A Quick Study on Supplemental Retirement Plans

By John Kevin/School Administrator, August 2015

Today, many people will work into their late 60s and will live at least another 20 years. That necessitates a sizeable nest egg.

Ensuring that employees have financial options when it comes to retirement planning is important. Public school employees have a generous retirement benefit: a defined pension plan that will typically replace about 50-60 percent of their income.

But because people live so much longer than ever before and face very different financial and family situations, supplemental retirement plans are an important benefit. School superintendents and the human resource administrator can lead efforts that educate employees about financial planning options.

When leadership tells employees to pay attention to retirement planning, it signals that it’s important, says De Hawley-Brown, director of benefit services for Fairfax County, Va., Public Schools. In her experience, “Teachers care so much about their kids and are so focused on taking care of their students that they need to be reminded to take care of themselves.”

Contribution Plan Basics

Tax-sheltered 403(b) or 457(b) retirement plans allow employees to put a portion of their salary into an employer-sponsored plan to help them save for retirement. Another term for this kind of retirement plan is a defined contribution plan.

Such plans offer flexibility as employees choose how much to contribute and how to invest their money from a menu of options, typically, variable annuities, fixed annuities or mutual funds.

In return, the government allows employees to forgo paying taxes on retirement savings until the money is withdrawn. Traditional pretax contributions grow over time since employees don’t pay taxes on dividends, interest or capital gains until they take a withdrawal. Most people will be in a lower tax bracket during retirement, so overall taxes paid on the amounts contributed would generally be lower.

Some school districts offer Roth options that allow employees to save on an after-tax basis regardless of income level. A Roth option, an increasingly popular plan feature, provides additional flexibility to employees on withdrawal options in retirement.

Defined contribution plans may also be used to provide additional retirement savings for a district’s senior staff or other identified key personnel. The IRS limits overall 403(b) contribution limits to $53,000 including the employee-elective deferral limit of $18,000. This means a district could make an employer contribution to an employee’s plan of up to $35,000, in calendar year 2015, assuming the employee was contributing his or her elective deferral limit. These additional retirement monies are another compensation tool to use for certain senior staff.


A Well-Rounded Approach

The importance of tax-deferred supplemental retirement plans cannot be overstated. They complement both an employees’ defined benefit plan and Social Security (if applicable) retirement savings. An advantage of these plans is that they diversify employees’ sources of retirement income. Additional saving opportunities afforded employees in these defined contribution plans may improve overall retirement readiness.

When it comes to creating a nest egg for retirement, starting early helps. Consider this hypothetical example to see the effect of postponing it for 15 years. A 22-year-old employee who saves $4,000 per year and earns six percent interest would have a nest egg of over $400,000 by the age of 62 years old. An employee who begins saving $4,000 a year at the age of 37 years old and earns six percent could have a nest egg of over $200,000 by age 62. Of course, the annual rate of return in these examples is only for illustrative purposes.

Alternative Models, Vendors

Superintendents may wonder whether there is a model for a school district to use when it comes to supplemental retirement plans. The answer is no.

Districts must decide which employees will be eligible to participate in the plans along with plan provisions such as loans and withdrawal options in addition to how many plan sponsor vendors are available.

Defined contribution vendors are generally evaluated on five key features that distinguish one company from another. Each company has a service model; investment options; administrative fees; and surrender or withdrawal charges.

Service models. When it comes to service models, essentially, the district will want to understand whether the interaction between the firm and the district is high-tech or high-touch. High-tech companies direct participants to a website for a more do-it-yourself experience. The other common option is a full-service model that provides a financial advisor to work one-on-one with client, including sitting down to do a personalized financial plan.

Employee demographics may play a role in which type of plan employees will be most comfortable. Age may dictate how comfortable employees are with technology, for instance.

Investment options. Every vendor will have different investment options. These can vary by type of investment and number of choices within a category.

Administrative costs. For districts, retirement supplement plans carry some compliance and administrative costs. IRS regulations have formally recognized these supplemental retirement plans as “plans.” Therefore, they have increased administrative requirements on school districts, such as having a plan document. Many districts rely on a third-party administrative service to assist in plan compliance.

The price to the sponsor and to the client (employee) usually varies by participation rates, average account balances and overall plan size. Smaller districts have mitigated administrative costs by joining together to share the cost of the plan. (This option is only available in states that allow it.)

Surrender Fees. A surrender fee is a fee imposed by the investment product under certain circumstances.

Withdrawal Fees. Districts should understand any applicable surrender charges or withdrawal restrictions from the investments.


Participation Goals

Plan sponsor engagement is critical to the success of these supplemental retirement plans. Plan sponsors will want to know what the district’s current overall participation rate is. This information can likely be obtained from the payroll system and/or plan administrator. Next, working with defined contribution vendors, the district should identify a participation rate goal and period of time to achieve it.

Segmenting participation data by gender, age, bargaining unit, work location, etc., can further identify what populations of employees superintendents might want to target for participation. Segmentation is also useful in determining how to engage employees effectively. Just as students have differentiated learning styles, so too do employees. Partnering with a defined contribution vendor(s) to create an education and engagement campaign that works throughout the year using various media will help improve overall participation as employees learn the value of the plans.


Reaching Financial Goals

Anecdotally, only about one-third of public school employees participate in supplemental retirement plans. Many more of them could benefit from this option.

The quality of life that employees will enjoy in their retirement is directly related to the decisions they make now and in coming years about saving and investing. Encouraging employees to educate themselves about investment options can help them reach financial goals.

John Kevin is vice president of K12 education services at VALIC. E-mail: john. Copyright © The Variable Annuity Life Insurance Company. All rights reserved.