Today’s question comes from Mike in Albany…
“I’m in my early 40’s and I just started a job with New York State that’s giving me two different retirement options to pick from.
The first is a traditional pension that requires 20 years of service, and I can get the full benefit at age 63. Which would be 35 percent of the top 3 year average salary while I’m there. I do have to contribute 6% of my weekly salary in perpetuity for this.
The other option has a little more flexibility, and it’s brand new. It’s called an enhanced 401a. That also requires a weekly 6% paycheck deduction. However at the end of every year NY State gives me an additional 8% match for self-guided investment through the 401a. Now that doesn’t require a 20 year vesting period – it vests fully after only 1 year. So if I leave I can take that with me somewhere else.
Currently my retirement savings are about $500,000 in an old IRA that I rolled over from some 401ks, and I also contribute 7% to a Roth 457b at no match.
So my question is, which retirement option do you think is smarter given my age, and the fact that I have so much money already in the market? Should I stick with the safety of the traditional pension? Or should I roll the dice with the enhanced 401a and that 8% match”
Matt & Joel’s response: First off – you’ve done an excellent job saving for retirement so far. And you’re continuing to contribute with every paycheck, which is great!
401a Plan (No, not 401k)
Let’s talk about the 401a first. Some readers might have thought we made a spelling error, lol. A 401a is very similar to a 401k, but it’s for government workers. They are a little less flexible than 401ks, because participation and contribution amounts are usually mandatory, instead of voluntary. In your case Mike, it sounds like you want to contribute 6% anyway, so no big deal.
And getting essentially an 8% match for investing 6% is pretty darn good! That’s more than dollar-for-dollar matching – an excellent deal for retirement savings.
No vesting period is a killer perk too. Having the flexibility to keep both the money you put in and what your employer matches if you don’t stay a full 20 years is clutch.
The one thing I’d want to look into is how the money will be invested inside the 401a, because they typically have far fewer options than a private sector 401k. These options are usually more conservative, which means your investments grow at a slower rate. I really hope you can invest in a low-cost S&P 500 fund, that’s our favorite!
We really like this 401a option. But, while that 8% match is sweet, if the investments are too conservative, that could impact your decision.
Pension Plan (aka Golden Handcuffs)
You mentioned that you are in your early 40s. And the pension option is all about you working there for 20 years.
If you don’t plan on working until you’re 63, I’d take this pension option right off the table. The same is true if you don’t plan on working for this government organization for all those years either and want to retire earlier.
Pensions are awesome, but they truly are golden handcuffs. They require you to stick with that narrow career through thick and thin for decades. It’s awesome for some people who are going to do it anyway. But it’s not great for others. You don’t want to feel “stuck” in your job, just counting down the years until your pension kicks in.
That being said, there’s a reason the handcuffs are made of GOLD. The pension payout can be incredible if you work the required number of years!
Dropping 6% of your pay and getting 35% of your top 3 salary years in perpetuity for decades to come sounds like a pretty good tradeoff to me!
But what you gain in potential retirement security, you give up in flexibility and work options. Moving to be closer to family, changing careers, or even taking a few years off work isn’t an option for you in this scenario. Life circumstances can change at the drop of a hat, and if so, you might find that your retirement savings plan that seemed incredible is now non-existent.
The Bottom Line:
If you like this potential job and truly see yourself there over the long term, even though you can’t be 100% sure that you’ll be there for 20 years, the upside of the pension is pretty sweet. But in our eyes, the 401a option is more favorable. It will offer you more flexibility while still being a killer deal for matching.
By the way, you’ve done an excellent job saving for retirement so far. That nest egg will continue to grow over the next couple of decades. Combining those existing investment dollars with either the pension or the new 401a will lead to a really comfortable retirement! Either way, you’re headed in the right direction.
For the full version of this discussion, check out Podcast Episode #871 (it’s question #2 in the episode)
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