Are you taking care of one of your most important financial assets?
If you have worked in higher education for most of your career your retirement plan is likely to be one of your largest financial assets. For example, nine of the ten largest institutions of higher education in Massachusetts have retirement plans that provide the possibility of an employer contribution of 10% of income or more to their employees. Over time, these accounts can really accumulate a substantial savings.
With so much money invested it is vital to understand how best to utilize and manage these accounts. In some cases, there can be substantial penalties for not knowing the rules that apply to your accounts.
Here are five common retirement account mistakes to avoid for employees of higher education:
- Not taking advantage of retirement savings opportunities
- Having an inappropriate investment allocation for your goals and comfort level
- Understanding the opportunities to access your account during your working years
- Using your retirement account to avoid minimum distribution on IRAs
- Not taking required minimum distribution from past employer’s retirement accounts
1. Not taking advantage of retirement savings opportunities
With college and university employer contribution rates so high it may feel that the employee contribution is not as important. However, there are many reasons this belief is not true. First, the employer contribution alone will not grow retirement assets enough to replace your income even when combined with social security. Second, you may need to catch up for past years when your income was much lower and the gross retirement contributions was much smaller. Third, your work or life circumstances may change due to reasons out of your control or because you move to another institution and maximizing contributions while you are able to is your best strategy.
Finally, if your income is exceeding your spending, you have many strategies you can employ to take advantage of these opportunities. These range from catch-up provisions, additional retirement accounts as well as utilizing combinations of pre- and post-tax savings.
2. Having an inappropriate investment allocation for your goals and comfort level
The amount contributed to retirement plans can be substantial with the savings rates found in many retirement plans of higher education. Receiving large contributions is fortunate but it can be overwhelming to make appropriate investment decisions especially with so many investment options (and tiers) offered in each plan. For account holders to make investment decisions with a lack of knowledge, time, desire or experience can be a challenge.
Employers try to solve this dilemma by offering a QDIA (Qualified Default Investment Alternative) which provide a default investment. It is important to understand what is offered and whether that option is appropriate for you. For example, target date funds are often used as the QDIA in retirement plans. Employees are defaulted into the retirement plan based on their date of birth. The largest provider of target date funds is Vanguard and they state that you may consider each fund depending on when you plan to retire not your age.
In this example, the employer is using one criteria and the investment company is using another criterion but the most important factor for each investor is to consider their own specific situation. For those employees early in their career these options will likely do a good job, but for employees closer to retirement it is imperative to find a strategy unique to your situation.
3. Understanding the opportunities to access your account during your working years
"I may retire next year." This was a common refrain I have heard over the years working with employees of academia. Due to the unique nature of jobs in higher education especially those in the fields of teaching and research, many employees will work beyond the "normal retirement age" of 65ish (depending on your birthdate). It can be a common occurrence on campus to see professors working longer than the general public.
Having access to some of one's retirement funds especially for those who intend to work longer can be beneficial or even factor into specific strategies. In looking at different university retirement plans you will find withdrawal options that include:
- Access to the employees own contributions after age 59 1/2
- Access to any retirement funds following the attainment of a specific age such as 65
- Access to the amount equal to required minimum distributions
- No access until retirement
I am not suggesting robbing retirement but being thoughtful and strategic about the retirement asset is important. In fact, there were times when an employee's tax bracket might have been lower prior to retiring in which case withdrawals during work might have been advantageous from a tax perspective.
4. Using your retirement account to avoid minimum distribution on IRAs and prior employer retirement plans
The flip side to taking withdrawals is avoiding required distributions from retirement accounts not related to one's current employer. For those who continue to work beyond the mandatory age (now 72), they can delay taking minimum distributions from those retirement accounts and may be able to defer taxable income until retirement by rolling retirement accounts into their current employer's retirement plan.
There are many factors to consider such as the following:
- The liquidity of the assets rolled into the employer's retirement plan. If you might need access to any of the funds then you probably should avoid this.
- The tax consequences and benefits of any transfers. You should work with your tax advisor and financial planner to determine if this is an appropriate strategy.
- The quality of the employer plan you are transferring to especially costs, investment selection and advice with portfolio allocation.
5. Not taking required minimum distribution from past employer’s retirement accounts
A mistake that is less common but can be substantially more costly can occur in the following circumstance: you have worked at many employers and have multiple retirement plans invested with the same investment company but not in the same account. In this case, you will need to withdraw the required minimum distribution from the past employer's retirement plans regardless of whether the investment company is the same. If you miss making the required withdrawal the penalty can be 50% of the amount you were required to withdraw.
The retirement benefits for employees of higher education are often very generous and can be one of the largest and most important financial assets in any individual's financial plan. For those who work in academia their unique nuances to address to ensure the greatest success in meeting all of one's financial goals.