Originally Posted by namesbond
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?