Stories abound about the fireman who retires at age 45 with a
six-figure pension, or the city manager who leaves after just five years'
service with full salary and health coverage for life.

What doesn't make headlines, however, is the growing number of
public sector employees who have seen their retirement benefits erode in the
face of budget cutbacks and mounting public deficits. States and cities across
the country are taking steps to reduce pension costs by whittling away
employees' retirement entitlements. Even San Francisco, bastion of liberal
handouts, recently saw voters approve a plan to scale back retirement benefits
for city employees.

Although traditional pensions still dominate at all levels of
state and local government, hybrid plans are emerging that combine a
401(k)-type component with a guaranteed benefit. In fact, 11 states --
including Alaska, Michigan, Colorado, Florida, and Ohio, plus Washington, D.C.
-- now have primary retirement plans that include some defined contribution
component.¹

The upshot for public
sector employees is that, increasingly, they are likely to need to augment
their pensions with salary contributions to employer-sponsored plans or save on
their own if they want to maintain their preretirement lifestyle. And since
many states have "double dipping" laws in place that prevent public
employees from collecting both Social Security and a state pension, the need to
set aside their own funds for retirement is even more important.

How to Compensate

Several tax-advantaged retirement savings options exist that
may be accessible to public sector employees. The most popular include:

• 403(b)
  plans are generally available to employees of qualified public organizations
  such as schools, hospitals, and certain nonprofit employers. Similar to 401(k)
  plans, 403(b) plans allow employees to contribute a portion of their salary on
  a pre-tax basis; and no tax is paid on contributions or earnings until it is
  withdrawn in retirement.²
• 457
  plans are available to state and local government employees and are somewhat
  similar to 403(b) plans. There is no penalty for early distributions from a 457
  plan (however, taxes are due), although you generally cannot take in-service
  distributions unless you have an unforeseen emergency.
• IRAs
  are available to both public and private sector employees. Like 403(b) and 457
  plans, IRAs also offer tax-deductible contributions and tax deferral. However,
  IRAs have lower annual contribution limits and eligibility for favorable tax
  treatment may be subject to certain income limits.2

To find more information on these or other tax-advantaged
retirement savings plans, see Publication 590 at http://www.irs.gov/.

Source/Disclaimer:

¹Source: Journal of Pension Economics and Finance,
"Behavioral Economics Perspectives on Public Sector Pension Plans,"
April 2011.

²Withdrawals from 403(b) plans and IRAs prior to
age 59½ may also be subject to a 10% early withdrawal penalty, in addition to
ordinary tax on withdrawn amounts.

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January 2012 — This column is provided through the Financial
Planning Association, the membership organization for the financial planning
community, and is brought to you by Ronald J VanSurksum, CFP®, a local member
of FPA.

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