mutual funds. These are explained athttp://www.sec.gov/ investor/pubs/teacher options.htm.
You should contact the administrator at your workplace and ask for an explanation of all fees you would pay. The percents might sound small, but the SEC gives this example: If you invested $10,000 in a product that produced a 10 percent annual return before expenses of 1.5 percent, then after 20 years you would have roughly $49,725. But if the investment had expenses of only 0.5 percent, then you would end up with $60,858.
Fees in some 403(b)'s are much worse than 1.5 percent. Morningstar analyst W. Scott Simon said in a report that the investment products offered by insurance companies in 403(b)'s can cost 2 percent to 5 percent.
Mutual funds probably do not charge as much. The average fund charges 1.4 percent.
"It just seems crazy for school districts to offer teachers investment options that have an added layer of fees," Simon said. "It's not that such options have no value at all; rather, it's that they do not have value enough to justify their oftentimes grossly higher costs."
You can analyze the effect of fees from your retirement choices using the SEC mutual fund cost calculator athttp://www.sec.gov/investor/tools/mfcc/get-star ted.htm.
Above all, do not procrastinate: Find a financial planner who does not charge commissions. Planners who charge commissions might steer you away from your retirement plans at work so they can sell you something.
You want impartial advice, someone who will have you use your workplace plan if it's good for you. Look for a fee-only planner who will charge you an hourly fee to compare your workplace retirement plan choices. Find one at Garrett PlanningNetwork.com or Napfa.org.
Gail MarksJarvis is a Your Money columnist. Contact her firstname.lastname@example.org.
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