Discover the Benefits of Supplemental Retirement Plans
Executive Summary
University of Illinois employees, as well as other Illinois public university employees, will be familiar with the State Universities Retirement System (SURS). Unless, of course, you are a new employee yet to choose a specific SURS plan, in which case you should visit our previous post on making this important and irrevocable choice! Many employees are less familiar with the available supplemental 403b and 457 retirement plans.
In this blog post, we will discuss the importance of utilizing supplemental 403b and 457 retirement plans for University of Illinois and other Illinois public university employees and provide guidance on how to decide where to save and how to choose investments. We will highlight why relying solely on the State Universities Retirement System (SURS) pension may not be enough for a comfortable retirement and why supplementing it with other sources of income can provide peace of mind. Additionally, we will provide tips on how to choose between the supplemental plans available and discuss the tax benefits of contributing to them. If you are a UIUC employee or an Illinois public university employee looking to improve your retirement readiness, read on for valuable insights and feel free to reach out to us for guided advice.
IMPORTANCE OF SUPPLEMENTAL SAVINGS:
At this point you might be thinking - “I already have 8% of my salary automatically going into SURS; won’t my pension be enough for me to retire?”. And to be honest, the answer is a big, ambiguous ‘Maybe’. First off, the question of “enough” is a very personal and tricky one to answer well. The biggest factor within your control is how much you expect to spend each year in retirement. (Though it would also be helpful from a mathematical standpoint to know just how long you plan on living). Will your pension meet whatever expectation you have for a retirement lifestyle? Without going into too much detail, the Traditional and Portable plans will pay a maximum of 80% of your final average salary, depending on the number of years worked under SURS. The RSP is separate from the pension system and so the option of creating a stream of income at retirement will depend greatly on how the investments within your account grow over your working career.
For many of our clients, working 30+ years under the SURS system is not part of their ideal plans. Some have plans to retire early, while others will move to a new university, switch to a private employer, or become self-employed. If you can maximize your pension, does 80% of your average ending salary sound like enough (or better yet, more than enough)? According to SURS.org FAQs – “Supplemental savings plays a critical role in retirement readiness. This is especially true for Tier II members who have longer vesting requirements, older normal retirement age, lower pensionable earnings limits, and a cost-of-living increase at retirement that will not keep up with inflation.” Remember, your spending is never perfectly smooth. There will be years where larger expenses, such as home improvement, travel, or helping children, will require more spending. The flexibility to spend more at certain times, while cutting back in other years, is a really important tool to make your retirement comfortable.
It can also be prudent to not rely on one source for your retirement income – to not trust your nest egg to the one proverbial basket. Yes, we remain confident in the staying power of the SURS pension. Barring any seismic changes to Illinois state law, your state constitution guarantees the SURS pension benefits owed to you. However, seismic changes may not feel as strange as they would even 5 years ago, so having access to other sources for your retirement income can provide a great peace of mind as you plan for your nonworking years.
Lastly, there can be a great benefit from a tax perspective of electing into supplemental contributions. If you make pre-tax contributions, you will lower your overall taxable income which means a smaller tax bill or larger refund. This strategy can also help get you into a lower tax bracket, which will further lower taxes paid. Overall, having some control to decrease, or even increase your taxable income in a given year is an incredibly powerful tax planning tool.
HOW TO CHOOSE A SUPPLEMENTAL PLAN:
Once the decision is made to commit some additional income into retirement savings, UIUC employees have some decisions to make as far as where to put it. First, there is the supplemental 403b plan directly through the University of Illinois (most institutions like U of I will have an equivalent option). Second, all Illinois public employees have two options for 457 plan savings. (See the Resource Library at the end of the article for more details). Depending on cash flow, you are allowed to maximize contributions into both a 403b and a 457. If you have enough excess funds to sock away, maximizing all available retirement contributions can have large potential tax benefits. Perhaps you are a two-income household, and your kids are out of the house. Or maybe you’ve inherited some funds and are wondering how to get serious about your retirement savings. Let’s look at an example of just how powerful this strategy can be.
In this example, we have an individual who is 50 years old and is at the top of the 24% tax bracket (roughly $180k of taxable income in 2023). They decide to enroll in both the 403b and 457 plans and maximize their pre-tax contributions. That is $30,000 into both plans when including catch-up contributions. (Note: there are special ways to save even more as you approach retirement which are beyond the scope of this example). To be conservative, let’s assume that they won’t earn any raises and that contribution limits remain the same. As illustrated below, starting supplemental savings at age 50 can still have a tremendous impact on your ability to retire, plus take a huge chunk out of your tax bill. If you are in a higher tax bracket, your tax savings could be even higher. And we have clients who are couples and are both able to maximize plan contributions, which doubles the below benefits!
The above level of savings can be a tall order and does not fit into all budgets. Don’t worry, there is still plenty of room to set yourself up with supplemental savings. To begin, you can always split contributions between the two plans. Or if you tend towards minimalism and prefer to limit the number of accounts you manage, it could be best to choose between the two. In comparison, the 403b plan has a wider range of investment options, as well as the choice between using Fidelity or TIAA (more to follow here). This flexibility often leads many to start off contributing into the 403b, and only adding 457 savings if additional cash flow allows. Conversely, one potential benefit to the 457 is that you can access the funds without penalty upon retiring, whereas you can be penalized for withdrawing from your 403b before age 59 ½.
An important caveat here is that for private employers, a deferred compensation (457) plan is not guaranteed money like contributions to a 403b or 401k. In fact, it is the uncertainty of these ‘deferred’ benefits that allows these additional tax-advantaged contributions on top of one’s 401k or 403b. However, governmental 457(b) plans, such as the public university options here, are not at risk like private 457 plans¹. So, while your employer technically holds possession of your contributions, your assets must be funded upon separation.
If you decide to save into a 457 plan, you have the option of using the State of Illinois Deferred Compensation plan or the SURS Deferred Compensation plan. There are no fundamental differences between the two and both will fulfill the same role. One potentially important distinction is that loans are permitted under the State of IL 457 plan but not the SURS 457 plan. Other than this, the biggest differences you’ll see are the investment choices, (more to follow below), and ease of management. If you prefer to limit the number of passwords to retain, you might like the convenience of accessing your SURS 457 account directly within your SURS member website.
Recent Announcement: For SURS members starting employment on or after 7/1/2023, a new auto-enrollment policy into the SURS 457 plan will be in place. New members will receive a notification letter from SURS explaining the auto-enrollment and informing them of the 30-calendar day period to opt out. If they do not opt out, a 3% pre-tax salary deduction will begin, with a default investment option of the Lifetime Income Strategy (more detail to follow). If you miss the initial opt-out, you have 90 calendar days to cancel contributions and withdraw your money. After 90 calendar days, you may cancel contributions, but your existing contributions must remain in the account.
The final decision to make when setting your contribution is pre-tax versus Roth. As mentioned above, pretax contributions are not subject to income tax in the year you contribute, so they lower your overall tax upfront. However, these funds are taxed when you take money out later in life. Roth savings are the opposite, where you pay tax upfront but then all the growth over your lifetime is tax-free. Knowing which is right for you depends on which tax bracket you are in now, and which you will be in when you stop working. If you are in or near your peak earning years, oftentimes you can expect your retirement income to be lower once you stop earning a paycheck, so pretax contributions make sense. Alternatively, it is common for those in the first half of their career to be earning lower than their expected earning potential, and so it makes sense to pay taxes now in a lower bracket and earn tax-free growth over a long-time horizon. If you are in the middle or unsure of your future earning potential, you can always split your contributions between both options.
HOW TO CHOOSE INVESTMENTS:
Once you’ve enrolled in your chosen retirement plan(s), you will start seeing your contributions coming out of your paycheck. Great work so far, but your job is not done! The final step is to choose how your contributions should be invested. Most plans will have a default investment, so your contributions likely won’t sit stagnant in cash. However, to get the most out of your supplemental plans, you should review your investment options to ensure your choice aligns with your situation. We have included links to the full investment lineup for the University of Illinois plans in the below Resource Library.
If you like a set-it-and-forget-it approach, you can choose a ‘Target Retirement Date’ fund where you choose your approximate year of retirement and let the fund do the work of adjusting the mix of stocks and bonds (for a slightly higher fee). If you want the ability to control your own stock and bond split, we recommend identifying the “Index Funds” available. These will be the lower cost options which aim to buy a representative sample of the specific market segment rather than an active strategy of trying to pick the winners and losers (generally, with much higher fees).
There are some unique investment-related items particular to UIUC participants that bear further discussion. Firstly, you have the choice between Fidelity and TIAA for your 403b plan. If you plan to choose a target date fund or specific investment funds, the costs are lower at Fidelity as of the time of writing. If you are more risk-averse and are interested in converting your 403b to an annuity-like stream of income, you could benefit from meeting with TIAA. Long-time contributors to a TIAA plan can earn loyalty benefits which increase the amount of guaranteed income you can secure upon retirement. Also, their TIAA Traditional investment is unique as it is essentially an insurance contract which pays attractive rates of interest. However, it comes with higher expenses than most straight investment options as well as potential restrictions on withdrawing out of the contract.
The 457 plan will have largely identical investment options. The State of IL 457 has the choice of a target date retirement fund or specific investment funds at a low cost. The SURS 457 has comparable, individual fund choices. However, in place of the target date funds is a proprietary product called the Lifetime Income Strategy fund. This product is very complex, in fact we recently wrote up an entire whitepaper dedicated to how it functions. But to summarize, they set your allocation of stocks and bonds just like a target date fund. As you get closer to retirement, larger chunks of your savings are moved into the Secure Income Portfolio, which is slowly buying into an annuity contract designed to provide you with a secure stream of income upon retirement. It should be noted that the expenses for your money placed into the Secure Income Portfolio are significantly higher than the investment funds you could choose. Therefore, there is a tradeoff of higher fees for purchasing what is essentially an additional monthly pension for yourself.
CONCLUSION:
In conclusion, making the most of the retirement benefits available through the State Universities Retirement System (SURS) can involve more than just relying on your pension. Supplemental 403b and 457 plans can offer more flexibility and provide peace of mind in your retirement planning. Choosing the right plan(s) can be daunting, but considering factors such as investment options and tax implications can help make the decision process easier. We encourage anyone with questions or wanting personalized guidance to reach out to us for help. Our team of financial advisors has experience working with State of Illinois university employees and can help you create a comprehensive retirement plan that suits your unique needs and goals
FOOTNOTE:
¹ IRS.gov – Government Retirement Plans Toolkit Government Retirement Plans Toolkit | Internal Revenue Service (irs.gov)
RESOURCE LIBRARY:
· UICCU Plan Comparison Chart -including contribution limits and withdrawal rules
· UICCU Supplemental Retirement Plan Resources – including how to enroll
· UICCU 403b Fund Menu – both Fidelity and TIAA investment choices
· State of IL 457 Brochure – including the investment options
· SURS 457 Brochure – including the investment options