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27 years old buying Pension Service Credits
Old 08-14-2013, 04:13 PM   #1
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27 years old buying Pension Service Credits

I currently have just over 4 years of service with a state agency. I'm fully vested and our pension is well funded and will most likely be well funded for the next 15 years atleast because of natural resources. So I want everyone to treat my question as if there isn't any doubt the pension fund will stay solvent eventhough I'm fully aware what can happen. I am currently 27 years old and have the opportunity to purchase 5 years of service credit for $14,500 at 8% interest . Our formula for determining our pension payment is (years of service * 2%) * highest average salary over last 3 years of service. If I were to leave before the rule of 85 I would receive this payment beginning at 65 years old with no inflation adjustment. I currently make $3,391 per month.

So I'm currently looking at 8% * 3391 = $271.28 per month at age 65

With 5 more years 18% * 3391 = $610.38 per month at age 65

For some background I have $32,000 in my Roth IRA and $3,000 in Deferred Comp fund.

I have very little expenses and think I can max out my Roth and pay a large chunk of the $14,500 very quickly. I want to do this to suppliment my investing. I see it as diversification. It also decreases my rule of 85 to 50 years old if I manage to enjoy state employment for that long which is possible since there are many state agencies I could work for. The idea of investing in myself is also enticing since I would receive a higher benefit based on each year I keep my employment and everytime I get a raise.

Is it a good idea? I alway read about people purchasing service credits at the end to retire early often paying $90,000 or more. Does it make more sense to do when you are young?
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Old 08-14-2013, 04:23 PM   #2
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I bought at the end and was sorry I didn't do it way sooner. The accrued interest was large.

From what I see, ND is fine (don't take that as gospel), much better than my state.

I think you should consider going for it as early as possible.
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Old 08-14-2013, 04:55 PM   #3
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Quote:
Originally Posted by namesbond View Post
I currently have just over 4 years of service with a state agency. I'm fully vested and our pension is well funded and will most likely be well funded for the next 15 years atleast because of natural resources. So I want everyone to treat my question as if there isn't any doubt the pension fund will stay solvent eventhough I'm fully aware what can happen. I am currently 27 years old and have the opportunity to purchase 5 years of service credit for $14,500 at 8% interest . Our formula for determining our pension payment is (years of service * 2%) * highest average salary over last 3 years of service. If I were to leave before the rule of 85 I would receive this payment beginning at 65 years old with no inflation adjustment. I currently make $3,391 per month.

So I'm currently looking at 8% * 3391 = $271.28 per month at age 65

With 5 more years 18% * 3391 = $610.38 per month at age 65

For some background I have $32,000 in my Roth IRA and $3,000 in Deferred Comp fund.

I have very little expenses and think I can max out my Roth and pay a large chunk of the $14,500 very quickly. I want to do this to suppliment my investing. I see it as diversification. It also decreases my rule of 85 to 50 years old if I manage to enjoy state employment for that long which is possible since there are many state agencies I could work for. The idea of investing in myself is also enticing since I would receive a higher benefit based on each year I keep my employment and everytime I get a raise.

Is it a good idea? I alway read about people purchasing service credits at the end to retire early often paying $90,000 or more. Does it make more sense to do when you are young?
Congrats on thinking and preparing for your future! I was one of those who bought late, but I didn't have the money to buy early (or probably even think about it at age 27, so good for you). When I bought mine, I didn't project the benefit it would net me immediately but more importantly how it affected my pension based on my final three years as I had more years tacked onto my 2.35 multiplier. Do you have a salary schedule that may loosely determine what your final 3 year salary would be in today's dollars? I think that number would motivate you even more to buy the years, than using your present salary and years totals. FWIW- I bought mine more to get out early than to add on additional years. As I could have worked the 4 years and came out the same. I do not regret the decision I made to buy. How many people are fortunate enough to just write a check and buy 5 years of extra freedom without working?
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Old 08-14-2013, 08:31 PM   #4
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Quote:
Originally Posted by namesbond View Post
I currently have just over 4 years of service with a state agency. I'm fully vested and our pension is well funded and will most likely be well funded for the next 15 years atleast because of natural resources. So I want everyone to treat my question as if there isn't any doubt the pension fund will stay solvent eventhough I'm fully aware what can happen. I am currently 27 years old and have the opportunity to purchase 5 years of service credit for $14,500 at 8% interest . Our formula for determining our pension payment is (years of service * 2%) * highest average salary over last 3 years of service. If I were to leave before the rule of 85 I would receive this payment beginning at 65 years old with no inflation adjustment. I currently make $3,391 per month.

So I'm currently looking at 8% * 3391 = $271.28 per month at age 65

With 5 more years 18% * 3391 = $610.38 per month at age 65
Welcome to the forum! (a fellow 007 fan, perhaps?

From a financial perspective, it appears to slightly make sense, based on these assumptions:

If you took that $14,000 and invested it in a taxable account, earned an average of @ 6% nominal returns for 38 years (when you turn 65), and paid 25% marginal taxes on gains/income each year, it leaves you with a value of $81,000 at age 65.

Immediateannuities.com site is down, so I could only find this AARP/NYLife site, which shows a 65 year old male in South Dakota would be able to get roughly $400/month for life with an $81,000 lump sum payment (this annuity has a rider that guarantees your initial payment back if you haven't received back your initial payment by the time you die. A traditional life-only annuity would payout a little more)

Compare $400/month income from an annuity you buy @ 65, compared to your increased pension of $340/month from buying credits.

Using that same website, it would only cost you about $70,000 lump sum @ 65 to get $340/month income from an annuity (with that "cash refund" rider). Which would leave you with $10,000 leftover.

This makes your 'break-even' point on whether you should buy the extra years or not a salary level of $4,000/month - this means the $14,000 lump sum today, invested in the market @ 6% with 25% taxes on gains, will buy you the same annuity as if you quit your employer earning $4,000/month. Doesn't matter if you work another 20 years or 20 days: the difference in question is that extra 5 years of service, which boosts your pension by 10%.


Variables that make the "buy credits now" decision better:
--Your salary will (hopefully go up.
--If you average nominal returns are LESS than 6%/year.
--If your marginal (federal/state/city) income tax rate is higher than 25%.
--Helps diversify a large part of your income stream when you retire.
--Lets you reach the "rule of 85" 5 years faster, which can be a huge deal if you think you can make it to age 50 with them.


Variables that make the "invest the $14,000 instead and buy annuity at age 65" decision better:
--Interest rates are much higher when you're at 65, which makes an immediate annuity pay out more for a given lump sum investment.
--Your investment returns with that $14,000 produce more than 6%/year.
--Your marginal federal/state/local income tax rate is less than 25% from now to age 65.


Overall, I would expect your final salary to hopefully average more than $48,000/year when you leave - but that's the big clincher. How long would it take you to get a total 18% raise from your current salary level? Any possibility you can apply for higher-up positions with higher salary?
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Old 08-15-2013, 12:07 AM   #5
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Wow, they'll let you buy now? In Washington you can only purchase at the time you retire. For our situation the purchase still makes sense -- I'm 9 years younger than my husband and it allows him to assure me a reasonable survivors' benefit without as much of a hit to his pension check.

Which brings up a question -- do you have to write them a check, or can you do a transfer from deferred comp or another pre-tax account? They'll let us transfer the money directly from deferred comp, so that $90,000 buy-in will cost us ~$65,000 in taxable dollars.
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Old 08-15-2013, 10:39 PM   #6
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Just Do It! I did!

I did it and I was young. When people retire they tell me all the time that they wish they had done it. I read the book on my benefits and spoke with a financial advisor and he told me it was a no brainer. He said that on top of it since my pension was protected by the California Constitution and has inflation adjustment that it was even better to do it. I am an educator in California.

I bought five years. The money was taken out over five years from my paycheck and it was pre-tax dollars. That helped a lot. I was 38 and a teacher at the time. My salary has more than doubled since then as I am now a school administrator. Thus, my pension will be based on my administrative salary and not my salary as a teacher. I will get more than 100% of my work pay because I will not be paying 8% of my pension into the pension system as I did when I was working. So to give you an idea I was making $40,000 as a teacher 1997 as an administrator, my salary is in excess of $150,000. My pension formula is almost the same as your except after 25 years of service they use only one year that is your highest and not your 3 year average. My salary would have increased as a teacher but my salary also increases as an administrator too. So when my pension is now calculated it will be 94% of $150,000 instead of 94% of $75,000 which would have been my teacher's salary now. I have more than covered my initial investment which was $42,000 at the time.

So if you have foresight like you seem to do, then it's worth every penny if you can do it now. By the way, I still have another 8 years before I retire. My son works for the federal government and is 28. I am trying to see if they offer that there too. Go for it!
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Old 08-16-2013, 05:37 PM   #7
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Thanks for all the input. I have now signed up to purchase 5 years of service credit.
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Old 08-17-2013, 02:31 PM   #8
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Congratulations on thinking ahead so clearly at a young age. A nice side benefit, oddly enough, is having to pay back that 8% interest loan. A lot of people are concerned about overvaluation in the market, future inflation, low bond returns, etc. You have a no-brainer "investment" option that pays 8% - other than funding your RothIRA, you should be throwing every dollar you can against that 8% for the next year or three - you don't have to worry about valuations, market movements, or the best CD rate. For all it's a result of borrowing money (albeit to make a good long term investment in your pension), the easy answer in questionable times is a nice side effect.
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Old 04-28-2016, 04:38 PM   #9
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I thought it might be fun to post a follow up to this a couple years later. The pension years have been paid off for awhile now. I currently have 11 years 7 months of service so I'm looking at a $833.68 per month benefit at age 65 on a average salary of $3,598.61. My current salary is $3,873.00. Currently, I have $50,000 in equity on my $120,000 condo, 12 grand in my roth ira, 12 grand in my deferred comp, 5 grand in my HSA, and my pension which currently has a cash value of $38,267.36 so my focus is currently on my 4% match in deferred comp, maxing out HSA, and maxing out the Roth IRA. I'm trying to get my index funds up since I used a lot of my Roth IRA to purchase my condo using the first time home buyer exemption.
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Old 04-28-2016, 07:06 PM   #10
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Although the increased pension will be nice, my belief is that real benefit is leaving 5 years earlier. I left government just before my 54th b-day (took a year of leave) and know more than one person who did not buy pension credits in the past and are now sorry for that decision today. The option to buy them still exists, but the accumulated interest over too many years has made it all but impossible to justify financially. Therefore, some of them are still at w*rk when they could have already been retired had they bought the credits years ago.
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