Update: Complicated retirement options thread

[utrecht]

Here is a thread I started in Sept 2012.
http://www.early-retirement.org/forums/f28/poll-complicated-retirement-withdrawal-options-63111.html

The thread talks about some complicated retirement options I had (have). To summarize: my wife and I both have pensions coming. At that point we were planning on retiring between June 2014 and June 2015. We have the option of having the pension checks deposited directly into a DROP account which is an interest bearing account that guarantees 8-10% depending on market returns of the pension fund. In that case we would live off of our IRAs, 457b ect and then at some point when our money starts to run out, we start collecting our pensions along with the interest from the DROP balance. My challenge was that 8-10% interest sounded too good to be true to me and many of the people who posted in the thread. If I let the DROP account build up and spend down my personal assets, and then the pension fund was forced to lower the interest rate, I could take a big hit to my retirement spending. There was no talk whatsoever about it, but everything in my gut told me that a lowering of the interest rate was inevitable.

Update: We have decided to retire in Jan 2015 on my 50th birthday. That's earlier than we had originally planned but later than we need to financially. I have much more flexibility with my pension options if I leave after 50. Here's the BIG update. The pension board has decided that changes need to be made to the DROP program. They are having meetings and listening to suggestions. At some point later in the year they will put their recommendations up for a vote of the members. So far its looking like the recommendations will be that 1) DROP accounts will be capped at some dollar figure and 2) The interest rate will be lowered. Possibly to 5%. Some have suggested it should be the 10 yr rolling avg minus 2%.

It looks like my (and others) predictions have come true that the interest rate was unsustainable. It was fine for a while but as more and more people joined the program, the total amount of money in DROP accounts became a larger and larger percentage of the total funds and the high interest rate has now become a problem. The pension fund itself is doing very well. Its ranked one of the best in the country. Partly because the board is willing to make changes to lower certain benefits when necessary.

Anyway, now I have to decide if its worthwhile to even use the DROP program at all if the interest is only 5%. A steady 5% is still not bad, but my assumptions are that my other investment funds will beat 5% long term.

 

[haha]

Anyway, now I have to decide if its worthwhile to even use the DROP program at all if the interest is only 5%. A steady 5% is still not bad, but my assumptions are that my other investment funds will beat 5% long term.

With the 30 year treasury less than 4%, I would think long and hard about giving up a guaranteed 4%, which I assume is a floor, not a cap. You group must have political power, or you would not have this offering, so it is likely if inflation sped up your rates would increase. Maybe you have details on this?

Ha

 

[utrecht]

Its early in the process of things changing right now. Discussions are under way to come up with possible changes. At some point later this year the board plans to bring something to a vote. Right now its looking like they want to change the interest rate from a 8-10% range to a flat 5%. So it wouldn't be a floor or a ceiling.

 

[Walt34]

Assuming your time horizon before you start withdrawing from the DROP is short, say 1 - 3 years, or even a bit longer, a guaranteed 5% isn't something I'd turn up my nose at.

But of course it depend on when you'll need the DROP money and what you believe you can do elsewhere.

 

[utrecht]

Here is the latest update:

A pension election was held to lower the DROP interest rate to a fixed 5% (its currently 8-10%). The day before the election a small group or retirees filed for an injunction to stop the election. These retirees want to continue to receive 8-10% on their DROP balances. The judge denied the injunction. The election passed with 88% voting YES. There were a few other smaller changes included in the pension amendment that aren't that interesting.

Immediately following the certification of the election results, this same group of retirees filed for another temp injunction to prevent the pension board from implementing the approved changes. The hearing date has not yet been set. The interest rate is set to drop to 7% next Oct, then 6% the following year, then 5% the following year. There are triggers that allow the interest rate to rise or fall with the funding ratio of the overall pension but they are wide bands and the interest rate will most likely stay at 5% (assuming the injunction is not granted).

Personally I dont think any court is going to stop an amendment approved by an overwhelming majority of its members to pass an adjustment that will strengthen the pension fund long term. I believe the plaintiff's position is that the amendment should be disallowed because retirees are not allowed to vote. Only working members can vote. It should be noted that these very same retirees voted to pass the rule that says retirees cant vote many years ago. (There are many people in the DROP program that are still working and can vote).

 

[utrecht]

Since it's inception about 10 years ago, the DROP program has cost the pension fund $300 million by paying out excess interest over and above the returns the pension fund earned on that money. This is a $3 billion fund so 10% of the fund was lost to excess interest. I believe they estimated that money would be made up in the next 10 yrs or so by paying 5% when the fund hopefully earns more than 5% yearly on that money.

 

[clifp]

Immediately following the certification of the election results, this same group of retirees filed for another temp injunction to prevent the pension board from implementing the approved changes. The hearing date has not yet been set. The interest rate is set to drop to 7% next Oct, then 6% the following year, then 5% the following year. There are triggers that allow the interest rate to rise or fall with the funding ratio of the overall pension but they are wide bands and the interest rate will most likely stay at 5% (assuming the injunction is not granted).

Personally I dont think any court is going to stop an amendment approved by an overwhelming majority of its members to pass an adjustment that will strengthen the pension fund long term. I believe the plaintiff's position is that the amendment should be disallowed because retirees are not allowed to vote. Only working members can vote. It should be noted that these very same retirees voted to pass the rule that says retirees cant vote many years ago. (There are many people in the DROP program that are still working and can vote).

Argh some people are so F*ing greedy. I'd be tempted to sue them just to recover the legal fees the pension fund is going to spend defending against such a stupid lawsuit.

The difference between 8-10% and 5% is the difference between a no brainer (I am pretty sure I said that original thread) and a pick um. You are a smart guy, with a good understanding of the market, I am sure you can do better most decades. It also sounds like your pension and SS (eventually) will fund a comfortable retirement. So even if the market/economy goes south you're ok.

I'd certainly keep a reasonable amount of money in it, and basically use it a as substitute for fixed income. It is like the 10 years 5% Penfed CDs from a few years ago, of course I'd have done much better with investing in the market, but I actually regret not maxing out to the FDIC limit.

 

[Quantum Sufficit]

In this environment I would give my arm for 5%!!

 

[PhrugalPhan]

I don't have much to add, other than where I work there is a DROP program too, though I thought the delayed payout (and interest - though I don't know the rate off hand) stopped once you stopped working for the employer. I'm nowhere near the point I could enter DROP, but I will make sure to see if this option exists. I have to doubt it does exist as my employer is pretty smart about taking market risks like that (and I figure I would have heard about this option).

 

[utrecht]

Update:

This is hard for me to believe, but a court has ruled that the amendment passed by 88% of the voting members is invalid and violates the Texas Constitution section that says that benefits can not be lowered. The Pension Board is appealing of course.

The amendment was to lower the DROP interest rate from a mandatory 8-10% (based on previous 10 yr rolling returns of the pension fund) to a fixed 5%. So even though just about anyone who knows anything about investment returns and / or pension issues knows that a guaranteed 8-10% return is unsustainable, the court has ruled that the interest rate can not be lowered even when the members want it lowered. This DROP interest rate is paid on your DROP account balance going forward. Nobody would lose any benefits already earned in the past and yet the court still would not allow the amendment. This boggles my mind.

 

[clifp]

Wow this mind boggling.

At 8-10% might as well put as much money as you can it, just make sure you study the financials very carefully and be prepared to take the money out before it goes broke..

Oh and if they accept outside money, I'm interested. I'll happily make a contribution to the Police Benefactor fund or whatever

 

[growing_older]

Sounds like the people drafting these rules, and those making decisions about them, do not actually understand the financial implications of their choices. It won't be the first or last time.

Voltaire became hugely wealthy by exploiting a flaw in the French lottery.
In 1729, Voltaire teamed with mathematician Charles Marie de La Condamine and others to exploit a lucrative loophole in the French national lottery. The government shelled out massive prizes for the contest each month, but an error in calculation meant that the payouts were larger than the value of all the tickets in circulation. With this in mind, Voltaire, La Condamine and a syndicate of other gamblers were able to repeatedly corner the market and rake in massive winnings. The scheme left Voltaire with a windfall of nearly half a million francs, setting him up for life and allowing him to devote himself solely to his literary career.

 

[NW-Bound]

This is hard for me to believe, but a court has ruled that the amendment passed by 88% of the voting members is invalid and violates the Texas Constitution section that says that benefits can not be lowered. The Pension Board is appealing of course...

When there are more and more benefits that become birthright because of stupid past promises, the solution is to have high inflation that will wash away all those liabilities. Problem solved.

 

[clifp]

When there are more and more benefits that become birthright because of stupid past promises, the solution is to have high inflation that will wash away all those liabilities. Problem solved.

LOL true. But despite some Texan's wishes they aren't an independent country and have harder time inflating the currency.

 

[utrecht]

Another update for anyone who was interested in this thread:

Our pension fund had a vote of the members lowering the DROP interest rate to 5% from a variable 8-10% return. There was a lawsuit and the judge ruled that the amendment was unconstitutional based on the fact that the Texas Constitution says that no accrued benefits can ever be lowered or taken away.

The judge has reversed her decision and has ruled that the interest paid in the future is NOT an accrued benefit (Duh!). So the amendment has been put in place. This is a major step towards strengthening the pension fund going forward. It is currently about 80% funded but was leaking money into the DROP plan by paying more in interest than that money had earned in the past 7 years or so.