My daughters and I spent the summer reading and discussing books about personal finance. They are both early career professionals – one in government and one in the non-profit sector. Some people read People magazine on the beach – we hashed out the benefits of contributing to a deferred compensation plan versus paying off student loans. The most common advice we found in the various books is to “pay yourself first.” Ideally, this would be 10% of your gross income. What we wanted to know was whether that maxim applies to employees (like many in local government) who participate in a defined benefit pension plan. The books don’t even mention pension plans, so we needed to do some research.
I contacted Jason Clark at ICMA RC, a leader in public sector retirement security. I had to laugh when Jason told me his first assignment as a financial planner was to read The Wealthy Barber by David Chilton. I read this book years ago, and both girls have read it as well. The advice is practical, accessible and achievable. It’s no surprise then that the advice I got from Jason was similarly helpful. In response to my original question about the 10% rule, Jason said that this amount is based primarily on what an individual can reasonably hope to accomplish. The 10% saving target should be above and beyond any other benefit such as a pension or social security. I have been assuming that I didn’t need to set aside the entire 10% because I am am eligible for a generous pension, and come to find out this advice applies to everyone regardless of planned retirement income stream. Oops.
What Jason tells people most often is to work toward maximizing their retirement plans. They can always stop contributing if they need to, but can never catch up if they don’t start. The preferential tax treatment alone is a reason to prioritize this type of saving. He notes that while we all believe in systems (social security, state and local pensions) there is always the possibility that they may fail. Adequate personal savings can help buffer any bumps in the road. Moreover, pretax retirement savings can be used to bridge the gap for those who decide to retire earlier than on a traditional timeline.
So back to the beach. Or more specifically the cottage after a day on the beach. Molly never met a spreadsheet she didn’t like, so she searched for an on-line tool to see what would happen if she were to maximize her 457 plan. If she starts contributing the maximum of $19,000 per year at 27 years old with an interest rate of 8%, she will have $4.5 million in her account at age 65. If she earns 10%, the figure is closer to $7.6 million. Even more astounding is that if Colleen (now 24) could contribute the maximum to her 403 B plan, she could have over $10 million at 65 earning 10% interest. Enough said. Most people cannot begin saving that amount of money when the are just starting out – but the importance of taking a small step and growing gradually to the maximum is evident.
Armed with data, my daughters will make their own plans for funding their retirement plans. As for me, I already set up a plan to gradually get to full funding by September, 2020 – or sooner if the universe conspires to make that possible. I feel better just having it on my calendar. Check.
The other question that we had is whether early career professionals should pay off their student loan debt before contributing to their retirement plans. While paying off debt seems intuitively to be the best strategy, Jason argues that loans will always be part of life – after student loans we often have car loans or mortgages. He suggests that if the interest rate is not too high, early career professionals should maximize retirement savings before paying off loans. The interest rate on the student loan must be considered in the context of historic market growth. The loan will eventually end, and when you are 65 you will barely remember it. However, you will never be 24 again, and that magic of compound interest and tax free savings cannot be recouped. Says Jason, “You will always have a loan. Don’t forgo retirement savings because of a debt with reasonable interest.”
I asked Jason what else local government managers should be considering. He noted that especially for city and town managers whose tenure is, well, more tenuous, emergency savings is a must. Having three to six months of expenses in a savings account remains tried and true advice for everyone. In addition, managers should evaluate the need for life insurance if they have people depending on them, and disability insurance to mitigate temporary setbacks related to illness or injury.
Something I think local government managers should also consider is adopting a 401 A plan for their community. Managers who have employment contracts can negotiate a percentage contribution to the the 401 A as a component of compensation. Contributions to the 401 A are in addition to the 457 plan, even if you are maxing out your contributions, and represent another tax-free benefit. Our town provides a 401 A match for most employee groups, which encourages personal retirement savings for them. Allocating resources to the 401 A rather than straight COLA as part of a compensation package also saves the town on long term “legacy” costs that are tied to employee salaries.
In summary – max out your 457 plan as soon as you can. Contribute to a 401 A if you can and without question if you have an employer match. Start early. Buy disability insurance, and life insurance if you have dependents. Let’s Practice saving some money for retirement.
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Many thanks to Jason Clark at ICMA RC for his advice. I am obviously not a professional financial planner so any misinterpretation is mine alone.