Buying additional pension credits?

[Chuckanut]

Defined benefit pensions are a thing of the past for many, but some of us still have one. I refused to give mine up when they offered us the option to switch to a defined benefit plan, despite some very big sweeteners.

Under the plan, assuming I retire next year, I could purchase an additional $4,800 per year of pension benefits for the rest of my life, at a one time cost of $66,000. The increased benefit is inflation indexed up to 3% a year. This is all defined benefit and the benefits are not subject to market conditions.

At first, I was skeptical since the $66,000 simply is gone from my asset base, but the inflation index has me thinking. I doubt if anybody is going to give me another chance to buy an inflation indexed retirement income (even partially indexed) in my life time. I have the money, though it would reduce my "the market goes to h**l and I don't want to sell this low" cushion from three to two years.

I would appreciate the thoughts of people familiar with these plans and anybody who has bought into one, or chosen not to.

Probable age at retirement: 62
No spouse, no need for a survivor benefit.

 

[clifp]

Absolutely you should buy it. $4,800 for $66,000 represent a SWR rate of 7.28% which is pretty fantastic by almost anybody's standard. The cap of 3% inflation decreases the value by a modest amount.

If you worked for Uncle Sam it would cost you $106,000 to purchase an annuity that provide $400/month with the same capped inflation COLA.

The only question is how safe is the pension. If you give us information about the company or public employee providing the pension, we might be able to give you some information.

 

[westcoast]

I just bought five years in my system after going through a careful analysis. My situation is a little different from yours as my wife is 15 years younger, so survivor benefits were part of my calculation.

The first question to ask is whether you would consider spending those dollars on a single premium lifetime annuity, because that's essentially what you'd be buying. At $4,800 a ear in additional income, it would take about 15 years (not including opportunity cost) to get back the money you invested. If you only live to 70, it wouldn't be a great deal. If you live to 90, it's a fabulous deal, especially when you consider the inflation protection. Check what kind of SPIA $66,000 would buy - probably a lot less than $4,800 a year and certainly not inflation indexed. I think that the Berkshire Hathaway website is a good place to check the numbers.

I was able to purchase my additional service credit using funds in my 403(b). These dollars were never taxed, so it's a much more effective way to purchase the credit than using $66,000 aftertax dollars.

 

[Chuckanut]

Of course, the big variable is life span. My ancestors are all over the place. About 2/3's living into their 90's, but some not making it much past 50. Since running out of money while alive scares me more than having some left over money after I die, I think I will assume I will live into my 90's.


My regular pension and any additional service should be safe. My pension is well funded, partly because the benefits are relatively modest and partly because I have paid in a higher percentage of my earnings to help fund it. So, I am not worried about collecting on the plan.

 

[arebelspy]

I was able to purchase my additional service credit using funds in my 403(b). These dollars were never taxed, so it's a much more effective way to purchase the credit than using $66,000 aftertax dollars.

This is what I'm planning on doing - we just upped our 457b contributions specifically with the plan to use them to purchase service credits. YMMV, check with your pension for caveats.

 

[nun]

Definitely buy the extra pension, it's a great deal. My take is to maximize all opportunities for defined benefits so you can minimize withdrawals from self invested funds.

I did a similar thing when I moved from the UK to the US 25 years ago. I decided to make voluntary payments into the UK's equivalent of SS. The cost last year was $200 (that's not a typo) and I only need to pay in for another 3 years to reach 30 years of payments and qualify for the full state pension when I reach 66 which is currently $12k a year. The benefit isn't as good as it sounds as my US SS will be reduced by the "Windfall Elimination Provision", but I still come out way ahead.

 

[utrecht]

I agree that you should buy the pension credits because the 7.28% withdrawal rate is a good overlay to a standard 4%, but I think its pretty close. If it was 5-6% I wouldn't do it. I think a lot of people get carried away with the thought that a pension is so much better than a defined contribution type plan, but remember that the pension has no survivor benefit and if it did the payout would be much less. When people talk about a SWR of 4% from their 401K or whatever personal funds they are drawing from, that withdrawal rate is based on having an almost certain chance of not outliving your money but that also results in having a very large pot of money to pass on to your heirs in most cases.

In other words if I had a choice of having $1,000,000 or a pension of $40,000 per year, I would take the $1,000,000 every time (no matter my age). Some will probably disagree I'm sure.

 

[clifp]

In other words if I had a choice of having $1,000,000 or a pension of $40,000 per year, I would take the $1,000,000 every time (no matter my age). Some will probably disagree I'm sure.

I'd generally agree (and if I had kids I'd certainly agree) but if we are truly in a different investing world with biflation (my word for the day) than earning a 4% real return maybe virtually impossible. Prior to 2007 I'd have agreed with you now as a 52 year old I'd happily hand over a $1 million for a 40K inflation adjusted pension.

 

[brewer12345]

To give you an idea of how good or bad this deal is, go get quotes on a similar spia to see if this is a bargain. Sometimes these deals are extremely generous.

 

[Mulligan]

I spent about 85,000 to purchase credit years from SS into my pension system. Although I did it to buy 4 years of my life and retire earlier,monetarily it was quite beneficial as it raised my pension about $12000 (COLA'd pension) as I also crossed several multiplier numbers. My salary increased after purchasing so that also contributed to increase. Buying service years with 401 or 403b money isn't necessarily a no brainer. I bought most of mine with after taxed money. Because of this a portion of my pension is considered tax free and I do not pay income tax on this portion of my pension.

 

[chinaco]

+1 on compare against an annuity quote.

This site provides quotes on nominal annuities (no cola) and some reports.

Immediate Annuities - Instant Annuity Quote Calculator.

Someone else in this forum might know of a website that provides quotes for annuities with a cola.

That cola on the pension could make it very attractive.

• Is the pension fund "fully funded"?
• Are you healthy and expect to live beyond your life expectancy?

If you can get the pension formula for payout and the formula for buying extra payout, it would help you to figure out how to analyze it.

Make sure you analyze it within the context of your full financial plan and all of your circumstances.

My personal opinion - I think it is important to have a secure, guaranteed income... at a minimum to cover the base lifestyle and needs.

 

[MichaelB]

I just bought five years in my system after going through a careful analysis. My situation is a little different from yours as my wife is 15 years younger, so survivor benefits were part of my calculation.

The first question to ask is whether you would consider spending those dollars on a single premium lifetime annuity, because that's essentially what you'd be buying. At $4,800 a ear in additional income, it would take about 15 years (not including opportunity cost) to get back the money you invested. If you only live to 70, it wouldn't be a great deal. If you live to 90, it's a fabulous deal, especially when you consider the inflation protection. Check what kind of SPIA $66,000 would buy - probably a lot less than $4,800 a year and certainly not inflation indexed. I think that the Berkshire Hathaway website is a good place to check the numbers.

I was able to purchase my additional service credit using funds in my 403(b). These dollars were never taxed, so it's a much more effective way to purchase the credit than using $66,000 aftertax dollars.

Hi westcoast, welcome to the forum. Please feel free to introduce yourself at the "Hi, I am ... forum here

 

[GregLee]

Sounds good to me, too.

 

[Chuckanut]

MichaelB, Normally, I am very leary of annuties since they are guaranteed only by the insurance company that issues them. Remember AIG? But, this would be guaranteed by my states public pension board and, of course, the financial power of the state. My pension plan is well funded and not one of those you read about that needs billions of dollars added to meet future obligations. On the other hand, it also does not allow me to retire after 20 years of service, with 120% of my highest salary, fully paid medical, and gentleman's valet to dress me in the morning. It's a tough life.

 

[clifp]

+1 on compare against an annuity quote.

This site provides quotes on nominal annuities (no cola) and some reports.

Immediate Annuities - Instant Annuity Quote Calculator.

Someone else in this forum might know of a website that provides quotes for annuities with a cola.

I use the TSP annuity calculator which has a (limited) COLA option I figure both it and Berkshire's are safe. .

 

[Chuckanut]

I was able to purchase my additional service credit using funds in my 403(b). These dollars were never taxed, so it's a much more effective way to purchase the credit than using $66,000 aftertax dollars.

This is an interesting idea. I am wondering if purchasing the additional service credits with tax-defered dollars has any future income tax consequences. At some point, I would think the Feds want to get their money!

 

[Mulligan]

This is an interesting idea. I am wondering if purchasing the additional service credits with tax-defered dollars has any future income tax consequences. At some point, I would think the Feds want to get their money!

Chuck they are going to get it one way or another. If you pay with taxed money (buying directly with cash from your savings acct, for ex.) you will not
pay taxes on that amount that it is given back to you in your pension. That money is amortized over your life expectancy. If you buy with pretax dollars you will be taxed as income from your pension. The benefit in using pretax dollars is you can buy more service years. Tax wise it should come out equal. However if you did make a big purchase with post tax dollars and income tax rates went up after you start drawing your pension you could say you might be better to buy the years with already taxed money.

 

[Chuckanut]

Buying service years with 401 or 403b money isn't necessarily a no brainer. I bought most of mine with after taxed money. Because of this a portion of my pension is considered tax free and I do not pay income tax on this portion of my pension.

How do you know how much is tax free? Do they send you that information at the end of the year?

 

[Mulligan]

How do you know how much is tax free? Do they send you that information at the end of the year?

Chuck, my retirement system sent me a package that showed how much was taxable and how much wasn't right when I retired. The yearly W-2 statement broke it down in different boxes, so I knew which box to report on my tax forms. What they do is basically spread the contributed tax portion you give them and amortize over your life expectancy. Most of my years were bought with 403b money, but I ran short of time and 403 b space, so I cut a check for the difference with cash. Somewhere between $1500-2000 a year of my pension is considered tax free because of the post tax money contribution.

 

[Mulligan]

How do you know how much is tax free? Do they send you that information at the end of the year?

I re-read my old post you replied to and forgot to correct it in my last one as I was dyslexic I guess at that time. I would say about 3/4 of my years I bought were PRE- tax and about a 1/4 th was after tax. In theory, at least in my pension system, if you worked 15 years and bought 15 years with after tax money, half of your pension would be tax free for life. If cola'd those increases would be taxable though, too.

 

[skipro3]

I have the same option to buy up to 5 years of additional pension that pays about the same; $135,000 gets me $850 a month plus a COLA capped at 5%. I'm turning it down. The reason is; I think there's a much greater chance that I would want access to the $135,000 as a lump than I need another $850 a month. I don't think I 'need' $850 a month although I'm sure I'd spend it if I had it. However, if I have $135,000 in my 401K I could use it to help a child buy a house, fund a business, pay for grand kids college, etc.
I see it like the lottery; take the lump sum or take the payments over 20 years. The liquidity of having my own cash is pretty important. And if I die tomorrow? Kiss that $135,000 good-bye.

Also, who's to say the pension won't or will be there in 20 or 30 years? For me it's California PERS. Every governor since Gray Davis has been trying every trick in the book to get access to that PERS fund. Some day some judge is going to agree it's the state's money until it's paid out to the account holder. Then what...?
Then there's social security. If it ever does go to a means testing method of distribution, I think I'd rather have my trust account holding the money than me personally having an additional $800+ a month.

Keep your 3 legged stool with even legs. If putting a lump sum of money into your pension results in an uneven distribution of your retirement sources of income, you need to assess that as a risk.

 

[Mulligan]

I have the same option to buy up to 5 years of additional pension that pays about the same; $135,000 gets me $850 a month plus a COLA capped at 5%. I'm turning it down. The reason is; I think there's a much greater chance that I would want access to the $135,000 as a lump than I need another $850 a month. I don't think I 'need' $850 a month although I'm sure I'd spend it if I had it. However, if I have $135,000 in my 401K I could use it to help a child buy a house, fund a business, pay for grand kids college, etc.
I see it like the lottery; take the lump sum or take the payments over 20 years. The liquidity of having my own cash is pretty important. And if I die tomorrow? Kiss that $135,000 good-bye.

Also, who's to say the pension won't or will be there in 20 or 30 years? For me it's California PERS. Every governor since Gray Davis has been trying every trick in the book to get access to that PERS fund. Some day some judge is going to agree it's the state's money until it's paid out to the account holder. Then what...?
Then there's social security. If it ever does go to a means testing method of distribution, I think I'd rather have my trust account holding the money than me personally having an additional $800+ a month.

Keep your 3 legged stool with even legs. If putting a lump sum of money into your pension results in an uneven distribution of your retirement sources of income, you need to assess that as a risk.

I certainly understand why you would do that. For me I had to buy years to be retirement eligible. I worked 24 years, but you couldn't retire unless you had 25. I remember that 25 would have been about a $50k pension and 28 got me into the $70s. Its been a few years ago, but I paid I believe a little under $90k to buy 4 years. So it increased my pension over 40% from 25, and I only had 24 to begin with. We didn't pay into SS and WEP swallows up most of my SS from other jobs, so I never got a chance for a 3 legged stool. Our pension, though public, is in a trust fund out of reach of legislature and is close to 90% pre funded. All things being equal, I would certainly prefer the 3 legged stool as opposed to my 1 legged stool with 2 small stubs.

 

[Chuckanut]

How times have changed. Since I posted the original message the price has gone up to $71,000 and the benefit down to $4,600. Of course, the initial estimate was just that - an estimate. Today's figure is the real deal. I still think I will do it since it will help even out the 3 legs of my retirement funding stool.

In effect, I am buying a more dollars every month with a side order of longevity insurance in the event I live much past my mid 70's.

 

[westcoast]

The price didn't exactly go up. You became a year older. The further you are from retirement, the lower the price. I'm not sure why your pension amount would decrease by $200 a month.

 

[Mulligan]

The price didn't exactly go up. You became a year older. The further you are from retirement, the lower the price. I'm not sure why your pension amount would decrease by $200 a month.

I don't know specifically about Chuckanuts situation, but in mine, a persons age had no bearing on it. The purchase cost was based on actual salary. In my case, a purchase credit is annual salary times 29% (employer and employee match combined). Eight years ago you could have bought at 22%, but employer/employee contribution rates went up to cover the market shortfall. In my system, the only the payout could drop is if the multiplier was reduced. Other systems I'm sure have different formulas though.