As I’ve worked with more and more members of STRS Ohio, it’s become clear the recent changes to the system are not only on the mind of the participant, but also the participant’s spouse. In fact, on several occasions I have been sought out by a spouse of an STRS Ohio member to provide clarity regarding the changes. Few STRS Ohio members seem to have a complete grasp on how their benefits have changed and what planning opportunities they still face – especially retirement savings. But these opportunities may be further magnified when one spouse doesn’t participate in STRS Ohio.
So what do I suggest when it comes to retirement planning when one spouse is a member of STRS Ohio, but the other is not?
1. Plan Conservatively
If you are a participant in the STRS Ohio system, you’ve seen a lot of changes the past handful of years. Whether you agree with the changes or not is a different discussion. However, it’s become clear all facets of the system, from the way retirement benefits are calculated to health care premiums, are on the table for discussion and, in my opinion, we are likely to see more changes in the future.
How do you plan for that?
It’s prudent to plan conservatively. Current STRS benefit projections may be revised down at some point in the future, so your long-term savings goals should account for that. This is similar to what I advise young professionals in the private sector to do regarding projected Social Security benefits. While it would be great if current projections pan out, it isn’t wise to fully rely upon current projections.
For younger members of STRS Ohio, Is it likely their projected pension will disappear? Not really, based on the current funding status of STRS Ohio. However, stranger things have happened.
Given the ongoing changes and uncertainties, It’s important families not fully rely on STRS Ohio benefits to meet future living expenses. Maybe this means only counting on 50% or 75% of projected benefits and saving the balance of your retirement needs in an investment portfolio. Whatever this means for your family, plan conservatively!
2. Be sensitive to future income taxes
Many times I see STRS Ohio members and their spouses allocating all of their retirement savings to tax-deferred accounts (e.g. traditional 401k or 403b). While this may seem like the most beneficial way to save for the future, it may not be. Let’s take a look at one scenario:
Jim is a teacher, currently earning $70,000 a year. His spouse, Jessica, works in corporate America and also earns $70,000 per year. Their combined annual income is $140,000.
In 2016, their income places them in the 25% marginal, Federal tax bracket so saving to a traditional 401(k) and/or 403(b) effectively means they avoid paying a 15-25 cent tax on every $1 of income. (I’m trying to simplify the actual tax calculation!)
Fast forward 20 years to retirement and Jim is eligible for a pension of $90,000 each year.
Because Jim’s pension will pay him $90,000 each year, this may put the couple in the 25% marginal, Federal tax bracket. And this is the lowest it will ever go because Jim’s pension is payable for life and other sources of income (e.g. 401k or 403b distributions, Jessica’s Social Security, etc) will only add to taxable income! This means all distributions from Jim and Jessica’s 401(k) and/or 403(b) will be taxed at 25% and above.
In this scenario, Jim and Jessica save to a 401(k) and/or 403(b) while foregoing the opportunity to pay 15%-25% in taxes now, but pay a minimum rate of 25% taxes later in life…And that’s if tax rates don’t go up. Clearly this isn’t an effective strategy.
What should you do if you are in a similar situation?
Perhaps it makes sense to pay some taxes now to hedge against future tax rates. After all, tax rates may rise. In the example above, at Jim and Jessica’s current income level, they are still eligible to save to Roth IRAs and could contribute a total of $11,000 per year ($13,000 if age 50 and over) between the two of them ($13,000 if age 50 and over). Roth IRA contributions do not provide current tax benefits, but, provided certain criteria are met, all distributions during retirement will be tax free.
If Jim or Jessica’s employer offered a Roth 401(k) or Roth 403(b), they could each contribute $18,000 to the accounts ($24,000 if age 50 and over) ($24,000 if age 50 and over), in addition to making Roth IRA contributions.
The planning opportunity derived from this theoretical scenario is “tax diversification of investments”. Tax diversification creates future .planning opportunities that may reduce your future income taxes!
3. Be cost conscious
Identify and select investment accounts and products that are cost effective to own.
I frequently discuss 403(b) options with members of STRS Ohio, but this recommendation also applies to 401(k) accounts. Consider the following:
Did you know that an annuity 403(b) could lock your money in for a period of years, and you may incur significant fees to move that money should you want to transfer or withdraw it?
Did you know that some investment options may be significantly more expensive than alternatives, and they don’t perform any better?
Even if you don’t use an annuity product (e.g. AXA), do you know how much you are paying the account representative on your account to manage it?
In your company 401(k), do you pay any additional management charges? How high are your administration fees?
Not many people know how to analyze their accounts with this level of detail, but doing so may provide significant cost savings opportunities. Understanding how much money you pay to maintain your accounts effectively helps you maximize the money you keep. Over the course of a career, this could add up to a significant sum!
Clearly, it’s important you have a holistic view of your finances to take advantage of planning opportunities that may exist. Understanding STRS Ohio benefits is a great start, but it’s also imperative you consider the options available to a spouse who isn’t a participant in the STRS Ohio system.