Online Teaching Blog

Best practices, tips & tricks, and career advice—served up fresh

No Pension? No Problem!

No Pension? No Problem!

by Joe Templin, CLU, ChFC, CA
May 16, 2017

Once upon a time, smart people would go to college and work hard.  They would get their Bachelor’s degree in a cost effective way, and then the better ones would go on and get advanced degrees.  The best would then get their PhD’s and go on to long and fruitful career as professors, protected by the Ivory Tower from the time they entered college until retirement in their mid-sixties with a full pension, all needs ultimately taken care of by academia.  And there were sparkly unicorns bringing buckets of gold from research grants, and leprechauns would grade all the tests in the middle of the night.

In that long lost idyllic age, academia was respected and profitable, with guaranteed employment.  But the same forces that have altered the landscape for the corporate world have buffeted and reshaped the world of education.  In this brave new world of the gig economy, the rules are different and survival more difficult.  Luckily we still can borrow the knowledge of others to be able to make our way.  

Let’s assume that you are an intelligent person, but not a financial planner.  For the vast majority of the people reading this that should be true.  Let’s further assume that you earn a decent income teaching or consulting on education, but not on a full-time basis with any one employer.  Fairly reasonable assumptions.

You probably just recently completed your taxes and filed a bunch of 1099’s as your documentation for your income. And might have had some not so nice things to say.  Best is my friend the astrophysics professor: taxes suck worse than a black hole.  So to make sure you don’t disappear into the event horizon in the future lets lay out some ideas you might consider applying to your future planning.  And taxes, like gravity, are ever present but once accounted for in our calculations.

First and foremost let’s come to an agreement on taxes and spending habits, because these are two of the most important factors in retirement.  Taxes will go up, and you will spend more money in the early parts of retirement than you do now.  These are predictions but ones I am willing to bet my reputation and own money on, and like all good scientists I have external data to reference so you can peer review my claims.

Let’s focus on the spending habits.  If you want a more in depth discussion it can be found in my book “Financial Mistakes of Young Americans”, available at Amazon .  What did you do on your last vacation?  Did you go to the library, check out a few books and sit around reading?  Or did you go out to eat, and visit friends, and spend money?  When you retire, that is what you do all the time for the first few years because you have time to do it and still maintain your vigor.  It’s more like a sabbatical than Spring Break, but it is still an uptick in lifestyle for a while.  Doubt me?  How about this study from the Employee Benefit Research Institute and referenced by the Motley Fool that 120% of your pre-retirement income is really the target?  Or look to Tom Hegna’s book “Pay Checks and Play Checks”, where he analogizes that the first few years of retirement is Saturday every day, with golf and restaurants and museum visits.  He draws upon the work of Dr. Moshe Milevsky of York University in Toronto and uses a multiphase retirement model like what I do (Go Go, Slow-Go, and No-Go or Maintenance).  I target 150% of Pre-Retirement Lifestyle for that first decade of spoiling grandkids and yourself, a conservative assumption but I doubt you will complain about having too much money to spend.

So you will spend more money early in retirement, and less when you are much older and can’t drive a golf ball or car.  A reasonable assumption.  Now let’s look at taxes.

Anyone think taxes are going to go down in retirement?  Raise your hand.  Nobody?  Good, you have been paying attention to the world around you.  The US Debt (per http://www.usdebtclock.org/) is about to pass $20 Trillion.  The Congressional Budget Office (non-partisan provider of info to our elected leaders at www.cbo.gov ) says that tax rates will have to go up anywhere from 1/3 to ½ to cover our obligations.  So in retirement you will be at least the same tax rate as now and likely higher, so we need to focus on minimizing the tax impact to your retirement.   

Almost every accountant I know (sorry accounting professors reading this) will say “Fund an IRA and take the current deduction!”  But if we agree that you are going to need more money early in retirement and that taxes are going to go up, taking a current deduction to pay at a higher rate on a bigger dollar amount down the road is the opposite of what you should do.  It is like eating donuts and double cheese burgers every day because it makes you feel good now, diabetes and heart attacks in the future be darned.  If you were to now think about it for a moment, it should be intuitively obvious that the “common advice” of current pleasure (deduction to avoid taxes) will have negative consequences in the future, just like the burger donut diet.

A better alternative is to pay your current taxes and max out a Roth IRA (http://www.rothira.com/2017-roth-ira-limits-announced for details on limits for 2017).  This money will grow tax free if you don’t touch it (there are some loopholes to tap into a Roth IRA pre-retirement, beyond the scope of this discussion) when you retire the entire amount is available to you tax free.  This is clearly a better outcome than the Traditional IRA alternative because you can take more in those Go-Go years without being penalized with extra taxation, plus if you are still working and don’t need the money you can delay taking money out without RMD’s (Required Minimum Distributions) creating an additional tax burden.  In 2017 you can put in $5,500 per person (plus an additional $1000 if you are over 50), phasing out if you make $118,000 or more as a single individual ($186k if married).  If you were to do a calculation as I have, you will find that you have easily an additional 25% or more of spending money in your pocket in retirement with a Roth vis a vis a Traditional IRA for the same allocation of dollars.

NB: a Roth IRA is great, but probably won’t be enough to get you the retirement you desire and deserve.  To have the retirement you want that we discussed, you need to be setting side 15% of your income by the time you are 25 years old, and that number goes up roughly .75% per year.  So if you are in your early forties, and haven’t been regularly allocating money to retirement, you are going to need to set aside a quarter of your earnings each year to be ok for retirement at 65.  So where else should we allocate the cash to grow for the future, with the mindset of trying to minimize the tax burden?

A Section 7702 Plan is similar to a Roth IRA in tax treatment: after tax dollars going in, tax deferred growth, and as long as you obey the rules (a bit more onerous than those for a Roth) tax free distribution (as laid out in Section 101 (https://www.irs.gov/pub/irs-drop/rr-07-13.pdf) of the IRC if you want to research).  There is also no annual earnings cap, nor the limitation on contributions like a ROTH or other defined contribution retirement plans.  There is a good chance wherever you are teaching is using this as the funding for benefits for the President of the college or university, and every large bank in the country (people who know something about money we can assume) uses this to offset their benefit costs.  My research proves that on an after tax, risk adjusted basis a 7702 Plan is the most efficient wealth accumulation tool available in the US today.

By the way, 7702 is the section of the Internal Revenue Code that defines life insurance.  Hopefully you are not allowing emotional bias at the name and reputation to overwhelm the mathematical and legal proof of value of this asset.  If you do succumb to that bias and won’t consider a tool because your cousin’s wife’s ex dog keeper (or some talking head on TV whose job is to sell advertising instead of educating like you and I do) said it is a bad idea, I can’t do any more than point you to the facts and hope you do your research like I did.

Those same TV talking heads will tell you that an annuity is a bad idea too, probably because “the fees are too high!”  Even though they all own them, and annuities have been endorsed by the US Treasury Department.  Your peers that are tenured love their pensions for the guaranteed income they will never outlive, and an annuity will replicate this for you.  A discussion of the types is beyond the scope of this discussion, consult your adviser to explore your options.  There are many studies showing that having guaranteed income in retirement increases happiness and life expectancy (such as this one: https://www.towerswatson.com/en-US/Insights/Newsletters/Americas/insider/2012/Annuities-and-Retirement-Happiness ), so if the goal is to live a longer and happier life without worries, an annuity to supplement you Roth IRA is a good idea.

So class, let’s recap what we learned today.  Unicorns no longer bring research dollars, but in the gig economy you can still piece together a great retirement with a guaranteed income by allocating dollars into Roth IRA’s supplemented by annuities and cash value life insurance.  There will be no pop quiz, but a final exam at the end of your career.