The original premise for a 403(b) plan was to allow for additional retirement income if you wanted to save. However, there’s been a movement to get rid of or decrease the benefits of pensions. This puts pressure on the 403(b) plan to become the core source of income. In Illinois, the cost of living adjustment in the pension is under fire. Your cost of living adjustment may just come entirely from your 403(b) plan contributions.

Calculating your 403(b) need

Before calculating how much income to plan for from your 403(b) we start with how much money you want to live off annually when you retire. If you have a spouse or partner, what income do you need from their contribution? What do they need from you? After that, we look at your potential sources of income.

  • Will you be receiving any pensions? Do they have cost of living adjustments or are they fixed? If you have survivor benefits, it is important to calculate all of your income options. Do not assume that a 50% survivorship benefit is adequate for the spouse and any dependents.
  • Will you be receiving Social Security? If so how much Social Security will you be receiving? I have seen statements from Social Security, including my own that say somewhere around 2040 that I will only receive 75% of what it’s telling me today. What is your thought on how the Social Security system crisis will get resolved? Unlike pensions, Social Security does have a cost of living adjustment.

Let’s say that you expect Social Security or pension will provide $26,000 and you want to live on $50,000. That means that your 403(b) needs to create $24,000 or $2000 a month in monthly income. The following hypothetical uses the following assumptions:

  • You have not saved any money so far
  • You are 40 and plan to work to age 70
  • Will live to a healthy age of 100 based on medical advances
  • Investment returns average 7% return before retirement after fees
  • Investment returns average 5% return after retirement after fees
  • Inflation or cost of living (COLA) increases at the current 20-year rate of 3.72%

You would need to save $10,000 per year increasing by 5% per year ($10,500 in year 2). A 403(b) plan allows you to save $17,500 per year today and more when you reach 50. This answer is based on simply spending as you need. These are gross numbers as future tax rules are impossible to predict.

Of course, no one knows how long they will live so this may not be enough. There are other strategies such as using a single premium fixed annuity with a COLA which would alter how much you need to accumulate. There are several benefits of a single premium fixed annuity with a COLA:

  1. Provide for and tailor a survivor benefit that does not have to be a spouse
  2. Shift the risk of outliving your money to an insurance company(ies),
  3. Hedge the risk of outlasting your money. you won’t run out based on their claims-paying ability,
  4. Diversify the risk of insolvency. You can’t do that with a pension.
  5. Increase payments for life. If you pick a 3% COLA adjustment your $2000 payment at age 70 becomes $4000 24 years later.

On the flip side, you lose the premium you gave them. This allows them to pool the risk among other fixed annuity investors. This is just like a pension. There is no money left over to provide for children or charities, just one survivor. Don’t let the term fixed annuity throw you it’s essentially what most pensions leverage when it’s time to payout.

Need help to calculate your 403(b) needs?

None of the clients and prospects that have 403(b) plans have told me they receive education on their 403(b) work. Not too surprising considering it was originally thought to be a supplement to other sources of income. I’ve talked to some of the sponsors of 403(b) plans and their feeling has been that their people are on their own to make their own choices. I find this surprising. It’s not readily apparent what one should do besides save money and I guess hope for the best regarding their investments. In academia, I find this puzzling as investing is actually taught in business schools by their own professors. If you’re like a lot of people math was not your best subject.

You may want someone to help you figure this out and tailor a plan for you. Look for credentials such as the Charter Retirement Planning Counselor® or CERTIFIED FINANCIAL PLANNERTM professional. You’re welcome to use our risk assessment service which is free of charge to see if your actual risk tolerance reflects your risk comfort zone. That is a great step towards tailoring a plan that you will be comfortable implementing. You can use it if you choose to work with us or with another retirement credentialed planner.

(1) Fixed annuities are long-term investment vehicles designed for retirement purposes. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Guarantees are based on the claims-paying ability of the issuing company. Withdrawals made prior to age 59 are subject to a 10% IRS penalty tax and surrender charges may apply.

(2) The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

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