If you’re a public school teacher in California, there’s a lot to consider when saving for retirement. In fact, teachers have more choices than employees in the private sector and the options can be confusing. In addition to some of the nuances involved with CalSTRS and Social Security, many teachers are eligible for 403(b) and 457 plans.
In this article, we’ll take a closer look at 403(b) and 457 plans and examine how they can work together.
To better understand these plans, let’s look at some similarities between 403(b) and 457 plans:
- Pre-tax salary deferral contributions which are taxable upon withdrawal in retirement
- After-tax (Roth) contributions that are tax-free in retirement
- Select from various investment options like mutual funds and annuities
- Rollovers to IRAs if you leave your job
- $18,000 annual contribution limit (2017) with additional “catch-up” contributions of $6,000 for those age 50 or older.
The main differences between 403(b) and 457 plans center on how and when you can access the funds:
With a 403(b) you can take a withdrawal without penalty if you retire after after age 55, for death or disability, or via a lifetime annuity. Distributions while you are still employed (in-service distributions) are allowed only on a hardship if under age 59 1/2. Even with a hardship, 403(b) plans will assess a 10% penalty tax (in addition to ordinary income taxes) for an early withdrawal if you are under age 59 1/2.
With a 457 plan, you can take a withdrawal with termination of employment at any age, for death or disability, or for unforeseen emergency. Most importantly, there are no 10% early withdrawal penalties.
Contributing to both plans
A major benefit for those with access to both a 403(b) and 457 plan is the ability to contribute to both at the same time. Stated another way, you can contribute up to the maximum for each! Granted, the maximums are pretty high. In 2017, for those under age 50, the annual limit for the 403(b) is $18,000 and $18,000 for the 457. That means you could contribute up to $36,000 combined. That is a huge advantage and one not found in the private sector. By any measure, reducing a current salary by $36,000 is a tall order, but consider the following scenario and what it could do to boost your retirement nest egg.
A 40 year old is not eligible for the additional “catch-up” contributions like their colleagues age 50 or older. The ability to contribute to both plans allows you to essentially “catch-up” early! So let’s compare two teachers both age 40. One teacher maxes out the 403(b) each year. The other “catches-up” early by maxing out the 403(b) and puts an additional $6,000 toward the 457 plan. As you can see below, the teacher who contributes an additional $6,000 per year and “catches-up early” will have an additional $72,000 in the retirement account by age 49!
*Rate of return of 4% is for illustration only and is not meant to represent the return of any specific investment. Your results will vary. No taxes or fees were included in this calculation. Investing involves risk of loss and investments are NOT guaranteed or FDIC insured.
Fees and expenses
Don’t go blindly into the investment options. There are so many that it can be overwhelming and there can be a huge difference in costs and fees associated with them. Get to know the ABCs of mutual fund share classes and make sure you understand what you’re buying. If you’re considering an annuity, make sure you understand what strings may be attached. If someone is recommending it, there is likely a commission waiting for the broker so ask questions about how they are compensated. In addition, with annuities, there is often a surrender penalty if you change your mind. Fees and costs have a huge impact on your long term earnings so make an effort to seek out low cost options when available.
It takes a special person to take on the challenge of being an educator. It’s not easy to meet the requirements to become a teacher and the daily management of the classroom is no walk in the park either. But I’ve always been told, if it were easy, anyone could do it. In addition to the many challenges teachers face, planning for retirement can be another daunting task. Visit ctainvest.org for more information. Be sure and do your homework and study up! You’ll be glad you did.
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