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Pension Option Help
Old 11-27-2020, 07:14 AM   #1
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Pension Option Help

Hi...was hoping I could get some thoughts on which pension option folks here would think would be the best choice for my wife when she retires early next year. She is is in good health, and when she retires she will be 58, so she will, hopefully, live a good long while.

Option 1: She receives a fixed monthly amount until the January after her 62nd birthday, when the amount is fully adjusted by annual increase in the CPI-W. The amount cannot ever decrease if there were any deflation.

Option 2: She receives $193 more per month than option 1....$2318 more per year. That amount is also fixed until the January after her 62nd birthday, but the COLA adjustment works as follows:

If the CPI-W increase is between 0% and 2%, her pension is increases by the full CPI.

If the CPI-W increase is between 2% and 3%, her pension is increased by 2%. (Ex: CPI increases by 2.9%, she gets a 2% increase in her pension; CPI increases by 2.1% she gets a 2% increase in her pension.)

If the CPI-W increases by more than 3%, her pension is increased by the CPI-W minus 1%. (Ex 4.2% inflation translates into a 3.2% increase in pension.)

In Option 2, like Option 1, her pension can never be decreased if there is deflation.

Obviously, the more inflation we have, the better Option 2 is over an extended period of time. I guess the reduced initial pension for Option 2 is effectively the cost of insurance for fully protecting the real purchasing power of my wife's pension over her lifetime. We are pretty risk adverse, so like the idea of that protection, but we are wondering if the insurance is "fairly" priced.

Any perspective would be appreciated. Thanks.
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Old 11-27-2020, 08:25 AM   #2
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You neglected to provide how much the monthly/annual amount is. It is important in determining how much of an increase in inflation there needs to be in making Option 1 ultimately the better choice. Obviously in the early years, Option 2 will likely net more. However, how high does inflation need to be and for how long before Option 1 looks better?

Without any additional information, I'd say that Option 2 is better, considering that the Fed's objective is to keep inflation right around 2% - and yet, they have not been able to do that for the past 10 years.
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Old 11-27-2020, 08:44 AM   #3
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+1. Hard to judge without knowing how much the +193 is as a percentage. Given the Fed's 2% target I would think that Option 2 would be preferable.

So if inflation is 2% the under option 1 she would get 2% and under Option 2 she would get +193 + 2%.

If inflation is 3% the under option 1 she would get 3% and under Option 2 she would get +193 + 2%.

But OTOH, why get greedy.... it's hard to argue against a straight forward COLA like in Option 1 especially since it would better protect you against hyper inflation.

Flip a coin?
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Old 11-27-2020, 09:01 AM   #4
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Looks like what they did was grandfather (i.e. freeze) the old COLA methodology on the benefit accrued at some point, then went with the new cola methodology on the entire benefit. For us to opine, we need both pieces.
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Old 11-27-2020, 09:05 AM   #5
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Originally Posted by pb4uski View Post
+1. Hard to judge without knowing how much the +193 is as a percentage. Given the Fed's 2% target I would think that Option 2 would be preferable.

So if inflation is 2% the under option 1 she would get 2% and under Option 2 she would get +193 + 2%.

If inflation is 3% the under option 1 she would get 3% and under Option 2 she would get +193 + 2%.

But OTOH, why get greedy.... it's hard to argue against a straight forward COLA like in Option 1 especially since it would better protect you against hyper inflation.

Flip a coin?
I agree with pb for the highlighted reason
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Old 11-27-2020, 10:48 AM   #6
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FWIW, we had some really big inflation numbers from 1970 to the mid 1980's. It can happen.

https://www.in2013dollars.com/inflation-rate-in-1970

I would go with the #1 - the full COLA option. My guess is that this is one of the last times anybody will offer you, me or the man behind the tree a COLA'd pension plan.
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Old 11-27-2020, 10:53 AM   #7
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Originally Posted by pb4uski View Post
... it's hard to argue against a straight forward COLA like in Option 1 especially since it would better protect you against hyper inflation. ...
+1 That would be my choice too. Hyperinflation will probably never come, and my house will probably never burn down. But I buy fire insurance and, through buying TIPS, I buy inflation insurance.

That said, @ProGolferWannabe, your answer will depend on where this wonderful COLA pension fits in your overall assets and spending picture. If this pension is a minor piece of the plan, you won't miss that $193. If OTOH the $193 would be a critical piece of your spending then you may decide to forego the hyperinflation insurance.

Either way, if I read the post correctly, you are not protected against inflation for the first four years. Probably nothing can be done about that.
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Old 11-27-2020, 11:00 AM   #8
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You didn't say if the COLA is compounded with future COLA's. My pension doesn't. This means that the pension amount I started with is what the COLA for all future years is based on. For example; lets say I started retirement with a pension of $5000 a month. My first COLA is 2% or $100, making my pension now $5100 a month. Next COLA is also 2%. It also is $100, not 2% of $5100, the base pension plus first year's COLA, but just the base starting pension.
Since all future COLA's are based on the original starting pension when first retired, it benefits me to make that amount the highest I could get it. In your case, Option 2 offers the larger initial pension, making all future COLA increases that much larger. I realize future increases on Option 2 are capped at 2% until inflation reaches 3%, but there's risk in everything.
However, if all future inflation adjustments are compounded, then go for option 1.
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Thank you...more info
Old 11-27-2020, 12:42 PM   #9
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Thank you...more info

Thanks to everyone who has shared their thoughts. In response to some of your comments, let me share the following:

(1) The Monthly Pension amount that is fully adjusted for inflation starts out at $5862/month. The Monthly Pension amount for the reduced COLA pension is $6055...$193/month more.

(2) The COLAs in either case are compounded with future COLAs....so NOT just based on the first year’s pension amount.

(3) The loss of/or addition of $193/month really won’t have any meaningful impact on our spending or lifestyle given our spending patterns, income streams, and assets. In thinking about it that way, and consistent with what some of you shared about protecting some portion of our income against long bouts of inflation, it probably makes taking the fully COLAed pension a more logical choice.
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Old 11-27-2020, 12:52 PM   #10
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That's one very nice pension.... I'd take Option 1 to hedge hyper-inflation risk, but a fair argument could be make that either one are fine. Since you would have hyper-inflation risk covered you could make a case that you don't need as much equity exposure in your AA.

I'm guessing that they are designed to be actuarially equivlalent in theory.
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Old 11-27-2020, 12:54 PM   #11
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Quote:
Originally Posted by ProGolferWannabe View Post
... The loss of/or addition of $193/month really won’t have any meaningful impact on our spending or lifestyle given our spending patterns, income streams, and assets. In thinking about it that way, and consistent with what some of you shared about protecting some portion of our income against long bouts of inflation, it probably makes taking the fully COLAed pension a more logical choice.
That makes sense to me. It's basically what we have done by buying a slug of TIPS and foregoing the slightly higher yield we could have with conventional T-bills, notes, and bonds. As I said, we don't expect our house to burn and we don't expect hyperinflation, but we can afford to buy insurance against both, so we do.
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