Join Early Retirement Today
Reply
 
Thread Tools Search this Thread Display Modes
Take the pension or make larger ROTH rollovers
Old 02-21-2015, 08:06 PM   #1
Thinks s/he gets paid by the post
nun's Avatar
 
Join Date: Feb 2006
Posts: 4,836
Take the pension or make larger ROTH rollovers

I've been running some numbers to compare the option of using a 401a account balance of $263k to buy back into my state's pension plan and get a generous COLA pension of $20k/year starting at 55 or keeping the 401a account, living off after tax money and making larger IRA to ROTH conversions. I have ample money in my after tax accounts to cover my expenses until SS starts and if I don't take the pension I can basically convert the entire 15% tax bracket amount each year to a ROTH......with the pension I can convert $20k less each year.

The results for my various account balances (assuming 5% annual growth) and income streams at age 70 are as follows.

Taking the pension

IRA = $1M
ROTH = $0.6M
After tax = $0.5M

Pension = $27k
US SS = $30k
UK SS = $20k

Not taking the pension and keeping the 401a account

IRA = $1.1M
ROTH = $1.1M
After tax = $0

US SS = $30k
UK SS = $20k

So I'll have to take similar RMDs and the size of the portfolios are also similar (the pension scenario has almost paid itself back) but with the pension scenario I have $27k extra in taxable income that I must take. For the 401a scenario I have been able to shelter all my taxable money in the ROTH and if I needed the $27k I could take it tax free from the ROTH. I'm basically trading guaranteed taxable pension income against a bigger tax free ROTH balance and the uncertainty of stock market returns.

These sorts of decisions are what makes retirement planning so complex and interesting. So what would you do....and importantly why?
__________________

__________________
“So we beat on, boats against the current, borne back ceaselessly into the past.”

Current AA: 65% Equity Funds / 20% Bonds / 7% Stable Value /3% Cash / 5% TIAA Traditional
Retired Mar 2014 at age 52, target WR: 0.0%,
Income from pension and rent
nun is offline   Reply With Quote
Join the #1 Early Retirement and Financial Independence Forum Today - It's Totally Free!

Are you planning to be financially independent as early as possible so you can live life on your own terms? Discuss successful investing strategies, asset allocation models, tax strategies and other related topics in our online forum community. Our members range from young folks just starting their journey to financial independence, military retirees and even multimillionaires. No matter where you fit in you'll find that Early-Retirement.org is a great community to join. Best of all it's totally FREE!

You are currently viewing our boards as a guest so you have limited access to our community. Please take the time to register and you will gain a lot of great new features including; the ability to participate in discussions, network with our members, see fewer ads, upload photographs, create a retirement blog, send private messages and so much, much more!

Old 02-21-2015, 08:34 PM   #2
Full time employment: Posting here.
 
Join Date: Jan 2013
Posts: 660
Your calculation gives you a $200k larger portfolio in exchange for foregoing the pension. A back of the envelope type calculation suggests that you should increase the differential to an even $300k. That's because, if you take the pension, most or all of the $1M IRA may have to be withdrawn at a 25% tax rate, which naturally gives you 10% less to spend than if you were able to withdraw it all at a 15% tax rate.

Your calculations are doubtlessly more sophisticated than this, but if you accept $300 as the approximate difference in purchasing power between the two portfolios, then the question is quite simple - can you purchase a $27k COLA annuity on the open market for $300k or less? If you can't, then the pension option is preferable. I haven't researched annuities, so I don't if $300k would get you anywhere close to a $27k COLA pension, but it shouldn't be hard to get a quote from a number of online sources.
__________________

__________________
karluk is offline   Reply With Quote
Old 02-21-2015, 08:34 PM   #3
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
pb4uski's Avatar
 
Join Date: Nov 2010
Location: Vermont & Sarasota, FL
Posts: 16,461
How can the IRA be bigger under the scenario where you are doing more in Roth conversions than the scenario where you are doing less in Roth conversions? I can see the Roth being bigger but don't understand why the IRA isn't smaller.

The whole idea of doing Roth conversions is to make the IRA balance lower when you get to 70 so RMDs are lower. Shouldn't the IRA be at least $300k lower ($20k a year * 15 years)? + growth that effectively is transferred from the IRA to the Roth? If you transfer $20k more a year for 15 years and the earnings rate is 5% thne the Roth should be $413k larger than the other alternative (and the IRA $413k lower)... all else being equal.
__________________
If something cannot endure laughter.... it cannot endure.
Patience is the art of concealing your impatience.
Slow and steady wins the race.
pb4uski is offline   Reply With Quote
Old 02-21-2015, 08:50 PM   #4
Thinks s/he gets paid by the post
nun's Avatar
 
Join Date: Feb 2006
Posts: 4,836
Quote:
Originally Posted by pb4uski View Post
How can the IRA be bigger under the scenario where you are doing more in Roth conversions than the scenario where you are doing less in Roth conversions? I can see the Roth being bigger but don't understand why the IRA isn't smaller.
The balance of the ROTH starts out larger in the case where I do the bigger conversions

Quote:
The whole idea of doing Roth conversions is to make the IRA balance lower when you get to 70 so RMDs are lower. Shouldn't the IRA be at least $300k lower ($20k a year * 15 years)? + growth that effectively is transferred from the IRA to the Roth? If you transfer $20k more a year for 15 years and the earnings rate is 5% thne the Roth should be $413k larger than the other alternative (and the IRA $413k lower)... all else being equal.
If I take the pension I buy it with $263k from my starting IRA/401a balance so the pension scenario starts off with $263k less in the iRA/401a than that if I keep the 401a. I do smaller ROTH conversions if I take the pension which allows the IRA in that scenario to catch up with the larger starting balance and larger ROTH conversion amounts for the IRA if I keep the 401a
__________________
“So we beat on, boats against the current, borne back ceaselessly into the past.”

Current AA: 65% Equity Funds / 20% Bonds / 7% Stable Value /3% Cash / 5% TIAA Traditional
Retired Mar 2014 at age 52, target WR: 0.0%,
Income from pension and rent
nun is offline   Reply With Quote
Old 02-21-2015, 08:57 PM   #5
Thinks s/he gets paid by the post
nun's Avatar
 
Join Date: Feb 2006
Posts: 4,836
Quote:
Originally Posted by karluk View Post
Your calculation gives you a $200k larger portfolio in exchange for foregoing the pension. A back of the envelope type calculation suggests that you should increase the differential to an even $300k. That's because, if you take the pension, most or all of the $1M IRA may have to be withdrawn at a 25% tax rate, which naturally gives you 10% less to spend than if you were able to withdraw it all at a 15% tax rate.

Your calculations are doubtlessly more sophisticated than this, but if you accept $300 as the approximate difference in purchasing power between the two portfolios, then the question is quite simple - can you purchase a $27k COLA annuity on the open market for $300k or less? If you can't, then the pension option is preferable. I haven't researched annuities, so I don't if $300k would get you anywhere close to a $27k COLA pension, but it shouldn't be hard to get a quote from a number of online sources.
The differential is $100k. The tax rate on the RMD will depend on where the tax thresholds end up in 16 years time and also how much of my SS will be taxed is important too. The extra $27k pension income could push me into a higher SS tax area and also marginal tax bracket, but the $50k in SS and RMD might get me there by themselves. It's ridiculously complicated and crystal ball gazing. I actually plotted the rise in the 15% tax bracket upper threshold and came up with the following very good linear fit

15%_threshold(year) = 765*year - 1505404

So I predict the top of the 15% bracket (and bottom of the 25% bracket) will be $48k when I'm 70. My RMDs in either scenario will be $39k and with my SS type income I'll be into the 25% tax bracket even without the pension. Of course if I don't take the pension then in later life I'll be able to take tax free income from the ROTH if I need it
__________________
“So we beat on, boats against the current, borne back ceaselessly into the past.”

Current AA: 65% Equity Funds / 20% Bonds / 7% Stable Value /3% Cash / 5% TIAA Traditional
Retired Mar 2014 at age 52, target WR: 0.0%,
Income from pension and rent
nun is offline   Reply With Quote
Old 02-21-2015, 09:22 PM   #6
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
pb4uski's Avatar
 
Join Date: Nov 2010
Location: Vermont & Sarasota, FL
Posts: 16,461
I get it now, the pension transfer also comes into play, which is a way of reducing the IRA (and therefore future RMDs) that not many of us have but those reduced RMDs are offset by the pension income.

It looks like the pension is the winner, especially if you include the value of the pension at age 70 in the taking the pension scenario and all else is similar, even though the taking the pension scenario results in higher taxes later in life it is hard to fathom that the advantage at age 70 would be totally erased.
__________________
If something cannot endure laughter.... it cannot endure.
Patience is the art of concealing your impatience.
Slow and steady wins the race.
pb4uski is offline   Reply With Quote
Old 02-21-2015, 09:49 PM   #7
Thinks s/he gets paid by the post
nun's Avatar
 
Join Date: Feb 2006
Posts: 4,836
Quote:
Originally Posted by pb4uski View Post
I get it now, the pension transfer also comes into play, which is a way of reducing the IRA (and therefore future RMDs) that not many of us have but those reduced RMDs are offset by the pension income.

It looks like the pension is the winner, especially if you include the value of the pension at age 70 in the taking the pension scenario and all else is similar, even though the taking the pension scenario results in higher taxes later in life it is hard to fathom that the advantage at age 70 would be totally erased.
I've used 5% return for the tax deferred funds and 4% (to account for taxes) on the after tax money which is a bit conservative given that that is the same implied interest rate on my pension if I live to 70. If I take it farther out to age 84 the pension scenario pulls ahead on purely account levels because the COLA and longevity takes the interest rate up to 7%.

In the end there may be to may "maybes" in all this and I might just go with the pension for the insurance aspect, it makes taking income super simple and lets me put more of my other money into equites.
__________________
“So we beat on, boats against the current, borne back ceaselessly into the past.”

Current AA: 65% Equity Funds / 20% Bonds / 7% Stable Value /3% Cash / 5% TIAA Traditional
Retired Mar 2014 at age 52, target WR: 0.0%,
Income from pension and rent
nun is offline   Reply With Quote
Old 02-22-2015, 11:58 AM   #8
Full time employment: Posting here.
 
Join Date: Jan 2013
Posts: 660
Quote:
Originally Posted by nun View Post
The differential is $100k.
Yes, the nominal difference is only $100k. Sorry about using the wrong number. I'm not certain how I made the error, but the fact that there is such a tiny difference in the nominal values of the two portfolios leads me to believe that the pension option is starting out with a nearly unbeatable lead, at least using your assumptions.


Quote:
Originally Posted by nun View Post
I actually plotted the rise in the 15% tax bracket upper threshold and came up with the following very good linear fit

15%_threshold(year) = 765*year - 1505404

So I predict the top of the 15% bracket (and bottom of the 25% bracket) will be $48k when I'm 70.
If I understand you correctly, I think that it would be quite hard to justify this sort of linear extrapolation. I believe that tax brackets are adjusted annually based on the change in CPI, so the top of the tax bracket is an exponential function of the inflation rate over time.

Looking more closely at your linear approximation, it appears to give significantly wrong results for current tax years. For example, in TY 2014 the top of the 15% tax bracket is $36,900. Your formula says that it should be

15%_threshold(2014) = 765*2014 - 1505404 = $35,306

which is off by about $1600 from the correct amount.

Looking into the future, your formula predicts that the top of the 15% tax bracket will hit $48,000 in either 2030 or 2031. Going from $36,900 in 2014 to $48,000 in either 16 or 17 years works out to an annual inflation rate of about 1.6%. That's not impossible, but it would require inflation to persistently be below the Federal Reserve's target of 2%. Since the Fed has a lot of monetary tools to influence inflation, I would guess that projecting 1.6% average inflation through 2030 is probably too low.

All in all, it looks to me that the uncertainty in your projections makes your results too imprecise to have much value in assisting with your "pension or no pension" decision. If I were in your shoes, I would abandon a calculation that has so much uncertainty in it and make my decision based on whether I felt more comfortable with the guaranteed income for life that a pension provides, or the somewhat larger nest egg that the "no pension" option promises.
__________________
karluk is offline   Reply With Quote
Old 02-22-2015, 03:49 PM   #9
Thinks s/he gets paid by the post
nun's Avatar
 
Join Date: Feb 2006
Posts: 4,836
Quote:
Originally Posted by karluk View Post
Yes, the nominal difference is only $100k. Sorry about using the wrong number. I'm not certain how I made the error, but the fact that there is such a tiny difference in the nominal values of the two portfolios leads me to believe that the pension option is starting out with a nearly unbeatable lead, at least using your assumptions.
I'm only using 5% return for the tax deferred assets and 4% for the taxable....to account for tax paid on dividends etc which is probably a bit conservative.....so the pension option does quite well because the 3% COLA pushes the return of the pension up to around 5% even at age 70.

Quote:

If I understand you correctly, I think that it would be quite hard to justify this sort of linear extrapolation. I believe that tax brackets are adjusted annually based on the change in CPI, so the top of the tax bracket is an exponential function of the inflation rate over time.

Looking more closely at your linear approximation, it appears to give significantly wrong results for current tax years. For example, in TY 2014 the top of the 15% tax bracket is $36,900. Your formula says that it should be

15%_threshold(2014) = 765*2014 - 1505404 = $35,306

which is off by about $1600 from the correct amount.
The linear fit is excellent for 2015 back to 2002. I omitted some decimal places do if you use this.

15%_threshold(2014) = 765.824*2014 - 1505404.256 = $35,306

you will get better answers. 2009 is off the line a bit. Of course this only works if the bands stay the same.

Quote:
Looking into the future, your formula predicts that the top of the 15% tax bracket will hit $48,000 in either 2030 or 2031. Going from $36,900 in 2014 to $48,000 in either 16 or 17 years works out to an annual inflation rate of about 1.6%. That's not impossible, but it would require inflation to persistently be below the Federal Reserve's target of 2%. Since the Fed has a lot of monetary tools to influence inflation, I would guess that projecting 1.6% average inflation through 2030 is probably too low.

All in all, it looks to me that the uncertainty in your projections makes your results too imprecise to have much value in assisting with your "pension or no pension" decision. If I were in your shoes, I would abandon a calculation that has so much uncertainty in it and make my decision based on whether I felt more comfortable with the guaranteed income for life that a pension provides, or the somewhat larger nest egg that the "no pension" option promises.
I agree about the basic futility of my efforts, but they were an interesting exercise. At 70 I'll have to cough up some taxes whatever I do and pay for all the tax deferring I've done earlier in my life. In the end I think the basically excellent value of the pension wins out. I mean, spending $263k at age 54 to get a $20k COLAed pension starting at age 55 is way better that you could get in the open market. The starting payout rate is 7% (that's $20k/$283k as I compound my $263k over one year) and the interest rate at age 84 is 7.5%. It also fits in nicely with those studies that show using 20% of your money to buy an SPIA works out better than a regular bond allocation, again with lots of assumptions that could change very quickly.

Also I can actually protect the capital and pass the remaining value of the pension onto my heirs if I die early by taking a reduced pension of $19.8k...so by taking $200 a year less if I was to die as soon as I was to take the pension my beneficiary would get the balance of the pension account...around $283k.

With the $20k pension and rental income I can cover my expenses so I decouple my income from the stock market which I think will be good for my blood pressure. All in all the pension looks like the way to go even if it does mean I'll be paying more tax on my RMDs after age 70. Once again I'm happy my problems revolve around having too much money rather than not enough.
__________________
“So we beat on, boats against the current, borne back ceaselessly into the past.”

Current AA: 65% Equity Funds / 20% Bonds / 7% Stable Value /3% Cash / 5% TIAA Traditional
Retired Mar 2014 at age 52, target WR: 0.0%,
Income from pension and rent
nun is offline   Reply With Quote
Old 02-24-2015, 07:16 AM   #10
Full time employment: Posting here.
 
Join Date: Jan 2013
Posts: 660
Quote:
Originally Posted by nun View Post
The linear fit is excellent for 2015 back to 2002.
You do have an excellent fit looking back at past adjustments. The trouble is that using a model which projects linear growth into the future will give inaccurate results going forward because the growth is really increasing exponentially. With exponential growth, one gets accelerating increases over the years instead of the constant $765.824 average increase per year that your model predicts.


Quote:
Originally Posted by nun View Post
Of course this only works if the bands stay the same.
I have known for years that the tax brackets are adjusted annually for inflation, but until now I had no idea how the adjustment is actually calculated. Your post encouraged me to do some research on this issue, and I found the following article which explains how the very small increase for TY 2010 was calculated from the CPI numbers from September, 2008 through August, 2009. It's very interesting and not exactly what I would have expected.

Quote:
The IRS uses the average CPI-U monthly value from the previous 12 months (September through August) and compares it to a "base year" CPI-U average for each tax variable.
Inflation Adjustment of Tax Brackets Almost Zero for Next Year | Tax Foundation

So the actual adjustment varies quite a bit from year to year, but over time it will exhibit the same type of exponential growth as things like compound interest. I'm afraid your projection that the bands will remain the same is most unlikely to come to pass. Continuing the same rate of increase for the next 16 years would require extremely unusual behavior from CPI - decelerating inflation that exactly balances out the accelerating effects of compounding.


Quote:
Originally Posted by nun View Post
I agree about the basic futility of my efforts, but they were an interesting exercise.
I agree, this has been a most enjoyable and instructive thread. I've learned a lot.
__________________
karluk is offline   Reply With Quote
Old 02-24-2015, 08:27 AM   #11
Thinks s/he gets paid by the post
nun's Avatar
 
Join Date: Feb 2006
Posts: 4,836
The linear fit I'd great for the limited data set, probably not very good for predicting the future. Fitting an exponential would probably not be good either as you'll get lots of equally poorly fitting curves that predict different growth rates and it all assumes no new ax brackets or radical changes, just a nice stead growth of the existing brackets.
__________________

__________________
“So we beat on, boats against the current, borne back ceaselessly into the past.”

Current AA: 65% Equity Funds / 20% Bonds / 7% Stable Value /3% Cash / 5% TIAA Traditional
Retired Mar 2014 at age 52, target WR: 0.0%,
Income from pension and rent
nun is offline   Reply With Quote
Reply


Currently Active Users Viewing This Thread: 1 (0 members and 1 guests)
 
Thread Tools Search this Thread
Search this Thread:

Advanced Search
Display Modes

Posting Rules
You may not post new threads
You may not post replies
You may not post attachments
You may not edit your posts

BB code is On
Smilies are On
[IMG] code is On
HTML code is Off
Trackbacks are Off
Pingbacks are Off
Refbacks are Off


Similar Threads
Thread Thread Starter Forum Replies Last Post
Proposed budget plan would stop backdoor and after-tax Roth rollovers zesty FIRE and Money 2 02-04-2015 12:46 AM
Roth IRA rollovers question Luhar Other topics 9 09-12-2013 08:40 AM
Take SS at 62--Reapply at 70 for Larger Benefit RetireeRobert FIRE and Money 16 04-25-2008 06:30 AM
Buying a larger home: "just enough" or "all the way" Lusitan Young Dreamers 36 03-20-2008 08:00 AM
Hypothetical larger nest egg question cardude FIRE and Money 16 12-05-2007 05:25 PM

 

 
All times are GMT -6. The time now is 12:31 AM.
 
Powered by vBulletin® Version 3.8.8 Beta 1
Copyright ©2000 - 2017, vBulletin Solutions, Inc.