Which way to go - retirement savings

mamaz27 · November 2013

I have previously posted about our future retirement savings and the difficulty we are having with having to pay into a pension, which we may never actually receive and then having no growth on the money we have put in. With that being said, there is a program through our retirement plan that allows me to contribute up to 10% of my base salary with a guaranteed 7.5% rate every year. This would then be an extra pension check that I would receive. Obviously the program could be stopped at any point and/or the rate could change but it has held steady at 7.5% even through the recession. My question is, should I try to fully fund that at 10% or as much as I am able or fully fund my Roth IRA each year. Obviously starting this program while in my early 30's would bring on the biggest return. Thoughts?

Xstatic3333 · November 2013

Tough one! I am personally pretty distrustful of pension-type programs, so I would probably fund my Roth first. That said, returns on my Roth have not consistently been 7.5%-I'm currently at around 7 since I opened it.

I think a big consideration is your level of job security. I know H only gets his pension if he's at his job 10 years, and there is a chance his project may not last that long. If he leaves, he gets back only what he has put in, which is currently earning less interest than inflation. If you had to leave your job, would you get back what you had put in, plus the accrued interest?

hoffse · November 2013

Well I think most people would say yes you should do it. I'm going to take the contrary position and say that I wouldn't do it if I had that option. Here's why:

1) You mention you are in your early thirties. So your employer reasonably has 30-ish years to change its mind about how the pension plan works before you retire. I think it's really important to be able to afford your lifestyle in retirement based entirely on external savings you manage on your own. Money that you contribute to a 401(k) and Roth accounts is yours. Employer contributions to 401(k)s are typically yours after a certain vesting period. The point is, having that money in an account with your name on it, means that nobody can take it away from you.

I think pensions are a lot like social security - we pay into it because we have to, but who knows what we will see on that back end of things. So if you get something from your pension, great - that's a bonus and maybe your lifestyle actually increases in retirement. But I absolutely wouldn't arrange my financial life to depend on receiving it.

2) A 7.5% return is decent but not spectacular. Even if it grew during the recession, the fact of the matter is the stock market crashed and then roared back. It's vastly exceeded itself from its pre-2008 levels, and a slow and steady 7.5% return from 2008-2013 would put you behind the market right now.

If you were 55 and were asking this question, I might encourage you to do it because 7.5% is pretty damn good for safe investments. But when you are younger you should be riskier, if you can stand it.

My "average" mutual funds have had more than a 20% return the last two years. I have one fund that has had more than a 50% return the last two years. If the market crashes again (and it probably will between now and my retirement age), that sucks, but I'm also young enough to ride it out. You are too.

3) Taxes - my favorite topic. Without knowing more details I can't be certain, but I would bet that your pension is taxed as ordinary income when you receive it. Many retirees are in the 25-28% marginal tax bracket. But Roth contributions aren't taxed at all when you pull out money - and the earnings aren't taxed either. So my mutual fund that is giving me a 50% return right now happens to be growing tax free. As always, my disclaimer about this is that the tax law on this could change - but the lawmakers would have to be willing to endure some very negative public opinions if it did because Roths have become very mainstream.

Even capital gains taxes have been at a 15% rate for years now, so it's less than ordinary income. And while capital gains rates have historically fluctuated, it seems that lawmakers today can't bring themselves to raise it because they're afraid of what will happen if they do. Too many people use capital gains to build wealth. It also encourages people to invest in small businesses and start-ups. Nobody really wants to lose that.

That means I would put your spare money into Roths until you max out your Roths. And then I would put any extra spare money into regular investment accounts to lower your taxable rate upon withdrawal. Keep in mind, too, that once you receive a pension it just happens at regular intervals, so you will always be taxed on that money as you get it. But investment accounts are only taxed when you liquidate them. You aren't obligated to ever liquidate them, so if you don't find that you need them in retirement, you can pass them down to your children and then the taxes become their problem.

4) As always, a caveat - if this pension option would allow you to remove yourself from the non-growth pension that you are being required to pay into, then the answer is obviously yes. Some growth is better than no growth. But if this pension option would be on top of what you already pay into, then I would look elsewhere.

hoffse · November 2013

@Xstatic - out of curiosity, when did you open your accounts and buy the funds you own now? I'm wondering because you really need to hold onto funds for at least a year to know what kind of return you are getting. For instance, I bought a new fund a couple weeks ago and I'm reporting a 1.3% return at the moment.

Xstatic3333 · November 2013

@Hoffse, with advice and some help from my parents, I opened my Roth with Fidelity in 2006. I talked to an advisor there, and ended up keeping some money in cash and some in the Fidelity Balanced Fund. I added a few thousand a year for the next few years until I went to grad school, but didn't think about it or analyze it at all.

Since getting into personal finance and beginning to add to the account again, I realized I needed to diversify. As of last week, about half of my money is still in the balanced fund, but I decreased the amount in cash and sold some of my original shares to buy two different funds. So now it's about 15K (way behind, I realize) between three funds, all stock, one international. Hopefully returns over time will improve!

hoffse · November 2013

Xstatic, I'm sure it will improve - for me the very worst thing about buying new funds is when you buy them and they go down for a few days or even weeks before you start to see real growth. I am admittedly an impatient person, so that part is hard for me. However, looking at it a year later (in good years) is usually very satisfying!

Xstatic3333 · November 2013

Haha I hear you on being impatient! The international fund, in particular, lost around $30 the first day, which doesn't really matter long-term but was a bit of a bummer. I'm sure in a couple of weeks I'll stop checking it so much. They're both 5-star rated so I feel good about them as long-term decisions.

Which way to go - retirement savings

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