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Re-evaluating my retirement / pension options
Old 11-06-2010, 11:15 AM   #1
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Re-evaluating my retirement / pension options

As I posted in a different thread, my pension is under attack and there may be some changes coming soon that have me weighing my options.

My pension plan allows me to "retire" on paper and enter a program called DROP (delayed retirement option program). The idea is that I can keep working and have my pension check deposited into an account that currently pays 8-10% interest. Once I enter DROP I no longer accrue further pension benefits so its the same thing as actually retiring and going to work somewhere else with no pension at the same salary I make now. The interest rate is based on the rolling 10 year avg returns of the pension fund but cant go below 8% or above 10% and can only change .25% per year.

I can enter DROP at any point after my 20 year anniversary. The earlier I enter DROP the lower my pension check will be but the higher my DROP account will be when I actually retire. The pension people can do calculations to show when the best time to enter DROP is for each person based on the circumstances (based on the current interest rate).

My wife who is also a member of the same pension fund is approaching her 20 year anniversary very soon so we are weighing our options. Since she started her career very young, it makes (made) sense for her to enter DROP at 20 years because she will accumulate a large DROP account even though her pension check will be smallish by comparison.

It appears more and more likely that sometime in the future the DROP interest rate could be lowered, maybe as low as 4%. This would take a vote of the pension members, but may be necessary if the City lowers contributions. It has always been common practice to build as big of a DROP balance as possible since we could get a high interest rate risk free, but as the chances of a lower interest rate increase, it may not make sense to enter DROP at all. Entering DROP is a non revocable decision.

Based on the numbers, it's a no brainer for her to enter DROP now and accumulate a large balance that will pay 8-10% even though her pension check will be considerably smaller, but what if sometime in the future she suddenly gets the interest rate cut in half? Would you still do it?

One more variable: At any point, she can transfer her entire DROP balance into a 401k. Knowing that, does it change your mind? If they DID lower the interest rate, she could transfer the balance to a 401k and use a 4% withdrawal rate which obviously would be lower than the current interest rate but at least she would have the potential to grow her account balance as opposed to only getting 4% of a stagnant account balance which will be eaten away by inflation.
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Old 11-09-2010, 05:55 PM   #2
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Originally Posted by utrecht View Post
The interest rate is based on the rolling 10 year avg returns of the pension fund but cant go below 8% or above 10% and can only change .25% per year......


It appears more and more likely that sometime in the future the DROP interest rate could be lowered, maybe as low as 4%. This would take a vote of the pension members, but may be necessary if the City lowers contributions....

One more variable: At any point, she can transfer her entire DROP balance into a 401k. Knowing that, does it change your mind? If they DID lower the interest rate, she could transfer the balance to a 401k and use a 4% withdrawal rate which obviously would be lower than the current interest rate but at least she would have the potential to grow her account balance as opposed to only getting 4% of a stagnant account balance which will be eaten away by inflation.
Sounds like a great plan. While reading, I assumed that once you entered the program, the .25% per year maximum adjustment would protect you and the 4% would only apply to new entrants, but you seemed to contradict that. What's the guarantee worth if it can be amended so "easily"?

The 401k option looks attractive and would make me more comfortable about having the ability to keep a balanced AA, bucket strategy or whatever. Does she have to xfer the ENTIRE balance? That would make it less attractive to me.
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Old 11-09-2010, 06:03 PM   #3
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The go-NoGo decision on this is that after some period in DROP, can the balance buy you an annuity (SPIA) that pays as much or more than the (extra) pension you would have earned staying in the pension plan.

get on the Vanguard (or other) SPIA calculator and see what a years worth of extra pension would cost you in cold cash. Then the decision will be more clear to you.
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Old 11-11-2010, 08:20 AM   #4
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Sounds like a great plan. While reading, I assumed that once you entered the program, the .25% per year maximum adjustment would protect you and the 4% would only apply to new entrants, but you seemed to contradict that. What's the guarantee worth if it can be amended so "easily"?

The 401k option looks attractive and would make me more comfortable about having the ability to keep a balanced AA, bucket strategy or whatever. Does she have to xfer the ENTIRE balance? That would make it less attractive to me.
Currently, the interest rate must be between 8-10% and can only change 0.25% per year, but if the pension ever became underfunded, the first thing that would be scrutinized would be the DROP interest rate. The "8-10%" couldn't be changed without a vote of the pension fund members, but if things ever get bad, the pension board would probably recommend to the members that they vote for the change so it's possible that it could happen at some point in the future. Right now, the fund is in great shape and no changes are coming, but there's rumors of the City trying to figure out a way to lower their contributions to the pension fund which would cause drastic problems.
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