“I need a four-oh-what??”
Many eyes glaze over when it comes time to decide how to save and invest for retirement. If you wish that somehow, magically, a stash of money would be waiting for you the minute you turn 65 — a reward for all the hard work you put in at the senior center or in the environmental advocacy group — well, it was a nice dream. For a not-too-painful dose of reality, Blue Avocado personal finance guru Steve Zimmerman discusses investment options in Part Two of our 3-part series on retirement planning:
The challenge of retirement is how to spend time without spending money. — Author Unknown
In Part 1 of this Nonprofit Retirement series we discussed calculating the savings you need and the usefulness of professional advisors. In this article we explore some of the most common ways for nonprofit people to save for retirement: through 401(k)s, a 403(b)s or individual retirement accounts (IRAs). (And in the next issue, we’ll look at what to do if you don’t have time to save.)
403(b) and a 401(k) accounts are retirement benefits administered by your organization as an employee benefit. Named after the legal codes that established them, the two are almost identical, although nonprofits frequently provide only 403(b)s: historically they were not allowed to provide 401(k)s, and a key advantage of 401(k)s is the ability to be used for profit-sharing in for-profit companies, not relevant for nonprofits. One of the main advantages of these accounts is that you can contribute money from your paycheck BEFORE taxes are calculated.
Why that’s useful: You have probably noticed the amount of payroll taxes that are taken out of your paycheck. If your paycheck is $500, and payroll taxes are, say, 10% ($50), and you deposit another $50 in a bank savings account, you would have $400 left from that paycheck. But, if instead of saving the $50 at a bank, you have $50 deducted from your paycheck and put into a 403(b) account, you would have $405 left from the paycheck. Remember, every dollar counts!
403(b) and 401(k) participants can then, by directing the company that has contracted with their nonprofit, invest their money in different types of mutual funds, stocks, or annuities–including socially responsible funds. Both the initial money earned and the investment earnings remain untaxed until the money is taken out in retirement. This is helpful because it is likely that your taxable rate will be lower once you are no longer working full-time. So instead of paying $5 taxes on that $50 you’ve put away, you’ll perhaps pay $2 in taxes when you withdraw the money from your account when you retire. (Plus, you’ll have earned money on the $50in the meantime.)
Nonprofit retirement matches
Some nonprofit organizations will match your contributions to your 403(b) or 401(k) up to a certain percentage. For example, let’s say “Jackie” works for an organization that offers a 403(b) and a match up to 3% of salary. If Jackie makes $40,000 and contributes 5% of her paycheck ($2,000) over a year to her retirement fund, her organization would add another $1,200 or 3% of her salary. In other organizations, the nonprofit contributes a percentage of salary whether or not the employee makes a contribution to his or own retirement.
If your organization provides a match, make sure you take advantage of it. Otherwise, you’re leaving behind free money!
403(b) plans are good ways for organizations to encourage employees to save for retirement and a nice benefit that can be offered without too much difficulty or expense, though setting it up can take some time. [And one study by a national nonprofit showed that among its chapters, the presence of a retirement plan correlated more closely with longer executive director tenure than salaries.] Talk with your banker, your health benefit provider or contact a brokerage like Charles Schwab or Fidelity directly to learn more about setting one up. After getting all the details, the board will need to review and approve the plan to. 401(k) plans take more work to set up and to administer, and while they offer more flexibility in investment choices to employees, they typically consume a great deal of time for the nonprofit staff that manage it (and very few nonprofits have administrative time to spare).
While we have spoken so far about retirement plans through your organization, the fact is that roughly half the American workforce — both for-profit and nonprofit — doesn’t have retirement savings plans through their jobs. There are still ways for you individually to take advantage of tax breaks in saving. The most common way is through an individual retirement account (IRA).
The IRA (Individual Retirement Account)
A traditional IRA allows you to contribute a tax-deductible amount every year. In other words, if you put $2,000 into an IRA, you don’t have to pay income taxes on that amount. In 2008 you can make tax-deductible contributionsof up to $5,000 if you are 49 or under, or up to $6,000 if you’re 50 or older. Similar to the 403(b), various investment options are available with an IRA and you won’t pay taxes on it until you withdraw it after retirement. You can set up your IRA through your bank or through a brokerage who handles investments by individuals, such as Charles Schwab, Fidelity or Vanguard. You can even do it online.
Another option with more flexibility is the Roth IRA. Unlike a traditional IRA where the money is untaxed when you put it in and locked up until retirement, Roth IRA contributions are taxed the year they are put in, but you have the right to withdraw the money at any time with only limited restrictions. So, if you want to buy a house or have a medical emergency you can access your cash without penalty. Of course, it will hurt your long-term retirement planning.
Once you have saved your money — whether through an IRA, Roth IRA, 401(k) or 403(b) — you’ll still need to invest it!
Where should you put your savings?
Where should you put your money? First, in terms of socially responsible investing, you can invest your 403(b), 401(k), IRA or Roth IRA funds in socially responsible funds. There is mixed evidence as to whether such funds perform financially better or worse for the individual investor. There are also different definitions of socially responsible investing. The bank, brokerage or other firm with which you work should be able to give you several options.
In terms of stocks, historically, over time, the U.S. stock market has returned between 11% and 12% a year. You don’t have to choose individual stocks, but can choose composite funds that average out a pool of selected stocks, or index funds that mirror the overall stock market.
But, as we’ve seen recently, there can be large swings in the stock market from year to year. In 2008, if all your money was in stocks, you would probably have LOST money. In fact, we asked one financial advisor, “How would you invest $150,000 if that were your life savings?” He answered, “Right now, in September of 2008, I’d keep it in cash. And given the risk of bank failures, I’d put $75,000 in one bank and $75,000 in another bank so that the amounts are below the maximum FDIC insurance.”
If you are getting closer to retirement and are focused on preserving that money, you may want to look at Certificates of Deposit (CDs), bonds or other more secure investments. Your returns may be lower, but you run a lower risk of losing your money!
Like with any portfolio, you may want a mix. So, when you are younger you might put 70% of your savings in the stock market and perhaps keep the rest in a Certificate of Deposit, but as you get older that ratio may flip.
Regardless of the way you go, two rules to remember:
1) Start early and contribute something! Even if you don’t have a lot of “extra” money, start by putting a small amount such as $25 from every paycheck into your program. Think about your savings and the tradeoffs. For example, in a previous column we talked about the tradeoffs between student loans and retirement. Gradually increase your savings over time. Putting a little money in early is better than putting a lot of money in later. Even if you leave yourorganization, you can take the money in your retirement savings with you by converting it into an IRA or by transferring it to another organization’s 403(b).
2) Keep saving over time: Retirement savings can grow only if the money is in your account. So, think twice or even three times before you take it out.
How much Social Security will I get?
Don’t forget that your investment will be paired withyour Social Security income. If you have worked and paid into Social Security for 10 years, you are typically eligible for benefits. Some younger workers fear that Social Security will be insolvent by the time they are eligible for it. Politics abound in the long-term future of Social Security payments. Nonetheless, it makes sense to assume that you will receive at least some income through your Social Security benefits.
The amount you will receive in Social Security depends upon your lifetime earnings from which Social Security (FICA) has been deducted for you and matched by your employer. Just this past July, the Social Security Administration unveiled a new online tool to estimate the amount you’ll receive. It can be found at http://ssa.gov/estimator/.
A quick follow-up to Part 1 of this Nonprofit Retirement series: after we published the September 1 issue, it was reported in the press that some brokers, including Charles Schwab, Fidelity Investments, Vanguard and Citigroup, are beginning to provide less-expensive advice for people with fewer assets. Smith Barney is even offering a new program called “My Financial Life” aimed at everyday workers and families without large nest eggs.
What happens if you don’t have time to save until retirement? In Part 3 of this series (publication date October 1, 2008) we’ll take a look at some options available to you then.
Click here forÂ Nonprofit Retirement Part 1 by Steve Zimmerman
Steve Zimmerman, C.P.A., M.B.A., is a former nonprofit finance director and development director, and currently is the Principal at Spectrum Nonprofit Services in Milwaukee, consulting to nonprofits in finance and strategy. Click here to email Steve.