Purchase Additional Pension Service Credits?

[mountainsoft]

My wife's pension has an option that would allow us to purchase additional service credits at the time she retires. For example, we could pay about $70,000 to increase our pension payments about $325 per month. Obviously, we don't have 70K sitting around, so this would have to come from our IRA.

So, I'm curious if it is a wise or foolish decision to take money from the IRA to increase our monthly pension payments?

The pension is a guaranteed amount for life (with COLA), whereas the IRA is subject to market ups and downs and could run out if we withdraw too much too fast.

Thoughts?

 

[enginerd]

To effectively evaluate your situation, we will need the time component. Such as current age and years until you begin withdrawal.

 

[Sunset]

With the limited data you have supplied, you could think of it as: 5.57% return on the 70K.

This drops the more you pull from IRA as you would pay tax, so you could take some out of IRA, and borrow the rest, then each year for a few years take out enough from the IRA to pay off the debt.
Basically spread the IRA withdrawal out over a few years to reduce the tax paid.

Possibly use a HELOC for the source of funds so you get a low interest rate.

 

[mountainsoft]

To effectively evaluate your situation, we will need the time component. Such as current age and years until you begin withdrawal.

Sorry, I just learned of this option this morning, so I hadn't given it much thought.

My wife is 48, hoping to retire in 7 years at 55.

My IRA (VBIAX 60/40 mix) should be worth around 150K at that time.

 

[mountainsoft]

This drops the more you pull from IRA as you would pay tax, so you could take some out of IRA, and borrow the rest, then each year for a few years take out enough from the IRA to pay off the debt.
Basically spread the IRA withdrawal out over a few years to reduce the tax paid. Possibly use a HELOC for the source of funds so you get a low interest rate.

Hmm.. I hadn't thought about the tax penalty. I don't know what a HELOC is, but sounds like I would have to balance interest rates against tax rates.

 

[Teacher Terry]

This is a math question. My DH ran the math for both of us and the breakeven point was in our early 80's so we decided it was not worth it.

 

[Sunset]

This is a math question. My DH ran the math for both of us and the breakeven point was in our early 80's so we decided it was not worth it.

If OP pension has great/good suvivorship included, it could very well be worth it unless they know they are both going to die young.

https://personal.vanguard.com/us/insights/retirement/plan-for-a-long-retirement-tool

Couple. If the man and woman are married, the chance that at least one of them will live to any given age is increased. There's a 72% chance that one of them will live to age 85 and a 45% chance that one will live to age 90. There's even an 18% chance that one of them will live to age 95, as shown below.

 

[Sunset]

Hmm.. I hadn't thought about the tax penalty. I don't know what a HELOC is, but sounds like I would have to balance interest rates against tax rates.

HELOC is Home Equity Line Of Credit.

Often you can set these up, for free.
It is basically a way to borrow against the value of the house, and the rates are often lower than regular loans just like mortgages are lower.

 

[Accidental Retiree]

With the limited data you have supplied, you could think of it as: 5.57% return on the 70K.

This drops the more you pull from IRA as you would pay tax, so you could take some out of IRA, and borrow the rest, then each year for a few years take out enough from the IRA to pay off the debt.
Basically spread the IRA withdrawal out over a few years to reduce the tax paid.

Possibly use a HELOC for the source of funds so you get a low interest rate.

Just as I was leaving the public sector, a few years ago, I recall they were starting to look at rollovers from IRAs and 457s to fund purchase of extra pension years ("air time").

If that ever went into effect, would being able to roll IRA funds over make this an even more attractive proposition?

 

[Just_Steve]

The only reason I would have bought time was if it allowed me to punch out earlier.

 

[mountainsoft]

This is a math question. My DH ran the math for both of us and the breakeven point was in our early 80's so we decided it was not worth it.

I ran a few tests in "Flexible Retirement Planner" and don't see that it would offer much benefit for us either. It sounded good in theory, not so much in practice.

Thanks for the feedback!

 

[nun]

With the limited data you have supplied, you could think of it as: 5.57% return on the 70K.

This drops the more you pull from IRA as you would pay tax, so you could take some out of IRA, and borrow the rest, then each year for a few years take out enough from the IRA to pay off the debt.
Basically spread the IRA withdrawal out over a few years to reduce the tax paid.

Possibly use a HELOC for the source of funds so you get a low interest rate.

The OP would be moving the IRA to another qualified plan so there would be no tax on the rollover.....double check with the plan administrator, but when I did the same thing recently, purchase of additional time was allowed from IRA, 403b, 401k etc etc. and no tax was due.

If we assume a 30 year lifespan past 55 and 2% COLA then the IRR of the plan is 5.6%. If you are in good health and like the idea of a 5.6% return and it fits in with your overall asset allocation then go for it.

 

[Persn]

You should see whether your wife could pay for the service credit with a pre-tax payroll deduction.

This was possible when I looked into it several years ago, but I don't know if it is possible now.

 

[mountainsoft]

You should see whether your wife could pay for the service credit with a pre-tax payroll deduction.

Unfortunately, we're already maxed out on savings and can't afford to set more aside right now.

I did some research last night and they do allow a tax free rollover from an IRA if it's in the same persons name. However, the IRA is mine so I would have to sell funds, get taxed, then purchase the additional service credits.

I ran some numbers and in most cases it just wasn't worth the trouble. Performance from the IRA was at least as equal as the income from the extra service credits.

 

[nun]

Unfortunately, we're already maxed out on savings and can't afford to set more aside right now.

I did some research last night and they do allow a tax free rollover from an IRA if it's in the same persons name. However, the IRA is mine so I would have to sell funds, get taxed, then purchase the additional service credits.

I ran some numbers and in most cases it just wasn't worth the trouble. Performance from the IRA was at least as equal as the income from the extra service credits.

If you would have to pay tax on a withdrawal from the IRA then I would forget the purchase of extra service.....5.6% (assuming an average lifespan and 2% COLA) is ok, but it's probably not worth raiding the IRA.

The extra payroll deduction is the way to go.

 

[Taxman59]

several years ago, I ran the # for my sister. for her, it was the vesting that was the true value. She was able to buy 5 years and be fully vested in the plan. Given that she worked for an elected judge, vesting was important. As it turned out, she made it to 25 years so the extra 5 bought her the full 30 year pension and the vesting was a non-issue. her return was about 6% on the purchase, not too bad.

 

[Big_Hitter]

can your wife accumulate 70K in a 401a dc plan in the next 7 years?

 

[Teacher Terry]

In our state it was a third of your yearly income to buy so really pricey. We could roll over $ from our deferred comp but still was not worth it. Mostly the people that did it used it to buy 5 years so they could retire with 30 years early. I only had 15 in so did not matter.

 

[Chuckanut]

Mostly the people that did it used it to buy 5 years so they could retire with 30 years early. I only had 15 in so did not matter.

It's interesting how states differ. Social Security participation, buying retirement credits, benefits after retirement, etc.

In my state you can buy up to 5 extra years but those years can't be used to retire early. After you work enough years and you are old enough, you can retire. Then there are 60 days for you to decided if you want to buy extra service years. IMHO, they are a descent deal - not great - due to their limited COLA, and if one plans on living at least 20 more years after retirement.

 

[Big_Hitter]

and if one plans on living at least 20 more years after retirement.

that's always the rub...

 

[Helios]

Ask her retirement system for a 1035 exchange. Transfers from 1 retirement plan to another without tax issue. I bought time in a defined benefit plan with 401k $.

 

[Sunset]

Unfortunately, we're already maxed out on savings and can't afford to set more aside right now.

I did some research last night and they do allow a tax free rollover from an IRA if it's in the same persons name. However, the IRA is mine so I would have to sell funds, get taxed, then purchase the additional service credits.

I ran some numbers and in most cases it just wasn't worth the trouble. Performance from the IRA was at least as equal as the income from the extra service credits.

Why only you have an IRA ?
The answer is stop funding an IRA in your name, and open one in her name and do all contributions there for the next 7 years.

As to performance of the IRA, the past is no indicator of the future, it's always possible 8 years from now, all markets will tank 50% or 95% like the great depression. That is what makes Pensions so valuable.

Especially if you can buy time with tax deferred money.

 

[Accidental Retiree]

Unfortunately, we're already maxed out on savings and can't afford to set more aside right now.

I did some research last night and they do allow a tax free rollover from an IRA if it's in the same persons name. However, the IRA is mine so I would have to sell funds, get taxed, then purchase the additional service credits.

I ran some numbers and in most cases it just wasn't worth the trouble. Performance from the IRA was at least as equal as the income from the extra service credits.

Deleted.

 

[mountainsoft]

Why only you have an IRA?

Limited income, minimal foresight, and general lack of knowledge I suppose.

When we decided to start an IRA we set it up in my name since she had her pension through her work. I guess our thinking was if things didn't work out between us we would each have something in our own names. We recently celebrated our 30th wedding anniversary, so it looks like we're gonna make it.

Once it was set up, we only contributed a small amount of money each month and never really gave it much thought. It has only been the last few years that we've started maxing out contributions. Last year I moved my IRA from my local bank to Vanguard so it would be easier to manage and keep track of. If only we knew then what we know now...

The answer is stop funding an IRA in your name, and open one in her name and do all contributions there for the next 7 years.

Hmm.. Interesting idea. I'll have to run some numbers again and give it some thought.

Thanks!

 

[H2ODude]

I did this fairly big time mainly to be able to jump 5 years earlier (60 vs 65). This system had a fairly smooth break in early penalty except going one day before 60 w/0 25 years was a 20% quantum penalty. Obviously, it's financial benefit needed me to live a certain time, and the break even was I think early 70's. The payout was basically a little over 10% of what I paid, per year. Theoretically COLA but there's been basically none first 5 years in. I do recall that if I croaked early they'd return my buy in, as though it was all my buy in paid out first; once that amount had been paid in pension nada. I paid it in as soon as I realized the value as it was based on income then; assuming you get raises your price would go up. I think it was about 20% of my then salary per year. I was limited to 10 but maxed.

I used after tax dollars. so somehow they figure out what proportion of pension income is already taxed and it's reported to IRS as not taxable. If I'd used the IRA then I assume all taxable. I supposed taxes would have been paid springing it from IRA.

These cases seem highly variable; others I've read mainly here don't seem as beneficial. Takes a good bit of analysis; for me it was kind of a slam dunk.