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Defined-Contribution Retirement Plans? A Bad Idea Defined



By Deborah A. Wilburn

Thinking about retirement may not be a favorite pastime, but it is necessary, especially if you hope to file away your lesson plans permanently one day. The good news? You’re likely among the 90 percent of all K–12 teachers and education support professionals who currently have what’s called a defined-benefit plan. That can make the difference between having enough money in retirement and coming up short. Defined-benefit plans have several key characteristics:

Predictability. You know how much of a monthly benefit you will receive at retirement age, making it easier to plan for the future. The benefit is typically calculated according to a formula based on years of service and final average salary.

Security. The benefit is guaranteed for the rest of your life.

Expert money management. The funds put into the plan on your behalf by your employer (and you, if your plan requires employee contributions) are professionally managed.

Low expenses. Fees associated with having the money professionally managed are low, increasing earnings.

Extra benefits. Many defined-benefit plans are comprehensive, offering additional perks such as cost of living adjustments, retiree health coverage, disability, and early retirement. 

The alternative is the defined-contribution plan. These are individual, tax-deferred investment accounts funded by the employer, the employee, or both, depending on how the plan is designed. However, it’s up to employees to determine how that money will be invested. As a supplemental investment product, they can be a useful tool. But if a state decides to offer a defined-contribution plan to fund employee pensions, the balance in educators’ accounts when they leave—especially in states that are not part of Social Security—could represent their entire retirement package. Judging by how poorly the majority of participants fare with thes e plans, many are in danger of reaching retirement with nowhere near adequate money.

When politicians make noises about converting public employees to a defined-contribution plan, it’s usually promoted as a cost-saving measure that workers are clamoring for—neither of which is necessarily true. “Experience in places that have converted to a defined-contribution plan shows it doesn’t save money and, in fact, can be more expensive,” says Nancy McKenzie, NEA’s senior pension specialist.

Unfortunately, some workers mistakenly assume they stand to gain from employee-managed plans. “People think, ‘My employer is putting 10 percent of my pay into a defined-benefit plan, I’d rather have that in my own account,’” says McKenzie. But, “usually the employer contribution is lower when the conversion is made, because the idea is to save the employer money.”

If you hear that your state legislature is considering changing your defined-benefit to a defined-contribution plan, it’s important to take a stand. NEA has developed a tool kit, “Protecting the Retirement Security of NEA Members,” available at www.nea.org/retired/tools/ publications.html. It has research, more resources, and concrete steps for developing an action plan. “It’s important for people to understand and appreciate the value of what they have,” says McKenzie. And, if necessary, to defend it.

Resolved for 2007:

Start Saving Now!

It’s a new year, and there’s no better time to review your finances and consider where you might make improvements. Teachers and other school personnel should pay special attention to their retirement savings, says financial expert John O’Brien of O’Brien Capital Management Inc. in Nyack, New York. “In early January, I try to educate my clients about how to change their contributions to maximize their account balances,” he says. Even if they benefit from a defined-benefit retirement plan (see “A Bad Idea Defined”), educators should also try to set aside supplemental funds in a tax-deferred 403(b) plan or IRA account. “It’s the one way to really build wealth,” he says. “And it’s important to start when you’re young. This is when you can take advantage of the power of compound interest, which makes your money grow over time.”

That said, O’Brien has a few guidelines for making such investments. If your school district offers 403(b) accounts, consider the options within the plan before investing your money. Educate yourself about features and fees, including early withdrawal penalties. If the offerings in your district’s plan are not what you’re looking for, consider opening an IRA or a Roth IRA. With a traditional IRA, taxes on your contributions and earnings are deferred until withdrawn in retirement. With a Roth IRA, you invest money on an after-tax basis and your earnings are completely tax-free when withdrawn in retirement. There are income limits on who can invest in traditional IRAs and Roth IRAs; check with your accountant or the IRS Web site (www.irs.gov) to see if you qualify.

 

Is It Worth It? Pet Insurance

It’s bad enough worrying about your own health insurance. But with veterinarians now able to diagnose and treat conditions ranging from cataracts to cancer, pet owners have the option of approving costly treatments should their furry friend get sick. If you’re the type of owner who would do anything to care for your pet, this type of insurance makes a lot of sense.

Even if you feel there are limits to what you can or should do for an ailing pet, the insurance is still worth a close look. Say your dog got a urinary tract infection requiring an emergency vet visit, the bill for which can easily hit $300, or your cat broke a leg. You would likely seek medical help, and pet insurance can help defray the cost. For example, a fractured bone bill could set you back about $2,250, says Lori Corriveau, a clinician at Purdue University’s Veterinary Teaching Hospital.

Pet insurance premiums start at about $19 per month for dogs and $12 per month for cats. “They are based on the species, age of the pet, where you live, and plan selected,” says Corriveau. Optional coverage for vaccination and routine care coverage is also available, and some companies even offer avian and exotic pet plans covering reptiles, birds, and others.

If you decide to go this route, choosing among plans requires careful consideration of what your money buys. “Consider what is covered and how the paperwork is submitted, exclusions for your pet, and price,” says Corriveau. “Most important is how long the insurer has been around. Many have come on the market and gone belly up.” One she recommends (and has no affiliation with) is Veterinary Pet Insurance, a 25-year-old company that writes 80 percent of the nation’s pet insurance policies. Fido might thank you.

Got a great way to save some cash? E-mail Cynthia Kopkowski at ckopkowski@nea.org.

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January, 2007