Pension vs 401(k) Case Study: University of Iowa IPERS vs 403(b)
Healthcare employees of the University of Iowa in Iowa City have their choice between the Iowa Public Employee Retirement System (IPERS) and a 403(b) plan. 403(b) plans are similar to 401(k) plans, typically used with non-profit organizations instead of for-profit businesses. This article won’t be covering those differences.
While both IPERS and a 403(b) are retirement plans, they are unique in how they assist you in retirement. 403(b) plans are generally referred to as defined contribution plans, because the employer clearly defines how much you can contribute and how much they will match your contribution. How it is invested and how much is available to you in retirement will be determined by your choices and the return generated on your investments. IPERS on the other hand is a defined benefit plan, which means there is a formula that determines exactly how much will be available to you in retirement.
At a very high level, the biggest difference is who takes on the risk. With a 403(b) plan, you, the employee, assume all the risk. On the contrary with a defined benefit plan the provider of the plan assumes the risk, in our case that is the state of Iowa. This leads to the question: why anyone would choose to take on that risk themselves? Let’s dig a little deeper and find out.
With both IPERS and your 403(b) you are always 100% vested in your contributions. That means if you change employers, you are entitled to take your contributions with you no matter what!
For employer contributions, IPERS has a vesting schedule that requires you to accrue seven years of service or are at least age 65 and working in IPERS covered employment. This means that if you work at the University of Iowa for six years and then change careers to an employer that doesn’t offer IPERS, you may never see the benefit from the University’s contributions into your IPERS. Pension plans are often provided by your employer so the service required to be vested must be with that employer. With IPERS, the plan is provided by the state, so you could work for the University for some of the years and another IPERS covered employer for the remaining years required to be vested.
With the 403(b)s, its also common for the employer to have a vesting schedule. Often it happens over time and not all at once as with IPERS. However, the University has made the choice to immediately vest all their contributions. This means that every dollar in your 403(b) is yours and stays with you even if you leave the University after a single contribution. Based on these distinctions, if you think you might not work at an IPERS covered employer for at least seven years, you should choose the 403(b) option.
IPERS funding starts with the employee contributing 6.29% of their salary and the employer contributing 9.44%. For easy round numbers lets assume a salary of $100,000. That means $6,290 is coming from your paycheck annually. The employer contribution to IPERS isn’t relevant to the employee because your benefit is defined, as stated above.
Conversely, the University of Iowa starts your 403(b) contribution at 3.33% with a match of 6.66% and after five years they increase you to 5% and 10%. At 5% and 10%, your account would accumulate $15,000 per year plus (minus) any investment gain (loss) and only $5,000 came directly from your paychecks. This means extra money in your pocket every paycheck with the 403(b).
Career Time Decisions
Once you have picked IPERS, your decision making is done until you start thinking about when to retire.
If you pick the 403(b) your decision making has only just begun. Next you must select if your contributions will be taxed today via Roth contributions or taxed in retirement via Traditional contributions. Note: employer matches are always traditional and taxed in retirement. You must then choose how to invest. If you are not familiar with investing, I highly recommend seeking an independent fiduciary advisor to assist you. Paying a fee for assistance is a small price to pay compared to making mistakes with your retirement nest egg.
IPERS has different rules about when you can retire and how to receive your benefits that we will not cover today. Pension plans are designed to be guaranteed income payments for your lifetime. It’s on the state of Iowa to make sure the money is there to fund these guaranteed payments. Always consider who is funding the pension plan to ensure the pension will be there when you need it. IPERS is well funded compared to many other pension plans, but unfortunately one of the ways Iowa choose to ensure benefits was to take away the cost of living adjustment. That means your payments stay the same throughout retirement, but over time it will feel like less because everything else is getting more expensive.
A 403(b) plan looks and feels different because when you reach retirement you have a large account balance where you begin making withdrawals. The challenge is with making sure you don’t withdraw too much too fast because you may run out of money. This can be a challenge for some, especially if that have not saved enough to begin with. If you are terrible with spending habits, you may choose the guaranteed option of the pension plan.
- IPERS offers some disability benefits.
- You can borrow from 403(b)s. (I advise against this in most scenarios)
- Survivor benefits of IPERS are generally limited in amount or limited to your spouse.
- The value of your 403(b)s can be passed on to anyone, which is important for those looking to build a legacy. (Inherited accounts are typically forced to distribute at a faster rate and incur tax at a faster rate.)
Which one should you choose?
If you do not mind taking on risk, understand investing or are willing to pay for an advisor, then you’d very likely be better off choosing the University of Iowa's 403(b) plan. If you have no concerns for building a legacy, don’t want to worry about running out of money, and dislike taking risk then you’re likely better off choosing IPERS.
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