Poll:Complicated retirement withdrawal options

[utrecht]

I have a complicated retirement withdrawal situation and thought I would get some opinions. I'll try to keep it as simple as possible so you can actually make it thru this. My wife and I both have DB pensions. Once we retire we have the option of delaying collecting the pensions ( for as long as short as we want) and having the money deposited into a "DROP" account which pays 8-10% guaranteed interest depending on the rolling 10 yr avg returns of the pension fund. We also have a pretty good sized chunk of money in tax deferred and taxable accounts.

Option 1) Live completely off of our investments until they run dry (about 10 years) while letting the DROP accounts build up. At that point we would start collecting our pension and the interest from the DROP accounts. There would be no stock market risk after the 10 years but there would be pension risk and we would have no money of our own to fall back on if the pension got into trouble. The pension fund is strong at this point but I don't like having all of my eggs in one basket. This option results in the highest amount of income due to being able to withdraw 8-10% interest every year as opposed to the standard 4% SWR of a lump sum of money.

Option 2) Forget about DROP and draw our pensions and 4% of our investments each year. Smallest amount of income, but still more than enough.

Options 3) Some combo of the first two options. The combo I came up with was this: Year 1 I draw my pension and she allows the pension benefit to go into DROP. The next year we switch. Basically we are drawing half of the pension amounts and depositing half into our DROP accounts. We do this for an arbitrarily picked 7 years. We then go to option 2 for 4 years and live off of pension checks and our investments while allowing the DROP accounts to compound but with no more contributions. After 11 years we draw our pension checks, the interest from DROP account as well as a percentage of our investment accounts.

Hopefully you made it this far....

Withdraw rates from option 2 look like this:

Year 1) 9.0%
Year 2) 5.9%
Year 3) 6.3%
Year 4) 5.3%
Year 5) 3.6%
Year 6) 3.8%
Year 7) 3.4%
Year 8) 3.5%
Year 9) 3.2%
Year 10) 3.4%
Year 11) 3.1%

Withdraw rates from option 3:

Year 1) 6.1%
Year 2) 9.0%
Year 3) 6.5%
Year 4) 9.0%
Year 5) 7.2%
Year 6) 8.2%
Year 7) 4.2%
Year 8) 4.5%
Year 9) 4.1%
Year 10) 4.4%
Year 11) 3.1%

Its too complicated to explain why the WR rates jump around but is related to the fact that our pensions start several years apart and are different amounts. Option 3 seems much riskier due to higher withdrawal rates but remember that our DROP accounts are being funded all during this time. At the end of 11 years the withdrawal rates are both 3.1% and will stay there. Option 3 results in about $18000 extra annual income basically for the rest of of our lives.

I'm assuming 7.5% returns each year on our investments. I think if I could count on consistent 7.5% returns, Option 3 would be a no brainer, but if returns are bad for a few years at the beginning of the plan, option 3 could be pretty bad since withdraw rates are significantly higher for several years at the beginning.

Thoughts?

 

[growing_older]

The DROP account sounds too good to be true. Is this a public or private pension? If it's public and backed by a taxing authority, then 100% DROP seems like the way to go. If it's private, then you will have to make a much more nuanced decision about the solvency of the issuer. Hard to offer any suggestions without enough detail to make that assesment.

 

[pb4uski]

It wasn't until I started spending time on these boards that I came to appreciate the value of diversifying my sources of retirement income (taxable, tax-deferred, tax-free and pension/SS) in addition to diversifying across asset classes, etc.

If I understand your post, then option 1 would be the least diversified in that after 10 years or so you would be totally reliant on your pension.

Between options 2 and 3, I think I would look at the diversification of income (by source) or assets (including the imputed value of your pension) and chose the alternative that seems most comfortable. It seems to me that it is sort of like AA, there is no right answer but judgement call.

 

[ducky911]

I do not have a pension but I would be terrified to have my future in someone elses hands. 8-10 percent return sounds nuts. I would vote to get the money out of the pension as quickly as possible. Lump sum roll over being best.

 

[utrecht]

Its a public pension (Dallas Police and Fire Pension), but the money is kept separately from the City of Dallas. Employees and employer contribute money and that is the City of Dallas' entire involvement (other than having 2 Council members in the Board of Directors). The pension fund is strong but there are some rich powerful people here in Texas trying to lobby the State Senate to do away with all public DB pensions and switch to DC plans. It doesn't look like its going to happen and even if it does, I seriously doubt that it will affect anyone who has already earned pension benefits but the mere fact that this subject keeps coming up leads me to want to diversify away from the pension as much as possible. The subject hasn't come up but I have a feeling that at some point down the road they will decide to lower the DROP interest rate to something more like 4-5%. At this point, a change like that would probably cause a lawsuit and draw more attention to the pension fund which I'm sure they want to avoid.

There are no lump sum payout options. The only choice is whether to collect our pension benefit each month, or to have the money deposited into the interest bearing DROP accounts or not.

 

[devans0]

The 8-10% guarantee sounds high. The caveat of the 10 yr rolling average sounds like there will be a decline coming. Current rates being purchased will drag future earnings. This sounds like it is guaranteed in the fine print. Sales (smoke and mirrors) alarms warn me to ballpark a rolling average trend line before choosing door #1.

KISS at 4% is attractive to me but that is my Bogle bias. A bucket approach could hedge market risk like DROP is designed to do, but leave you open to adjustment.

The answer for me entirely rests on trusting the DROP quality.

 

[kumquat]

If you want to leave anything to pets, charities or kids, option 1 appears to be a no go.

 

[rothlev]

I vote for option one because you will have the pension and the deferred pension payments once you start collecting. The deferred pension payments would replace some of the money you used up, wouldn't they? You are saving 11 years of pension payments, so that has to be a chunk

 

[MooreBonds]

Are you able to withdraw money from the DROP account at-will? I presume that when one of you passes on, the money in the DROP account will go to your heir(s)?

I do agree with diversifying income sources....perhaps keep depositing the smaller of the 2 pension withdrawals into the DROP, and let that earn the 8%-10% (assuming it's still that generous), while you spend the higher pension directly, and a smaller % of your portfolio. Then, when the 10 year rolling average return drops because of the 2008-2012 period, you can see what the new rate is, and then decide if you want to continue to putting money into the DROP or not.

Is SS an income source, or is it WEPed to zero? If you qualify for SS, I presume you'll be delaying it as long as possible to maximize longevity insurance? Delaying SS could also help justify putting more of your pension into the WEP to earn the juicy return (if it's still that generous down the road) and spending more of your portfolio now.

I didn't see a reference to CPI adjustments - is your pension a flat amount? You mention the 4% portfolio + pension is "More than enough" at your minimum income, but I'm wondering if you'll have savings out of your pension to makeup for inflation down the road, and/or if you plan on simply spending less as you age?

 

[Sirka]

diversifying income sources

I do agree with diversifying income sources....perhaps keep depositing the smaller of the 2 pension withdrawals into the DROP, and let that earn the 8%-10% (assuming it's still that generous), while you spend the higher pension directly, and a smaller % of your portfolio. Then, when the 10 year rolling average return drops because of the 2008-2012 period, you can see what the new rate is, and then decide if you want to continue to putting money into the DROP or not.

+1

 

[utrecht]

Yes, I can withdraw from DROP at will. If years down the road I have a good chunk of money in it and things change, I could roll the entire amount to an IRA. Yes, the DROP account passes to heirs.

The 10 year rolling avg already includes 2008. Maybe I stated it wrong, but its the avg of the last 10 years returns. The avg changes each year as the oldest years returns fall off to be replaced by the newest years returns. In other words, right now its 2001-2011 and next year will be 2002-2012

I dont pay into SS and if I ever collect anything based on previous employment it will be very very little.

The pension is inflation adjusted. I get a 4% COLA the first year and then that same dollar amount increase each year so the percentage slowly decreases.

 

[seabourne]

So long as the DROP account is essentially a personally owned and accessible account, why would you not consider the DROP as an investment account? Particularly since you can roll into an IRA should you choose, if you use Option 1, you aren't so much spending down your investments as changing their composition to the higher-yielding DROP composition, but you have the future option to change. I suppose that my point is that, being ignorant of the particular rules, why you aren't considering the DROP account as an investment with limited contribution option but allowable withdrawals.

 

[pb4uski]

So long as the DROP account is essentially a personally owned and accessible account, why would you not consider the DROP as an investment account? Particularly since you can roll into an IRA should you choose, if you use Option 1, you aren't so much spending down your investments as changing their composition to the higher-yielding DROP composition, but you have the future option to change. I suppose that my point is that, being ignorant of the particular rules, why you aren't considering the DROP account as an investment with limited contribution option but allowable withdrawals.

+1 Behind the smoke and mirrors of the DROP it is just another (attractive) investment vehicle that is available to you. So either way you are drawing your pension, it is just a choice of whether to receive it in cash that is used for living expenses or invest it at 8-10% guaranteed and draw down your taxable funds for your living expenses. Unless you have another alternative for low risk 8-10% guaranteed tax deferred returns, it seems to me that option 1 is the way to go. It also gives you the opportunity to do a full withdrawal and roll it into an IRA if you ever have concerns over the financial stability of the DROP or if the rates decline.

 

[clifp]

Utrecht I have read your pension plans annual report 5 or 6 years ago and looked at a couple of years ago. Of the pension plans I've examine for ER members and others it was the strongest both in terms of large contributions from the city and workers, (close to 30% IRRC) a good investment record and no particularly abusive benefits (although it is very generous plan like most public safety pensions.)

I remember thinking before the crisis that DROP was a great deal, in today's investing environment it is a fantastic deal. I see no reason not to take full advantage of it. For a retired cop, options speculator and poker player the risk associated with a pension crisis on a well funded, well run pension seem quite modest .

DROP is too good to be true, and I wouldn't be shocked to see the program changed in the future so I would take advantage of it while you can still get these returns. If the returns drop to 4-5% than the situation changes dramatically.

Obviously you should continue to monitor the pension plans health and I personally would always want to have relative easy access (but not necessarily cash) to a 2-5 year worth of living expenses. So you should probably revisit the decision every year.

 

[utrecht]

The pension plan did implement some changes last year to shore it up. They were recommended by the board and voted on and approved by an overwhelming percentage of the members. Most of the changes were for new hires, but DROP was changed slightly for everyone. It used to pay 8-10% interest and could only change by 0.25% in any one year. Now it can roam between 8-10% and change the full 2% points if the 10 year avg dictates it.

This is good in my opinion because it shows that the board and members will make changes to keep the plan strong even if it hurts a little to do it. Its also bad because it shows that they will change the DROP plan on the fly. There is no talk of it at this point, but my gut tells me that the interest rate will be lowered at some point unless we get back to late 90's style returns which I don't expect. If I did have a chunk of money in DROP and they lowered the interest rate to 4-5%, it would still be a higher withdrawal rate than just about everyone uses so I guess it would still be a good deal.

The one thing I found out today though is that if I retire before age 50, my withdrawal options are limited. If I leave before 50 it goes from me being able to withdraw and make changes to my withdrawals any time I want to, to being similar to an IRA being operated under 72T rules. I have to set my withdrawal amount (including deposits to DROP) and cant change anything until 59 1/2.

I was planning to leave at 50 1/2 but after taking a good hard look at my finances over the weekend, I could easily move it up a year and leave at 49 1/2 which would be in June 2014. Now I need to decide how much of a pain it will be to have no flexibility in my pension options for 10 years.

 

[MooreBonds]

The one thing I found out today though is that if I retire before age 50, my withdrawal options are limited. If I leave before 50 it goes from me being able to withdraw and make changes to my withdrawals any time I want to, to being similar to an IRA being operated under 72T rules. I have to set my withdrawal amount (including deposits to DROP) and cant change anything until 59 1/2.

I was planning to leave at 50 1/2 but after taking a good hard look at my finances over the weekend, I could easily move it up a year and leave at 49 1/2 which would be in June 2014. Now I need to decide how much of a pain it will be to have no flexibility in my pension options for 10 years.

I realize that this is much easier said than done ......but if the above holds true, I would be very tempted to fall victim to the "one more year syndrome".

To me, having the flexibility to change my DROP/Pension withdrawals at any time, as often as I wish, given today's investment environment and non-existent interest rates, would be a very compelling reason to stay just one more year in order to be virtually immune to the market fluctuations - and being able to keep your portfolios as fully invested as you wish however the market performs, and then adjusting your DROP withdrawals and balances as necessary to adjust to market conditions.

Don't forget that for any retirement (and most especially for a 40+ year retirement), the first 10 years can often be the most crucial in determining survivability year period of time 30-40 years hence.

Are you able to switch to part-time for that extra year? Or perhaps even take a 6 month unpaid sabbatical, then return for just 6 months full-time (or even just 6 months part-time) to then retire at the required age and qualify for the unlimited DROP adjustments?

 

[Rambler]

I vote for one more year. If it were me, I'd want as much flexibility as I could get. Just my two cents. That also gives you another year to consider the strategy.

Good luck with he decisions.

R

 

[Finance Dave]

I would do an NPV analysis with each of the cash flows represented, and introduce some scenario analysis around a few of the key variables. Agree with watching diversification though.

 

[utrecht]

There are no part time positions or unpaid sabbaticals or anything like that available. I have a meeting scheduled for today with one of the pension benefit counselors so hopefully I will have a better idea of what we will do after the meeting.

 

[utrecht]

Well, the poll results show that I should take advantage of DROP. Either by maxing it out or at least putting some of my pension money into it while drawing down my outside investments. Ive done a lot of thinking and I'm still leaning towards avoiding using it at all. Let me explain myself and see if this makes any sense to anyone but me.

First a little recap of the DROP plan. Basically its nothing more than a savings account that pays a guaranteed 8-10% interest. Instead of collecting your pension, it gets paid into the savings account for later. Most everyone where I work, join DROP at 48 and then work for quite a few more years. Some as many as 10-12 more years. During that time their DROP accounts can build to over $1 million. Then they retire and live off off their pension check plus the 8-10% interest off of their DROP money. Its a very good deal and very good plan.

But our situation is different. We were smart enough to save our butts off. We maxed out our 457b plans for years and years. I also did pretty well investing that money as well as a considerable amount of money Ive made playing poker over the years. The point being that we don't have to work those extra 10-12 years. We have enough money that we could basically retire in the 1-2 years and simulate what everyone else does letting our DROP accounts build for 10-12 years without working and by living off of and drawing down our outside investments.

However, this is where things get complicated and I start to question the plan. The general benefit to DROP when compared to a lump sum of money in a 401k or whatever is that the DROP member has a SWR of 8% but the normal guy can only have a SWR of 4%. Now, the way I see it, this huge advantage applies only to the withdrawal period not the accumulation phase. The DROP member is making 8% all along but the normal guy isnt limited to 4% investment gains during accumulation. He can probably project close to that same 8% and could get lucky and make more than that over 10+years ( I use 7.5% for projections).

That brings me to my situation. If we dont use DROP at all, we will have a WR of about 9.5% the first year and it goes up from there every year until we run out of money in maybe 10 years or so depending on market returns. During these 10 years I don't see any big advantage to use DROP to due being in the accumulation phase of DROP. At the end of that 10 year period is where DROP is a gold mine. The DROP member can now have a SWR of 8%+.

Here are the reasons I'm leaning away from using DROP.

1) My heart of hearts tells me that DROP interest could be lowered sometime in the next 10 years when the real benefits of it kick in, which would just about void all benefits of using it. If it was lowered to 4-5% I would definitely not use it. I would rather take my chances with the market.

2) We both want to retire before we are 50 which means that once we set a withdrawal plan in place we cant change it without 10% IRS penalties until we are 59 1/2. If we have a 10%+ WR from our investments and the market takes a big hit, we will run out of money much earlier than 10 years. We wont be able to stop putting money into DROP, collect our pension checks for a time to lower our outside investment WR.

3) I really like the idea of diversifying away from 100% reliance on our pension even though it is one of the strongest pension funds around right now. There are very rich people in Texas trying to pass legislation which will adversely affect public pension (at least for the pension members). I dont think it will pass and I dont think it will affect retirees but nobody knows for sure.

4) I like the simplified withdrawal plan of collecting our pension checks each month along with drawing 4% from our investments and that being our income. Not worrying about planning for the future based on 8% interest on DROP and then possibly having the interest rate cave in on us and having our retirement budget take a hit. If we bought a house...ect based on a certain budget and then it took a hit it would change our entire standard of living and we would take a big pay cut after getting used to a certain standard of living.

5) We have enough money to retire in June 2014 with an increased standard of living of what we have now without using DROP and the worries that comes with it for me. If we don't use DROP we can retire before 50 and not worry about the IRS tax penalty because there is no reason to make any changes to our pension withdrawals. Set it and forget it.

If there was no such thing as the DROP plan, I would be happy as a lark. We would be retiring in 20 months and would have more than enough money to live comfortably. On the other hand, every single person I know at work does join DROP because as some have said "8-10% guaranteed interest is too good to be true". But it is true, at least for now. The DROP plan has been in effect for about 15 years now. Does it make sense for me to blow off a plan as good as DROP based on my situation and concerns?

 

[pb4uski]

I think to me it would depend on how well your taxable investments cover your living expenses since the real constraint is the inability to access your pension from retirement to age 59 1/2 if you elect the DROP when you retire because you can't change it.

The risk is then that if your taxable investments underperformed you would not have enough for living expenses and would need to take a job. One thing might be to calculate what level of underperformance would cause you a problem. For example, if you had enough in your taxable accounts to cover your living expenses from retirement to 59 1/2 you could put those monies in safe investments and then put your equity allocation in your 457b. While that is the inverse of what people commonly do it might be appropriate in your situation.

I'll admit that a low risk 8-10% return opportunity is difficult to pass up but the restrictions that come into play if your retire before 50 are troublesome. Another alternative would be to work to 50 and then bail.

 

[utrecht]

I could work one more year which would put me at 50 1/2 but either way DW will be under 50. She is only 43 right now. We both work at the same place and have all of the same options available to us. Waiting until I am 50 would clear up the restrictions issues for one of us, but it still is a problem because she wont be drawing any pension at all for several years after we retire due to her younger age. So even if we waited another year and I was over 50, we would still have a very high WR and only I would be benefiting from entering DROP.

When I run some numbers I just dont see it as a much of an advantage until 10+ years down the road because it takes that long to build up any meaningful DROP balance to be earning 8-10% interest on. If the market took a hit and our money ran out in 7-8 years our DROP balance would not all that big. Also, if that happened and our DROP balance was smaller than I projected for and then they ALSO lowered to interest rate down to 4-5% it would've been a huge mistake. I'm leaning towards taking the known quantity of what I have. A pension check and a lump sum of investments that I can draw my 4% off of without concerning myself with all of these other "what ifs".

Here's another factor: If I live off of and draw down my investments to zero I will end up with XX amount in DROP. I will draw the interest off of that balance until I die and then leave the balance to my heirs. If I avoid DROP and draw 4% from my investments until I die, there a good chance that my investment balance will be many many times larger when I die. Firecalc shows an ending balance range of zero to $9,000,000. With DROP I will never end with anywhere near that much.

 

[pb4uski]

Would your options with respect to making a decision on the pension be any different if you (or DW) resigned rather than retired?

 

[utrecht]

No. Retired, resigned, quit, fired. It makes no difference.

 

[utrecht]

Update 4 years later

Some of you veterans may remember this thread of mine from 4 years ago. Wow, have things have changed. My wife and I were within a couple years of retiring and considering our retirement funding options based around our pension options. If you are interested in this thread, please reread the OP to refresh what was going on at that point.

In post #5 I said

[FONT=&quot]"The subject hasn't come up but I have a feeling that at some point down the road they will decide to lower the DROP interest rate to something more like 4-5%. At this point, a change like that would probably cause a lawsuit and draw more attention to the pension fund which I'm sure they want to avoid"


[/FONT][FONT=&quot]In post #20 I said


[/FONT] "My heart of hearts tells me that DROP interest could be lowered sometime in the next 10 years when the real benefits of it kick in, which would just about void all benefits of using it. If it was lowered to 4-5% I would definitely not use it. I would rather take my chances with the market."

We ultimatelydecided not to use the DROP option at all. I just didn't trust these people enough and wanted as much money in my own hands as possible. I read thru all the annual reports and saw problems that nobody else saw and none of the board members that I spoke to would admit to (some of them were actual friends of mine).



Wow, how things have changed!


In the past 2 years, serious pension fund mismanagement has been discovered. Now, this pension fund was rated the #1 mid sized pension fund in the country in 2012-2013. The board of directors has been voted out and replaced completely. The CFO was forced to resign and is under investigation by the FBI for fraud. Its a long story but there were all kinds of shenanigans going on and to make a long story short the fund is now 45% funded. Funding levels were around 80-85% when I wrote the OP, but it was smoke and mirrors, bad accounting practices and outright lies and fraud. They owned large amounts of real estate and were pricing it at what they paid for it and not what it was actually worth. Google "Dallas Police and Fire Pension" if you are interested in details. Its ugly.



There was a very important vote by the members to make changes to the DROP plan back in 2015 to stop some of the bleeding which resulted in lowering of the interest rate. The pension fund was sued over it (like I predicted) by the original architects of the DROP plan (who of course are collecting massive amounts of interest and dont want to lose it even though its unsustainable). The plaintiffs lost but are appealing.


As of Oct 2016, the DROP interest rate is slated to go to ZERO due to triggers that were voted in that say it pays no interest if funding levels sink below 55%.


Another major pension amendment election is coming soon that will make drastic changes to fix this whole situation. If the vote passes, contributions are being increased from 8.5% to 11%. The employer is being asked to kick in an extra $600,000,000. The retiree COLA, which is currently a simple (not compounded) 4%, will be lowered to the CPI but with a max of 2% compounded and only paid out on $30,000 no matter what the annual pension benefit is (and no COLA for the first 3 years).


You have no idea how happy I am that we avoided DROP altogether. I was chastised and mocked by many co-workers when we never joined DROP. Of course I couldve rolled the money into an IRA right about now, but what a nightmare in general.


Now I just have to figure out a way to re-run all my numbers with the new significantly lowered COLA that is certainly coming. I havent figured out how to do it in FireCalc so I guess I'll have to do it by hand.