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marcusfan: "I am a state employee covered by a state defined benefit pension plan. I have the opportunity to purchase up to four years of service credit. Our pension amount is based on final average pay times 1.7% times years of service.

If I purchased the pension service, in 15 years I would be able to retire two years earlier than I can retire now. The amount required to purchase this service credit is substantial (at least to me). Another benefit to purchasing this service is that my employer bases their contribution for retirees health insurance on years of service and I think that as health insurance costs increase that may be a large factor.

I could probably come up with the amount required within the next six months or so, but how do I determine if that's something I should do. I know there should be some mathematical formula for figuring this out but I am lost.

I already have an emergency fund and contribute the maximum to my 457 plan and my Roth IRA. Also, I understand that if I wanted to I could pay the amount required to purchase the service out of money in my 457 plan. I don't think this is something that I want to do because I couldn't later make this amount up and therefore I lose out on all of the compounding of the amount that I currently have in there. Is this right? Am I missing something that is obvious to everyone else.

I just have no idea where to start when trying to analyze what I should do. Does anyone have any suggestions?"

If you buy 4 years of service, why can you retire only 2 years earlier?

I suspect that it is time to fire up the spreadsheets and run present value analysis. You know what it will cost you to purchase the 4 years of service (in today's dollars). You need to calculate the present value of what those increased pension dollars are worth.

In addition, you might also look at the opportunity cost of the "spending" those current dollars to buy the additional pension dollars, and compare whether investing those dollars in another investment and receiving the reduced pension that would come from not buying 4 years of service might generate more dollars in retirement than buying the additional years of service.

Lots of assumptions will come into play, so to do it right, you probably should create a matrix and control all assumptions but one and then run three scenarios - probable, high and low for the assumtpion (variable) that you are testing.

Regards, JAFO

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