Episode 11 – How to save for retirement with DCP
Episode transcript:
[musical intro]
Jenny
Welcome back to Fund Your Future with DRS and we are talking about the classic DCP, our Deferred Compensation Program.
Seth
Yeah, it’s probably one of the things that DRS is most known for. I think sometimes people think DCP and DRS are two different things because like decades ago they were. The Deferred Compensation Program is our supplementary savings plan for folks who want to save more for their retirement through contributions out of their paycheck into an investment account. And it’s yeah, really, really great plan.
Jenny
I think it’s cool. I didn’t participate in DCP the first couple of years that I was in state service. I think because I either just because I didn’t know very much about it, I was more focused on my Roth IRA account. Now I do have both, and I think it’s a great option for people.
Seth
Yeah, I actually had a similar experience when I started working at DRS for the first few years, did not participate in DCP, had my own investments, and wasn’t really necessarily understanding that this was another investment vehicle outside of my pension plan, my PERS plan. And I think the thing to for people to remember is that, like all state employees have the option to participate in DCP.
But a lot of local governments and school districts do as well. And if they don’t, their employer might have their own supplementary retirement plan. So almost all public employers have some form of plan that they can save more for retirement. But we’re going to talk specifically about DCP today.
Jenny
Yeah, so we talk about how some private employers will offer something called the 401K, So this is sort of like our it’s not exactly like a 401K, but it’s similar to that like supplemental. Your retirement plan.
Seth
Yeah, money coming out of your check going into an investment account that is then your money when you stop working and there are rules for different types of plans are different rules on when you can get the money out if there’s penalties, how long you have to wait. One of the things I like about DCP is that there are rules, but they’re pretty generous as far as the person who has the money.
And so basically, soon as you stop working, you can have access to that money and there aren’t additional penalties. You’ll have to pay taxes on it when it comes out because it was money that hasn’t been taxed yet. Came out of your paycheck before taxes.
Jenny
Yeah, and I think that’s the great part is that we try to let people know that is it is tax deferred. So if you say I’m going to increase my contribution by $100, your paycheck’s only going to be reduced by about $85.
Seth
Yeah, that’s the real advantage of that pretax nature of it going in. Sometimes people won’t even notice because it shrinks your taxable income. And that’s the other nice thing when you’re actually doing your taxes, you know, in March or April or whenever, you do your taxes with the IRS, it lowers your income, your reported wages to the IRS.
Jenny
Right. So it could actually put you in a lower tax bracket so that you’re paying less taxes.
Seth
Yeah. Less taxes now. And that’s I think the thing to remember is that you’re going to have to pay taxes eventually on it. But the money gets to continue to grow without being taxed. And so your earnings are also continuing to compound over time because they haven’t been taxed yet.
Jenny
Yeah. So I think, like we said, there’s a lot of employers that offer this. So if you’re not familiar with the program, it’s good to ask if your employer does public employees are …you’re defaulted into the program at 3%.
Seth
Yeah. For state employees they’re automatically enrolled in the program at 3% of their salary and they can choose not to participate. But if you’re hired by a new state employer, you’ll automatically go into the plan starting after 90 days. You have a window of time to say you’re not going to participate in it, but if you don’t make any choice, you’ll automatically be enrolled at 3% of your salary.
And that’s one of the things I really like about it is how easy it is. If you automatically have the 3% coming out of your salary, it will also automatically be invested into an investment account, a target date retirement fund that’s based on your age. So it’s more aggressive when you’re younger, and then the fund will become more conservative as you get older.
So you don’t really have to think about it if you don’t want to. That money’s coming out automatically and it’s being invested. Those investments are changing over time based on your age.
Jenny
Yeah, I think that’s the important thing to mention here is that you’re not having to think about it. If you’re in a Plan 3 account, you can choose your investments. But generally with DCP, you’re just saying, okay, either I want to… you can choose either a set dollar amount or percentage, and then it’s all invested and taken care of for you.
So if you say, Hey, I want to contribute 3% of my income, it’s just to set it and forget it. You can watch it grow and continue to go from there. So I think people get a little iffy hearing the word investment around DCP, but it’s nothing that you’re having to worry about. That’s why the professionals are taking care of it for you.
Seth
Yeah, it sometimes there can be like that decision paralysis of like, oh, I feel like I’m going to have to make so many decisions. But with DCP it really is pick a percentage or pick a dollar amount and you’re off and running. And for folks who want to be more involved, they can you can change your investments.
There are different funds that people can choose. We pulled some data ahead of this podcast that over two thirds of the people who are in DCP are in one of those target date funds, and they’re.
Jenny
So…
Seth
The majority, the majority, the majority of people that have all of their money in one of those target date funds that’s based on their age. And so they’re just keeping it simple and just socking away a little extra money every month for their retirement.
Jenny
Yeah, So we had a great example here, too. If you have a, annual salary of $40,000 and you decide that you’re going to put in $100 a month and you do that for 30 years, after 30 years, you would have put in roughly about $30,000. And again, the numbers that we pulled is based on a let’s say, a safe estimate of 6% rate of return. Yeah.
Seth
Yeah the investments are going to earn 6% every year for that 30 year time period.
Jenny
Yeah. And then for the 30 years you would earn about $64,000 actually closer to $65,000 worth of interest. So you would be able to retire at 65. You have your pension and you have this nice chunk of change in your DCP account that these numbers would be close to $100,000. So then at that point you can decide how you’re going to withdraw your funds from DCP. It can be monthly and yeah…and you go from there.
Seth
You can do whatever you want.
Jenny
With that, whatever you want…after you retire.
Seth
One of my favorite things to talk to people about when they’ve got that lump sum of money, it’s like you can leave it there until the IRS starts making you take it out.
Jenny
Generally around age 72, yeah.
Seth
It’s actually increasing to 73. And then for folks as young as us, it’s going to be 75 …assuming that they don’t make additional changes in the future. So yeah, but you could also take the money out and buy a house or buy a boat or buy a Winnebago. That’s, that’s usually by default answer for folks of what I would do with my DCP money. So…
Jenny
Right. So once you turn 65, you could either take it out all at once or you can say, Hey, I want X a month for the next number of months.
Seth
Yeah. And that’s one of the things because we talked about this earlier, is the thing to be aware of is when you do take all that money out, it then is taxable and it can it can put you in a different tax bracket. If you take out all $100,000 at the same time versus spreading it out over the course of a number of months or years, you can really help keep the taxes more manageable.
And that’s where I think it can be advantageous to talk to an accountant or talk to somebody about what your tax situation looks like and figure out when you’re looking at getting that money out of the plan, what your options might be to still take the cash, still be able to use it, but make sure that you’re being as efficient with it as possible.
Jenny
Yeah, I kind of want to circle back to the percentage of income that you’re putting in and why we encourage that, because again, it’s kind of a “set it and forget it.” So if you just say I’m contributing 3% of my income, it’s nice because then that automatically goes up when you get a raise. So all of a sudden you’re getting more in your paycheck to take home and there’s more money going into your DCP account versus if you were to say a set contribution of I’m contributing $100 to $200 a month.
So that’s why we really encourage people to have a percentage. The standard is 3%, but we obviously encourage people to try to increase that if they if they have room for that in their budget.
Seth
Yeah, I don’t know if I’ve ever shared this data with you because I look at all sorts of data around all of our retirement plans and when people increase from 3%, they often increase to 5% or 10%. We really like round numbers. And so you’ll see not a lot of people contribute to 9% or 11%, but there’s a spike at 10% and even at 15%.
When you get to those higher percentages, it’s just a bias that we have that we’re looking at numbers in terms of five. So I think for a lot of people when they start at 3%, it is an easy jump to jump to five and say, I feel like I need to save a little bit more. And then that becomes kind of it’s not a round number, but it feels like a round number kind of in our minds. And we end up with a lot of folks who end up at 5%.
Jenny
And I think it’s important to point out, too, that you can always go in and change it. It’s taken out of your paycheck like once a month. So I wouldn’t advise changing it more than once a month. But if you’ve been contributing 10% for a long time and all of a sudden you feel like money’s a little tight, you could go into your account, drop that percentage down to 5% or 3%. Yeah.
Seth
It’s actually a good thing to keep in mind for folks. That change doesn’t necessarily happen immediately because your payroll folks might have already run payroll by the time you change it. You know, there’s sort of.
Jenny
…30 days sort of window.
Seth
A little bit of wiggle room in there. Yeah, Just to be aware of that is a good reason not to change it too often. But it is really important to realize that you can make those, as we’ve talked about in the past, of looking at your budget, making changes to those different categories that you’re putting money into. Maybe you decide, Hey, I’m going to start saving a little bit more for a new car, and so I’m going to set some more money aside for that.
And within my budget, that means I’m going to reduce my savings to fill this different savings bucket. And then once I purchase a new car, maybe then I go back from 5% back up to 10%, like the example you were giving. One other thing that I was wanting to just keep in mind, or for folks to know that oftentimes when people are looking at investments, they don’t necessarily think about like the cost of investments.
And one of the great things about DCP is at DRS we try to keep the costs for the for the plan really low. And one of the ways we’re able to do that is lots of people are participating in the plan. So you get this economy of scale, you get this the, the bigger plan you participate in, it’s usually less costly.
So we have over $5 billion in the DCP plan, which is really huge as far as those sorts of employer run investment plans. And there’s over I think last time I looked 120,000 people with accounts, obviously not all of those people are still working. Some of those people are retired and still have their accounts. But yeah, that’s a that’s a big chunk of people that are participating in the plan.
And so when you choose to participate, you get the advantage of having your money pooled kind of end with all of those same investment options that people that other people have chosen to invest in as well.
Jenny
Yeah, that’s great. And then like what you were saying is there’s not all of those fees that we’re having to pay versus if you were to invest that money privately with a private broker like TD Ameritrade, they do take a percentage.
Seth
Yeah, it’s always important to look at what the expenses are. There are some investments where there are zero costs, but assuming that you’re going to pay for something else along the way, a lot of our investments, you’re charged somewhere around like a quarter of a percent of the money. That’s in the fund.
But yeah, there’s some times where if you’re looking at investments in other areas where they’re charging you a full percent, which doesn’t seem like a lot of money, but if you have that over the course of 30 years, that takes out a big chunk and really that’s cutting into the gains that you your investment gains, that difference between what you could have paid and what you are paying in investment fees.
I know there’s one other thing that we were wanting to talk about is because these are plans that have rules by the IRS, there’s a limit on how much you can put in each year, a maximum. The folks who are most likely to put in like a set dollar amount, once again, looking at the data, are people who are at the maximum.
So they they’re trying to get to that very most amount of money that they can put into the plan. So they put in a specific dollar amount every month to make sure that they hit that.
Jenny
Yeah. So for 2023, the maximum is $22,500. And if you divide that by 12 for a monthly payment, that’s $1,875, which is a pretty good chunk of change for the average person.
Seth
But for a lot of people when they’re getting close to retirement, their salary has increased significantly kind of over their life. And that’s one of the things before we had automatically enrolled people into DCP, what we saw mostly was people who were in their 50’s and 60’s participate in DCP because they were trying to make up for lost time.
And so they were at those higher dollar amounts trying to get money into the plan, which is great. Like if you feel like I need to catch up or maybe I want to try to retire a year early and so I want to put some money away and give myself that little bit of wiggle room where now people who are starting saving early, they might not need to think about those maximum amounts because they’ve been putting in money the whole time.
Jenny
Yeah, yeah. And then we just want to mention too, for if you’re age 50 or older, the maximum is $30,000.
Seth
Yeah. It’s another way that the federal government is trying to encourage people to save money as they get close to retirement, realizing that, oh, maybe you maybe you weren’t doing as much as you could have been in your 20’s and 30’s and 40’s. And so here’s an opportunity to kind of catch up on your savings here.
Jenny
And so finally we want to mention that we have this great tool in the DRS website that’s specifically a DCP calculator and it’s for kind of estimating how much you could save with your DCP account. So if you go to DRS.wa.gov/calculator, it’ll take you straight to the page and it basically allows you to see…you select your DCP monthly contribution.
So if I go on here and I say I would like to contribute $100 a month to my DCP account, it’ll give me the breakdown. So it’s an $85 monthly out of pocket amount. So that means my because DCP is tax deferred, my paycheck will only be reduced by $85 and with $100 a month contributed, I would have an annual tax savings of about $180 and my total annual contribution would be $1,200.
So not too bad. But then I think what’s really handy is that you can also see how time will affect your savings. So it has it broken down by the percentage of return 2, 4, 6, 8%. And generally we like to use the figure of 6% as a nice sort of safe bet and just with using this amount.
So if I get a 6% rate of return on my DCP savings, I’m able to save $16,000 all the way up to 30 years. I would be able to save $100,000. And that’s just with putting in $100 to my DCP account every month.
Seth
Yeah. I like this calculator because it shows you all sorts of different scenarios all on one page. So you can see kind of what is that range that it could be because you probably don’t know how much longer you’re going to work. But I might work 20 more years. I might work 10 more years. So it can show you what that looks like over time.
And then you can choose different dollar amounts from the calculator and say like, okay, that is an amount that I feel comfortable having my paycheck reduced by though I’m putting this money in pretax. What’s the after tax result to my paycheck going to be approximately. Yeah I can find $85 somewhere in my budget, so I’m going to have $100 come out for DCP.
Or you can look at all the different examples there by choosing different dollar amounts. So if you figure out how much you can save in your after tax budget, you can then translate that to how much you can set up to have come out of your DCP account.
Jenny
Yeah. So this is a great tool to be able you can go in and see like how much maybe I could increase my DCP savings by just a little bit by $50 or less. Less the tax.
Seth
Yeah. Less the taxes.
Jenny
All right. Well, thank you so much, Seth.
Seth
Thank you.
[music outro]
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