Your Arizona State Retirement System (ASRS) pension represents decades of dedicated public service. Yet for many Arizona educators, state employees, and public servants, this pension alone won’t be enough to maintain their desired standard of living. Understanding this reality early allows you to make informed decisions.
The challenge facing ASRS members is unique. Unlike many private sector retirees who rely entirely on their own savings, you have a guaranteed pension income stream. However, this pension comes with limitations that require careful planning to address. Your ASRS pension doesn’t adjust for inflation, meaning its purchasing power will steadily decline over your retirement years. Additionally, every dollar of your pension is subject to ordinary income tax rates.
These factors create both challenges and opportunities for your investment strategy. By understanding how your pension fits into your overall financial picture, you can make strategic adjustments to your investment approach that help protect and grow your wealth throughout retirement.
Understanding Your ASRS Pension’s Role in Your Portfolio
Your ASRS pension functions similarly to a bond in your investment portfolio. It provides steady, predictable income payments throughout your retirement. However, unlike inflation-protected Treasury bonds, your pension payments remain fixed regardless of rising costs.
This fixed nature of your pension creates a unique investment opportunity. Since you already have a significant “bond-like” asset providing steady income, you may be able to take on more growth-oriented investments in your personal portfolio than retirees without pensions.
Strategy #1: Reduce Your Bond Allocation
Traditional retirement advice often suggests increasing your bond allocation as you approach and enter retirement. The common rule of thumb suggests holding a certain percentage of your age in bonds (a 65-year-old should hold 65% bonds). Personally, I think this is advice is much too conservative even for those without a pension. But when you add in a pension, it becomes even worse of an idea.
Since your ASRS pension already provides the stability that bonds typically offer in a portfolio, you can consider reducing your bond allocation by a decent amount. This doesn’t mean eliminating bonds, but rather recognizing that your pension serves this stabilizing function.
Why This Works for ASRS Members:
- -Your pension provides a guaranteed income regardless of market conditions
-Reduced bond exposure frees up space for growth investments
-Lower bond allocation can help combat inflation’s impact on your purchasing power
Implementation Considerations:
- -Maintain some bond exposure for additional stability and liquidity needs
-Consider your pension when calculating your overall stock to bond allocation (count the pension in the bond allocation portion)
-Focus on shorter-duration bonds to reduce interest rate risk
This strategy enables you to maintain portfolio stability through your pension while positioning your investments for growth that can help offset the impact of inflation.
Strategy #2: Prioritize Inflation-Beating Investments
Since your ASRS pension won’t keep pace with inflation, your investment portfolio needs to work harder to maintain your purchasing power. This means focusing on assets that have historically outpaced inflation over long periods.
Equity Investments:
Stocks have historically provided the best long-term protection against inflation. Over the past 50 years, the S&P 500 has averaged approximately 10% annual returns, well above the historical inflation rate of around 3%. For ASRS members, maintaining a higher equity allocation than traditionally recommended can help offset the declining purchasing power of your pension.
Real Estate Investment Trusts (REITs):
REITs can provide both income and inflation protection. Real estate values and rental income typically rise with inflation, making REITs a valuable component of an inflation-fighting portfolio. Consider allocating 5-10% of your portfolio to REITs through low-cost index funds (note: some index funds already have some real estate in their funds, even if they aren’t listed as a real estate index fund in the title).
International Diversification:
Global investments can provide additional inflation protection and diversification benefits. International stocks have cycles where they lag US investments, which is a reason why some people avoid it. However, for many other periods (like 2000 to 2010), they outperform US investments. Just because the US has done better recently doesn’t mean that that trend will hold forever.
Strategy #3: Maximize Tax-Advantaged Growth Opportunities
ASRS members face a significant tax challenge in retirement. Your pension is 100% taxable as ordinary income, and up to 85% of your Social Security benefits may also be taxable. This creates an opportunity to diversify your tax exposure through the strategic use of tax-advantaged accounts.
Roth Conversion Strategy:
Consider converting portions of your traditional 403(b) or IRA to Roth accounts during lower-income years, either before retirement or during early retirement, before claiming Social Security. Roth accounts offer tax-free growth and withdrawals, resulting in a valuable, tax-diversified income stream in retirement.
Maximize 403(b)/401(a)/457 Contributions:
These plans allow you to contribute up to $23K per year in either a tax-deferred account, or in a Roth account. While you need to know which one is best for you in your current tax situation, not taking full advantage of them when possible is a big tax mistake.
Health Savings Account (HSA) Optimization:
If you’re eligible for an HSA, maximize your contributions and invest the funds for growth rather than using them for current expenses. HSAs offer triple tax advantages: deductible contributions, tax-free growth, and tax-free withdrawals for qualified medical expenses. In retirement, HSAs can be used for any purpose (with ordinary income tax) after age 65.
Start Implementing These Strategies Today
Your ASRS pension is a valuable foundation, but maximizing your retirement security requires strategic investment decisions that account for your unique situation as a pensioner. Whether you’re reducing your bond allocation to capitalize on growth opportunities, prioritizing inflation-beating investments to protect your purchasing power, or maximizing tax-advantaged accounts to create income diversification, the key is taking action while time is still on your side. Don’t let the fixed nature of your pension limit your retirement potential – implement these strategies now to build a portfolio that works harder for you, ensuring your decades of public service translate into the financial freedom and security you deserve throughout your golden years.