Which Pension Plan is better: Plan Two or Plan Three
First things first, it’s extremely important to understand how Plan Two and Plan Three work, where you can do so here: Plan Two vs Plan Three. To begin comparing these plans, let's do a brief estimate for each plan using 100,000 dollars as our average salary and assuming you work 30 years. In plan two, you get 2% for every year you work. Therefore, 30 x 2= 60%. 60% of a $100,000 is a $60,000 pension guaranteed for the rest of your life. On the Plan Three side, remember it's only 1% for every year that you work, therefore, in this scenario you'd only get about 30% or $30,000 a year for the rest of your life. That's half as much as Plan Two.
However, Plan Three has something called a Defined Contribution side attachment. This is that common workplace retirement plan where you will be placing most of your money from monthly savings. That plan has the purpose of helping you pay for your retirement so that you can produce income for your future. Anytime you're taking money out of a retirement account, you want to make sure you're not taking out too much money. This is why we have a Safe Withdrawal Rate. This calculated rate will show you the amount of money you can take out safely without risking running out of money in the future. The present-day safe withdrawal rate is approximately 3% a year. In other words, if you had $100,000 saved up, you would receive $3,000 due to this rate. Additionally, you would need to save one million dollars for Plan Three to equal the same payout that Plan Two has in this scenario. If you had one million dollars, you could take 3% a year out or $30,000, and that would get you to that $60,000 total. Then, the plans would be equal. Now, a million dollars is a huge number and many people won't reach it. The average plan 3 balance for someone that has 30 years of service is between $250,000 and $500,000! Maybe a little bit more if you're working on the west side, but that's pretty much what I see running in these plans. Therefore, most people only have a third to half of that required number. From this example, Plan Two is the obvious winner.
Another option for going ahead with plan three is placing money into an annuity, which would guarantee a certain payout level. Annuities will guarantee you a 5, 6, or even a 7% payout level per year depending on your age, current interest rates, and your insurance company. The rate is double the amount of money received per year while requiring half as much saved. For example, if you found an annuity that paid out 6% a year guaranteed, all you would need is $500,000 to generate $30,000 of income. The plans would be equal then, but that's still half a million dollars that you'd have to save up over the years only to lock it up into the annuity just to break even with plan two. In conclusion, when comparing plan two to plan three as far as income levels in the future, plan two is going to be the easiest road to a higher guaranteed payout.
-Early Retirement and Pension
The nice thing with Plan three is that it does give you some liquidity by having that monthly savings build-up. If you wanted to retire early from working or decided to go work somewhere else (for example a 55-year-old leaving their previous job and working somewhere else), you could because of that saved money and not be forced to take a penalty. Additionally, if you don’t take your pension with that early retirement or job switch, it’s going to result in a pension collection amount increase. Pension amount increases by about 3% per year, just by waiting to collect your benefit.
If you wanted to retire early with Plan two, you wouldn’t have that flexibility. However, you can also save on the side. That's where things like your DCP and your 403 B savings come into play for building up that cash reserve. Therefore, if you ever need more money in your future, you’ll be prepared. The break-even is about 25 years. This means that if you worked until age 40 on plan two and then left, that benefit would stay set and wouldn't grow while you waited to age 65 to collect it. With plan three in this same scenario, it would increase by 3% for those 25 years that you waited (from age 40 to 65). So, unless you plan on leaving fairly early in your career, plan two will most likely give you the most guaranteed income in the future.
-Early Retirement and Medical
Another advantage that plan three has over plan two is that you're able to retire, not take your pension, and be able to enroll in the PEBB medical plan. Plan two doesn’t allow this, in fact, you’re required to take your pension before you're eligible to be on PEBB. So, if you are someone looking to possibly retire earlier, and don't want to take the pension, plan two may not be the best choice as it basically forces you to either work longer or take a penalty on that pension, just so you're eligible to get into the PEBB plan. With plan three, you have the option to stop working and aren’t required to take the pension if you don't want to. Therefore, you wouldn’t have to take any kind of early penalties and you can still get on the PEBB medical plan, which is a huge advantage for Plan three.
If your personal plan is to work up until your full retirement age or you plan on getting a second job, or even subbing just to help cover medical care costs, then you need to change your determining factor when it comes to choosing plan three or plan two. Remember, the ultimate goal for all of our retirement savings is to generate income for our future so when we stop receiving our paycheck, we know with certainty we have the income to last us the rest of our lives. Plan two assures you that by giving that 2% benefit on top of your social security. Another thing to know with plan two is, you do have to contribute money into it right now. It's about 8% per year and probably will go up in the future just like it has in the past. Many people see that as a negative point to plan two because they're being forced to put money into this pension plan and it's money that they're not able to put into the market to grow for their future. Personally, I'd be happy to pay 8, 10, 15, even 25% of my income into a plan if it gives me a guaranteed paycheck for the rest of my life and it guarantees a 2% payout for every year I put in. Remember, if we're just using that safe withdrawal rate of 3%, every million dollars is only worth $30,000 of income. If I worked that 30 years on plan three and got $60,000 per year, that's equivalent to having $2 million, really. So, it's a substantial benefit and I'd happily pay whatever they really wanted to charge me for that. The reason they created plan three was because it cost the state less and they were on the hook for less money.
Personally, if I were starting today as a teacher in Washington state, I would go with plan two. I'd pay the percentage they're going to charge me to be in that plan, and I'd save the rest of my money into a 403 B plan, Roth 403B, maybe Roth IRA (depending on what’s available in my school district) that way I can be saving for my future on top of my pension plan.
When you boil it down, having plan two with a separate retirement attached to it is really like plan three on steroids! This is because there’s a guaranteed 2% per year, instead of 1% and instead of being forced to save on a pre-tax basis into a state-controlled account, I'm able to save into a Roth account that grows tax-free. I maintain full control and flexibility of that account. For example, fast forward 30 years into the future, I would have 60% of my income guaranteed on plan two, plus all the money I've saved over the last 30 years.
All right. So I hope that settles the debate. If you have any questions or want to learn more check out our YouTube channel If you’re ready to make a change and want to get the best results, just schedule a meeting. And remember that your future depends on what you do today.