Teachers: Here’s How to Ace Retirement Without Social Security

Investing, Retirement Income
No Social Security, Teacher? Study These Retirement Savings Options

When it comes to saving for retirement, many teachers can’t use the standard lesson plan.

What’s different for them? Social Security coverage, or the lack thereof. About 40% of public school teachers aren’t covered by the Social Security system, according to the National Association of State Retirement Administrators.

That goes back to the initial draft of the Social Security Act in 1935, which left state employees out in the cold. Most states have since opted into Social Security for their public-sector employees, but 15 states haven’t. In those states, teachers and other state and local government workers are exempt from paying Social Security taxes and instead typically rely on a state-run pension plan.

Why teachers aren’t covered by Social Security

The short answer: In part, it’s because they don’t pay into the Social Security system. But in some cases, even if they’ve paid in at some point in their career, Social Security benefits — including retirement, disability and survivors benefits — could be reduced if they also have a state pension.

The retirement and disability benefit reduction is due to a rule called the Windfall Elimination Provision, which is designed to block state and local public employees from collecting a pension alongside Social Security benefits. It does that by reducing Social Security retirement benefits. A separate rule, called the Government Pension Offset, can also cut into Social Security survivors benefits.

The Windfall Elimination Provision

You might wonder how Social Security can be reduced if you weren’t covered by the program in the first place. The answer is that it can’t. The Windfall Elimination Provision doesn’t directly affect you if you’ve never paid into the Social Security system; you simply won’t receive benefits.

But if you have contributed to the system — most likely because you paid Social Security taxes in a different job — and you now work for a state or local government in a role that doesn’t participate in Social Security, the Windfall Elimination Provision could reduce any Social Security retirement or disability benefit for which you’re eligible based on that past work.

Your Social Security statements likely won’t reflect that reduction, which is based on a special calculation. The maximum monthly reduction in 2017 is $442.50, limited to one-half of your monthly pension benefit. You will be subject to a smaller cut if you have 21 or more years of “substantial earnings” from a job in which you paid Social Security taxes. If you have 30 or more years of substantial earnings, your benefits won’t be reduced by the Windfall Elimination Provision.

How teachers can save for retirement

Teacher retirement options vary by state, but you’re generally offered either a pension or a defined contribution plan like a 403(b) or 457(b), or both.

Pensions have plenty of perks, most notably a guaranteed benefit in retirement that lasts as long as you live. But they’re also not without downsides. Many are underfunded or in debt, and they typically don’t travel well, requiring you to participate in the plan for a certain number of years before you’re vested (“vested” means promised the full pension benefit you’ve accumulated).

If you leave teaching or move to a different state before you meet the vesting requirement, you may forfeit any employer contributions. Contributions you’ve made — and often at least a portion of interest earned — are yours to keep. Generally, the longer you work, the larger your pension benefit.

All of this means it’s wise to supplement your pension. You can do that in a couple of ways:

1. A defined contribution plan

You may be eligible for a 403(b) or 457(b) plan alongside your pension. Both are similar to the private-sector 401(k) plan, in that they allow you to put aside money for retirement pretax. The annual contribution limit for 2017 is $18,000, with additional catch-up contributions in some cases. If you have both a 403(b) and a 457(b), those limits are separate. You may also earn employer matching contributions.

The money you contribute generally grows tax-deferred and will be taxed as income when you take distributions in retirement. Both plans may also offer a Roth individual retirement account option, which allows you to put away after-tax dollars and take retirement distributions tax-free.

One word of warning: 403(b) plans can be rife with fee pitfalls for participants, sometimes even more so than other employer-sponsored retirement plans. An analysis by human resources consultant Aon Hewitt found that those costs could add up to a cumulative leak of $10 billion annually. No matter where you invest, be sure to understand your fee costs by asking to see investment prospectuses or annuity contracts.

2. A Roth or traditional IRA

These are accounts you would open and fund on your own at an online broker. You can contribute up to $5,500 in 2017, with an extra $1,000 if you’re 50 or older.

With a traditional IRA, you make tax-deductible contributions, then pay taxes on distributions in retirement. With a Roth IRA, your contributions don’t get you an upfront tax break, but distributions in retirement are tax-free. Depending on your income, you may be able to combine IRA contributions with a 403(b) or 457(b), increasing how much you put away for retirement each year. Review the IRA contribution limits to find out, then learn how and where to open an IRA.

» IRA vs. 403(b) vs. 457(b): Get all the details in our retirement plan comparison

Arielle O’Shea is a staff writer at NerdWallet, a personal finance website. Email: aoshea@nerdwallet.com. Twitter: @arioshea.