By Tina Wood-Wentz
Who works in non-profits or for the government?
While 75% of employees work in the private, for-profit sector, approximately 15% of employees work in federal, state, or local government, with the remaining 10% working for non-profits. And since education, daycare, social assistance, and medicine are heavily found in non-profit entities, in some career fields the percentage is far higher than an overall 75% for-profit rate would imply.
Additionally, the typical non-profit employer has more employees than the typical for-profit business! While equivalent non-profit/government jobs tend to offer lower pay than for-profit businesses, there is often a higher proportion of the total compensation for non-profit employees in the form of increased benefits. Therefore, it’s important to understand that while the benefits structures and implications of for-profits, government, and non-profits are largely the same, there are some key differences.
Pensions are a defined benefit plan – you know how much you get in a monthly payment stream. In the federal employment system they are one part of the Federal Employees Retirement System (FERS) and have the name “Basic Benefit Plan,” while through other employers they may be referred to as a pension or an annuity.
While pensions were common for a while in the for-profit world, they have mostly gone the way of the dinosaur and died out due to the cost and investment risk falling on the employer (defined benefit). They were replaced by the 401(k), where the investment risk problem falls entirely on the employee (defined contribution). Among the governmental and non-profit employer world, however, pensions are still common.
Problems with Pensions
Pensions very in quality. They may be very generous replacements for your employment earnings, or they may be so low as to be essentially a marketing tactic.
Pensions vary in fundedness. If they go bankrupt and aren’t insured with the Pension Benefit Guaranty Corporation (PBGC), you may be left with nothing. Do a check on your employer to see if your pension is insured.
Vesting: In order to draw your pension later, you must stay with the employer long enough to vest. If you change employers often, you may not be vested in the pension the employer offered, as there can be age and employment duration restrictions to keep the amount of benefit you accrued. And the vesting schedule may not be gradual, it may be a vesting cliff.
Eligible years of service: Pensions also tend to be a trap on the other end of service duration. Often your pension stops growing in value after you reach 30 years of service. If you stay with a single employer your whole career, which can be 40+ years, you may not be accruing a pension benefit from your final (and presumably highest paying) years.
Payout: Pension payouts aren’t as straight forward as choosing how much money to withdraw from your 401(k) whenever you need it. Instead, at retirement or age 65 you make an irrevocable lifetime election for how you would like to receive your money. This includes whether to take a lump sum versus a payment stream, if the payment stream is based on your lifespan or that of second-to-die between you and your spouse, and the percentage of eligible payout ratio. While all of these choices are considered to be actuarially equal, in reality some will benefit the recipient far more than others, and exactly which one will be best can only be determined in hind-sight, just like Social Security claiming strategies.
Cost of living adjustment (COLA): Pensions may or may not have a cost-of-living adjustment, e.g., an inflation factor added to the payout each year to keep inflation from eroding the purchasing power of the monthly benefit. Those with a COLA are more valuable than those without. The adjustment value can have a variety of rules and may be attached to one of a number of different inflation factors, and indeed the employer may change these for future earnings at any time.
In the non-profit world, the 403(b) is the functional equivalent of the for-profit world’s 401(k). While there are a few minor differences, they are similar on many fronts. A 403(b) is a defined contribution plan, where you can contribute up to a yearly maximum ($19,500 in 2021, with an additional $6,500 if you will be 50 or older during the year), and your employer can contribute a match based on what percentage of your income you contributed.
Just like a 401(k), your employer controls what fees and investment options are available. Educators do tend to be at a disadvantage here in that many school district 403(b) plans tend to be full of high fee annuity products.
One advantage of the non-profit world over the for-profit world – for 403b purposes – is if you’re a highly compensated employee (the most commonly met definition for 2021 would be having earned at least $130,000 in 2020). There’s no need to worry about having your contributions limited. If you were in the for-profit space and a highly compensated employee, you might well find your annual 401(k) contributions capped out at a percentage that was much lower than what you had hoped to contribute.
Thrift Savings Plan (TSP)
The TSP is the federal governmental employee’s equivalent to the 401(k) and 403(b). It’s a very low fee, low complexity offering that is widely viewed as highly desirable. You can even roll outside retirement accounts into your TSP, to take advantage of this account’s advantages with even more money.
If you have a 401(k) and a 403(b), by working two different jobs, you still can’t put in more in a year as employee contributions than the single $19,500 allowed. But imagine if you could double that number, and without even having to work a second job. If you are a highly compensated employee at a non-profit, or non-federal government employee, including public sector jobs such as teachers, it may be that you can! You may be eligible to have both a 403(b) and a 457(b), and contribute the maximum to each, in the same year.
While they have the same name, there are some unique differences between a “top hat” 457(b) from a non-profit versus a governmental or school-associated 457(b). The public sector 457(b) is generally considered the better plan of the two. While you have to separate from service in order to begin withdrawing these funds, it is generally more flexible on all other fronts than the top hat 457(b).
For the top hat 457(b), you have to have been considered a highly compensated employee in the previous year in order to be eligible to contribute this year. There can be a lag in eligibility and a year or more of missed contributions when changing institutions or if one or more extended unpaid personal leaves caused your income to drop. And finally, there’s much greater risk - that money is considered deferred compensation and it isn’t yours until it is paid out. If your employer goes under, creditors can take that money so you never receive it. You have to separate from service in order to start drawing this money, and you may have limited distribution schedule options (such as lump sum, 5, 10, and 15 years). But you do not have to be age 59 ½ or older in order to receive the money without early access penalties. It cannot be rolled over into any other tax advantaged retirement account, except for another top hat 457(b) plan.
Public service loan forgiveness (PSLF)
If you have student loans and work in the government and/or non-profit sector for 10 years you may be eligible to have your remaining federal student loans forgiven, without the forgiven balance being taxable. This requires consistent full-time work for an eligible employer for the duration, however, which may not align with the responsibilities of the sandwich generation, such as if there are children or aging parents who require support.
Teachers and others in local public service: WEP and GPO – losses that can make you weep
If you work for the federal government, in retirement the Basic Benefit Plan, TSP, and Social Security form a 3-legged and secure income stool. Similarly, working for a non-profit, in retirement you may have a pension, a 403(b) and possibly a 457(b), and Social Security.
But many who work in local public service (teachers, firefighters, local government) do not realize their income has not been subject to Social Security taxes. And because their income is not subject to Social Security taxes, they are not eligible to claim Social Security at retirement – in other words, like those in the private sector their stool only has two legs, and unlike those in the private sector they don’t know it until they try to sit down, which is well after it’s too late.
Worse, if they don’t spend their full career in public service or they spend some years working part time in the private sector in addition to their public service jobs (such as a teacher working a summer job during their time off), or they switch between districts that do and do not participate in Social Security, they may lose up to 50% of their Social Security benefit through the government’s Windfall Elimination Provision (WEP)!
And worse still, through the Governmental Pension Offset (GPO), these teachers and other public service employees have their Social Security spousal and survivor benefits decreased by 2/3 of the value of their public service pension, re-calculated every year if that pension has a COLA.
Neither WEP nor GPO implications are reflected on your Social Security statements from before you begin claiming Social Security.
WEP and GPO also would apply to career changers who have worked a first career outside of public service. To bring their knowledge to the classroom or into government service would cost them substantially, with the end result of discouraging these fields from benefiting from the diverse experiences of career changers.
Large numbers of executive-level employees in non-profits
Healthcare non-profit facilities are a common example of organizations where there are a much larger than average percentage of executive-level compensation employees. All of the staff doctors at a medical facility are likely at or near executive levels. With this many employees at high levels, look for an entire additional office devoted to providing the physicians with benefits in addition to those available to their allied health colleagues. These might include:
· Free tax preparation services
· Financial planning from student loan repayment planning through cash flow analysis and retirement planning, retirement benefits election consultations
· Daily free continuing education seminars eligible to check off the physician licensing requirements, complete with free meals
· Malpractice insurance
· Additional trip days and a large travel expense account for presenting at conferences in tropical or exotic destinations
· Funds for expenses related to publishing medical research articles
· Generous employer-funded reimbursement accounts for annual dental, vision, and/or medical care expenses that effectively wipe out the deductible, co-pay, co-insurance, prescription, and other out of pocket expenses
· An IT budget for non-standard hardware and software, and a dedicated IT support group for both professional and personal device maintenance
· A secondary pension fund or offset fund, to help make up Social Security covering a smaller portion of post-retirement funding, due to such a high proportion of employment wages being above the Social Security wage base
There are many unique benefits, complications, and considerations for employees in the non-profit and governmental space.
While the benefits and scenarios described here are those specific to a non-profit or governmental employer, be sure to look for my previous article on understanding the benefits that are commonly available at employers in general. And no matter your employer, make sure to look for my article on selecting your benefits when starting a new job.
About the author: Tina Wood-Wentz, MS
Tina Wood-Wentz wants to help you feel comfortable understanding your financial situation, and using your money as a tool for feeling more secure about your life. She is a financial educator, paraplanner, and founder of Wood Financial Services LLC. With an extensive background that includes whitewater kayak instructor, data scientist, tax preparer, and board member for many non-profits, Tina brings a passion for understanding numbers along with helping and educating others.
Got Questions About Your Taxes, Personal Finances and Investments? Get Answers!
Email Jeffrey Levine, CPA/PFS, chief planning officer at Buckingham Wealth Partners, at: AskTheHammer@BuckinghamGroup.com.