This post comes to us from Kim Riccardi at Colorado PERA, the Public Employee's Retirement Association of Colorado.
A Narrow Bridge reader recently asked this seemingly simple question: If you leave employment, what should you do with your Colorado PERA account (a retirement account for public employees in Colorado)? We know public pensions can be a bit nebulous, so we thought it was a good opportunity to dive deep on this topic.
The original question came from someone who has worked for a Colorado PERA employer for 4 years and 10 months and is now moving to New York for graduate school. First off, I agree with Eric that the reader should try to stick it out for two more months, if possible, to get to 5 years of work total. It will make for a better benefit in the future, should the reader decide to go that route. In addition, it will make the reader eligible to receive matching contributions if the reader withdraws his or her account in the future.
What to do with the account once the reader leaves employment is where I have a slightly different take on things. Eric recommended taking the balance and rolling it over to an IRA, which is certainly an option and it preserves the tax deferred status of the funds. As he noted, if you take a distribution before age 59½, the IRS will hit you with a 10 percent penalty in addition to normal taxes – that is a waste of money unless you really, really need the funds for something important. If you want to roll over your account, consider rolling it to the PERAPlus 401(k) account, which is a plan with very low fees compared to other comparable plans.
To the reader, I recommend that you consider leaving your account at Colorado PERA. The account will continue to earn interest (3 percent right now). Sure, you might make more money if you roll the money into an IRA and invest it wisely. However, if you take your account out now you are foregoing your ability to apply for a retirement benefit in the future. As I noted above, PERA’s hybrid DB plan offers a lifetime monthly benefit to all members at age 65, regardless of how much service credit you have. You would also then have access to group health care.
More importantly, if you do decide to return to employment at a Colorado PERA employer, you will just pick up where you left off and continue accruing a benefit. You are going to graduate school and are unsure of a future career path, so it may make sense to leave your account for now to see what happens down the road. Withdrawing now would mean starting from scratch if you go back to work for a PERA employer.
What is PERA and Public Employee Pensions In General?
You may be asking yourself (as I did when I first started working at PERA) – what is a defined benefit (DB) plan? In really basic terms, a DB plan is a type of pension plan in which an employer and employee contribute to a plan during the employee’s career, and in return, the employee receives income for retirement based on a formula that is fixed; thus, they are “defined benefits.”
At Colorado PERA, the monthly benefit is a formula based on the employee’s years of service and highest average salary (HAS). More specifically, it is years of service x HAS x 2.5%. Having a DB plan ensures that the employee saves adequately for retirement during their career through required contributions to the plan. The contributions are invested throughout the employee’s career by investment professionals and are distributed back to the employee through monthly payments for the life of the employee.
The employee also has the option to name a cobeneficiary (such as a spouse or other individual) to receive a continuing benefit for life once the employee dies. At PERA, you are eligible to receive a monthly benefit for life once you reach age 65, regardless of how many years of service you have.
What’s the Difference Between DB and DC plans?
So now that we have covered DB plans, let’s talk about defined contribution (DC) plans.
DB plans are much different than defined contribution (DC) plans because they provide a fixed and guaranteed income stream for life, whereas DC plans stop paying benefits once you exhaust your account balance.
Common types of DC plans are 401(k), 403(b), and 457 plans. In these plans, an employee makes contributions to the plan during his or her career, invests that money, and then receives only the amount that is in the account upon retirement. Hence, the amount of the benefit is defined by the employee’s contributions, so it is a “defined contribution” plan.
PERA’s DB plan is what is known as a hybrid DB plan because it incorporates some elements of a DC plan into the traditional DB plan components. When you make contributions to your PERA DB account, they are deposited into a separate account where they accrue interest. The interest rate has changed over the years, and is currently 3 percent per year. The advantage to this model is that if you do not wish to leave your account with PERA and take a monthly benefit at retirement, you can withdraw all of your contributions, the interest, and, if you are eligible, a matching amount of employer contributions.
Image by Jim Bowen / flickr