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Pension Question
Old 04-23-2014, 10:43 AM   #1
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Pension Question

I am seeking comments and opinions on the advice that I have been giving my police officer co-workers. We have a pension plan that requires a minimum of 20 years of service with a mandatory retirement requirement after 25 years of service regardless of age. Our pension payment ranges from 50% of of pay after 20 years to 60% at 25 years. 2.5% a year for the first 20 years; 2% a year after 20 until 25 years.

The plan benefits include a yearly 3% compounded COLA with the first COLA starting one year from he retirement date. Health care costs are not a concern. Family health insurance until Medicare and a supplement to Medicare after 65. (no payment or co-share of premiums)

My advice is to retire as soon as you become eligible and start collecting the pension so that the 3% COLA kicks in. We have not had pay raises of 3% for many years; our average yearly pay raise has been 2% for the last 6 or 7 years. I strongly advise younger officers to get out as they have more years to let the compounding work it's magic.

Social Security payments; union dues; 8 % pension contributions and a $1600.00 yearly health care co-share are approximately 20% of pay for active officers. Retired officers do not have any of these costs.

I am seeking thoughts and opinions on whether my rationalization to retire as soon as possible is sound advice from a financial standpoint. Thanks!
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Old 04-23-2014, 11:03 AM   #2
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Interesting... I have never heard of a pension with a decreasing multiplier, the longer you work. It's almost like they are wanting you to retire early. My pension is the opposite. 2.2 multiplier at 25 escalating to 2.55 at 31 years. I would not be the person to advocate what you are saying is correct or not. But, it would appear to me it would depend on the individual. If they cannot afford to live off the pension, and/or do not want to pursue a second career, drawing early retirement would be a moot point. Retiring at say 45 puts a lot of faith in the system to continue paying health insurance for 20 more years without them maybe being able to renege on the promise. FWIW- I went out on a smaller multiplier while my friends continue to work. They were not financially able to retire when I did. On the other hand, their pensions will be substantially more than mine. But I still tease them that they will have to live to be 85 to draw out the same amount of money I have drawn out on a reduced pension.


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Old 04-23-2014, 11:09 AM   #3
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There is a risk for public employees of The generous Cola being cut as governments struggle to find a way to make ends meets. Promises are not always kept.
Another angle to consider is the advantage of entering a new career a few years younger. Those few years can be a big advantage in finding that new job and the pay increases that will follow.
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Old 04-23-2014, 12:50 PM   #4
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Yes, it's a great retirement plan, and for that reason I have to wonder if it is sustainable. Have you checked to see if it is fully funded and their planned investment returns are reasonable? If it all looks good, then congratulations. If not, then I would recommend starting to build an independent pile of money just in case the plan goes 'Detroit' on you.
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Old 04-23-2014, 01:38 PM   #5
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It all depends on whether you can find another job that pays better. Say, for example, that you make $50,000 after 20 years. Over the next five years you will be giving up $250,000 in salary if you retire at 20 years, and getting only $125,000 in retirement pay. So you lose $125,000 if you retire early. Lets call it $122,000 to adjust for the higher COLA if retire early. Now it's true that you won't have to pay in SS, but your SS benefits are based on your highest 35 years, so I wouldn't count this. The rest amount to about 11 percent if you don't count health care contribution, or about 13 percent if you do. So this means you still be out nearly $100,000 if you retire at 20 vs. 25. If you can find a job you like better, that pays nearly as well, or if you can live comfortably on half pay then it makes economic sense to retire early. Otherwise, you must face the fact that you are giving up a lot of money by not working those 5 years.
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Old 04-23-2014, 01:42 PM   #6
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Mack44, I am not sure I could provide a right answer or if there is one. Income is only one part of the equation. I haven't done the math but it would seem from work year 20-25, an officer would have more take home pay by working vs. retiring. If the officer needs more money than available from the pension, it would be helpful to have a higher cash flow. Having said that, if I do not need the money and/or have another job upon retirement, your suggestion is a great option. Having said all this, I think the best approach is coaching on the tools for retirement like firecalc and other similar calculators since they encourage the analysis of income, spending and market forces.
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Old 04-23-2014, 02:03 PM   #7
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at 2%/year you get a roughly a 4% increase in pension payment for each additional year worked (2%/50%). Combined with a 2% pay raise, that should be a total pension increase of about 6% if the pension is final salary based. If you don't work you get a 3% increase in pension payment for each additional year.

So there is a benefit to continuing to work.
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Old 04-23-2014, 04:41 PM   #8
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Quote:
Originally Posted by Mack44 View Post
I am seeking comments and opinions on the advice that I have been giving my police officer co-workers. ...
My advice is to retire as soon as you become eligible and start collecting the pension so that the 3% COLA kicks in. ....I strongly advise younger officers to get out as they have more years to let the compounding work it's magic.

...
I am seeking thoughts and opinions on whether my rationalization to retire as soon as possible is sound advice from a financial standpoint. Thanks!
Are you advising your coworkers and younger officers as part of your job or just sharing your opinion?

Is your pension fund in good shape? It might be painful to have left early and then watch the 3% cola get cut or tied to some low level inflation index, to keep the pension fund solvent.
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Old 04-23-2014, 05:41 PM   #9
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....I am seeking thoughts and opinions on whether my rationalization to retire as soon as possible is sound advice from a financial standpoint. Thanks!
The below assumes an employee earned $50k at age 60 and received 2% annual increases. Their pension increases about 6% for each additional year that they work and their pension at age 65 is almost 1/3 higher than at age 60.

Their SS would be higher as well because they would have more years.

But... the mention of 8% pension contributions in your OP was confusing. Can you elaborate on that? Were those contributions to this plan or to a different plan?

AgeSalaryPension %PensionAnnual % IncreaseCumulative % Increase
60 50,000 50% 25,000   
61 51,000 52% 26,520 6.1%6.1%
62 52,020 54% 28,091 6.0%12.4%
63 53,060 56% 29,714 5.9%18.9%
64 54,122 58% 31,391 5.9%25.6%
65 55,204 60% 33,122 5.8%32.5%
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Old 04-23-2014, 05:50 PM   #10
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FWIW I took the 20 (actually 21) year plan. 52.5% with CPI COLA (your COLA may now be better due to lower returns; however that could prove unsustainable soon). IAE personally the COLA has become approximately 235% since "retirement". Additionally it may prove bit easier to find a second career the closer one is to 40 than later (I was 38).

Personally I would not advise someone unless asked and then only state it as a personal opinion.
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Old 04-23-2014, 06:30 PM   #11
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I only advise those who have asked for my opinion. Most are eager to leave and it is a topic that is talked about often. Everyone in my organization who has left at 20 years is very happy with their decision. The compounded COLA has only been a negotiated benefit since 2005. We didn't even have a simple COLA before then.

8% of salary contribution is the employees share. We agreed to bump up our contribution from 6% back in 2005 when we negotiated the compounded COLA. Obviously well worth it as the pension will double in about 23 years as a result of the magic of compounding.

Thanks for the thoughts. Keep them coming.
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Old 04-23-2014, 06:54 PM   #12
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Originally Posted by pb4uski View Post

Age Salary Pension % Pension Annual % Increase Cumulative % Increase
60 50,000 50% 25,000
61 51,000 52% 26,520 6.1% 6.1%
62 52,020 54% 28,091 6.0% 12.4%
63 53,060 56% 29,714 5.9% 18.9%
64 54,122 58% 31,391 5.9% 25.6%
65 55,204 60% 33,122 5.8% 32.5%
My guess is that most of the officer start young some right out of high school and most out of college.

I bet most hit the 20 year mark in their early 40 similar to military retirees. This gives them enough time to start a 2nd career, waiting the extra 5 year moves them into late 40s and makes harder to second career.

Once you account for payroll taxes, the 8% pension deduction, and the higher tax bracket and the more favorable tax treatment of most state for pension income. I suspect that take home pay is probably ~60% for working officers and ~40% for retirees. So the real question is can you retire on 2/3 of your take home pay. I suspect not unless you've been a good saver in which case you probably could.

As an editorial I find pension which don't use age as factor in benefits to be fundamentally unfair and financially dangerous to the employer.
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Old 04-23-2014, 07:26 PM   #13
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Looked at if someone was making 80,000 per year at 20 years and had 2% raises for the next 5 years the difference at 25 years is a pension of $26,500 vs $23,200. By age 78 the difference in pensions is $149,000 less for the early retiree with 20 years, assuming the retiree was 50 with 20 years, if you take it at age 40 the difference is going to be $232,000 over the course of retirement.
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Old 04-24-2014, 06:30 AM   #14
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My guess is that most of the officer start young some right out of high school and most out of college.

I bet most hit the 20 year mark in their early 40 similar to military retirees. This gives them enough time to start a 2nd career, waiting the extra 5 year moves them into late 40s and makes harder to second career.

Once you account for payroll taxes, the 8% pension deduction, and the higher tax bracket and the more favorable tax treatment of most state for pension income. I suspect that take home pay is probably ~60% for working officers and ~40% for retirees. So the real question is can you retire on 2/3 of your take home pay. I suspect not unless you've been a good saver in which case you probably could.

As an editorial I find pension which don't use age as factor in benefits to be fundamentally unfair and financially dangerous to the employer.
Good points. I should have made the ages in the table years of service instead and obviously the results would be proportional if the pay were higher or lower and the 8% contribution makes it slightly less attractive but a one time payment of 8% in exchange for 6% higher payments for life is a good trade.

The second career thing is also a good point. BIL's brother is a retired Detroit PD detective and earns pretty good bling doing some part time work. I wonder how long his pension will go given the problems Detroit is having though.

I think after taxes, union dues, retirement contributions, etc that many are probably living on about 2/3 of their gross pay to begin with. The OP suggests withholdings are income taxes plus 20% plus and voluntary withholdings.
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Old 04-24-2014, 03:04 PM   #15
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My advice is to retire as soon as you become eligible and start collecting the pension so that the 3% COLA kicks in. We have not had pay raises of 3% for many years; our average yearly pay raise has been 2% for the last 6 or 7 years. I strongly advise younger officers to get out as they have more years to let the compounding work it's magic.
I'm not sure what that means. I assume the 3% COLA also applies to people who wait until 25 years.
So, if the salary at 20 years is $60,000 ...

A) and the officer retires then,
the first year pension is $30,0000,
and the sixth year pension is $34,778.

B) or, if the officer works another 5 years with 2% annual raises,
the salary at 25 years is $66,245,
and retiring at that point creates a pension of 60% x $66,245 = $39,747

Note that the sixth year of pension in case A is the same year as the first year of pension in case B. So it looks like there is a $4,969 advantage in that year from working the extra five years.

(Note that even if raises were 0%, there would still be a $1,222 sixth/first year pension advantage to waiting.)

Since both pensions are COLA'd thereafter at the same 3%, the advantage grows in nominal dollars at 3% per year. It looks to me like the compounding for five years in the 20 year retirement is outrun by the combination of raises and the 60% factor for the 25 year retirement.

(That doesn't mean I'd always advise people to stay. There are many other factors to consider.)
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