Please help — I don’t understand my pension… can somebody ELI5??

Submitted by emmyloo22 t3_zzoa07 in personalfinance

Please feel free to call me stupid as long you do it with small words lol!

I’ve been working in the public sector for almost 3 years now, and honestly, I still don’t understand my pension plan and how it works. (For context, during the first 2 years, my gross salary was $40k. This past year, I got promoted and doubled it to $80k.)

I am enrolled in both a mandatory Defined Contribution plan and mandatory Defined Benefit plan. They call it a hybrid pension. I do not get to choose what percent of my income goes into either the DC or DB.

My DC plan takes 3.75% of each paycheck and puts it into an account managed by Prudential (now Empower). My employer also contributes 3.75%. My account says I have around $11k, with $8k vested.

My DB plan takes 8% of each paycheck, and my employer contributes 29%. I don’t know where this money goes — I assume this is the traditional part of the “pension” where it doesn’t matter how much I contribute, I’ll still receive fixed payments after retirement based on my years of service/avg salary.

So, does that mean the DC plan is like a 401k and is separate from the fixed pension payments? I’m confused on this.

Additionally, I feel like this isn’t enough retirement savings in general. I’d really appreciate any feedback on what to do next. (i.e Can I open my own retirement account separate from my employer? And if so, should I?)

Thanks so much!

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dcdave3605 t1_j2dhn0a wrote

The pension plan is like buying membership each year with that 8%. Until you have the minimum years needed, the money is just held in an interest bearing account. If you leave before you meet the minimum years you can request it back. When you reach the minimum or when you max it and retire from the government you will receive a monthly payment based on a calculation. This calculation varies based on your pension plan.

The 401a plan is where the money you must contribute and the money they give you sits and can be invested. If you leave before you reach vesting, the amount your employer has contributed can be reduced and taken back, the amount you pay in will always be yours.

Usually with government jobs you will also be offered a 457b or 401k type plan. If it's a 457b plan, you can contribute up to $22500 each year pre tax(traditional) or post tax (Roth). Ask your HR about this.

Of course you always have access to a Roth IRA up to 6k per year separately of your employer options. You would not be eligible for traditional IRA tax deductions since you are offered an employer plan.

So you could do the minimum of 401a contribution, pension plan, employer contribution, 457b or 401k, and Roth IRA. Whether all or less is what you need in retirement is up to you.

Your plan options should be spelled out in your handbook as far as if you have the 457b and/or 401k option.

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emmyloo22 OP t1_j2eul57 wrote

Thanks! Yes, we have a 457 plan that I could opt into, but I didn’t see the point because.. that money doesn’t grow, does it? Isn’t it almost like having a “savings account” with 0 interest, with taxes to be taken out whenever you withdraw?

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emmyloo22 OP t1_j2eyckp wrote

Okay, I looked at the 457b plan and I told you guys I was dumb lol So, you do invest it.

But you have to pick your own investments and that makes me really nervous. How do I know the percent to contribute to each fund? Or pick which funds to do at all? Ahhh!

Also getting mixed answers when reading about whether to focus on the 457 versus a Roth IRA. I’m thinking the 457 would be more beneficial to me since it doesn’t have withdrawal restrictions starting at age 59.5 like most retirement accounts. Sounds like if/when I separate from my current employer, I could take that money in a lump sum, pay taxes, and decide what to do from there.

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dcdave3605 t1_j2f4x7h wrote

You invest it in what you think will get returns, but based on evidence. Look at the data given to you about your options.

Or look for something called a target date fund and pick that. It will focus investments for you based on your target date for retirement (earlier dates being less risky investments farther away dates being more risky). All investments have risks. The 457b plan is special because it allows you to withdrawal without penalty after you leave employment, rather than after age 59 1/2, like 401ks and other retirement plans. So essentially it could be your early retirement fund.

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Cheaper2000 t1_j2ctdnx wrote

Looks like you’re understanding is correct.

The DC most likely is a 401k (or 403b or 457 but they’re all more or less the same). You most likely can adjust the DC contribution even if it’s not immediately obvious, at the very least you should be able to adjust upwards (until you hit that accounts maximum contribution).

The DB is the more confusing part but there’s zero work to do on your end if you work with the state until retirement. That is what you’re contributing to a pension fund that all public employees in your state are paying into and will receive benefits from when you retire.

The 8% you are paying is really only relevant if you stop working for the state before retirement, as that’s the amount that they’d refund you (plus interest earned) if you withdrew your funds.

On your state’s retirement website there should be a formula that breaks down your pension calculation. It will likely involve your years of service and your highest average salary and some pre determined factor to give you a monthly payment that you’ll receive from retirement until you die. Usually you have to work for ~30 years to get this immediately when you retire. Typically that payment will amount to slightly less than your average pay (at 80k mine would be 72k).

So, when you retire, you’d have two streams of income, the pension (determined by your states formula), and your DC account (determined by your investments and their performance). Combined these should amount to comfortable living as is, but it’s never a bad idea to save more (either through an IRA or by increasing your contributions to the DC if it’s possible like I’m assuming it is).

The DC part can and will pretty easily be able to rollover to your next company plan should you stop working for the state before retirement. The DB part can get messy and I’m not person to give insight there.

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emmyloo22 OP t1_j2cul3e wrote

Thank you! Good to know I wasn’t too far off with my understanding… We have a handbook for with all the formulas for calculating pension benefits, and it makes me really nervous and unsure about the future... I like working here but who knows what will happen in 40 years! It’s a relief to know that in a worst-case-scenario, I should back my 8%.

Also, I just confirmed my DC plan is a 401(a), if that makes any difference. We had open enrollment this past month for benefits, and there wasn’t an option to adjust the contribution. I’ll have to look into it more because I’d definitely like to contribute additional money if possible.

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Cheaper2000 t1_j2cv0qj wrote

Employers do set the limits for 401a plans so looks like I was wrong and you won’t be able to adjust the contribution. Start with an IRA (through any financial company) and contribute as much there as you can (up to 6500/yr).

I’m not actually sure if you’d be able to contribute to retirement beyond the IRA through tax advantaged accounts, that’s a question for HR or somebody with more financial literacy than myself.

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emmyloo22 OP t1_j2cvt04 wrote

Okay, yeah, that stinks a little! Was hoping to put it in the 401(a) and just let it do its thing lol. Would you recommend a Roth or Traditional IRA? I don’t feel like my salary will get much higher than it is now tbh. I really lucked out with this last promotion — I think I’ve already hit a lofty ceiling for my line of work.

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Cheaper2000 t1_j2cw5sc wrote

Roth if you’re under 30. Give it a few years to make the call on whether or not you’ll make more in retirement and then switch to traditional if appropriate. Plus it allows you to contribute “more” since you paid the taxes already (6500 post tax>6500 pre tax).

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emmyloo22 OP t1_j2cwapr wrote

Points taken! You’re killing it with the advice, man. :) Thanks a billion.

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maedocc t1_j2cukzp wrote

>(i.e Can I open my own retirement account separate from my employer? And if so, should I?)

Yes you can.

You can't open a 401k or anything, but you can open an IRA on your own and invest inside that tax-advantaged retirement account. You can contribute up to $6,000 for 2022, and that's increased to $6,500 in 2023.

A helpful post:

https://www.reddit.com/r/personalfinance/comments/a1fsa3/i_want_to_open_a_roth_ira_but_i_dont_know_where/

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emmyloo22 OP t1_j2cv3vt wrote

Thanks! This is really helpful. Based on my other retirement accounts, would you recommend I try to max out the IRA each year? (Or is that unnecessary?) I usually save around $2000 a month after all my expenses, which I’ve been putting in a HYSA because I don’t know what else to do with it.

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maedocc t1_j2cvbtq wrote

Yes!

Maxing out your Roth IRA when you have $2k going into your HYSA is a no-brainer.

Oh, and you have until April 18, 2023 to max out your Roth IRA for the year 2022. So no huge rush to get it done before the end of the year.

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emmyloo22 OP t1_j2cvz4e wrote

Awesome! Thanks again, this has been super informative. I’ve read a little about IRAs but didn’t know if it was an option for me. Excited to delve further in and get one started!

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petrock85 t1_j2e0alq wrote

Sounds like you mostly understand it, but here a couple more things to know:

Pensions usually require you to work at the employer a minimum number of years to get the monthly benefit. It varies by plan but can be rather long for a government pension. If you leave before then, you should be able to get back the amount that is considered your contribution, but not any of the employer contribution.

You definitely can open your own IRA in addition to the mandatory workplace plan. The workplace might also have another retirement savings plan that you could use in addition to the mandatory one.

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