Skip to main content
No. of Recommendations: 0
My wife and I are trying to decide whether to buy 3-6 years of service credit in her state retirement plan or put that same money to work in the market. We have a sizable and growing (thanks to MF) investment portfolio which we will continue to contribute to for the next 10-15 years.

My current thinking is to buy service credit - it is a guaranteed benefit and balances our retirement income streams by increasing the pension payment.

What do others think.
Print the post Back To Top
No. of Recommendations: 0
What does it buy you and what is the cost? How secure is the pension fund? I'd guess that in most cases, buying the service credit is a good deal.
Print the post Back To Top
No. of Recommendations: 1
akck asks,

How secure is the pension fund?

I'd be more comfortable buying service credits on a Federal pension. At least they have the flexibility of printing more money if things turn South.

intercst
Print the post Back To Top
No. of Recommendations: 4
My current thinking is to buy service credit - it is a guaranteed benefit and balances our retirement income streams by increasing the pension payment.
A guarantee is only as good as the guarantor. Think about all the Detroit civil service retirees and their "guaranteed" pensions.

I would keep the money in your name.
Print the post Back To Top
No. of Recommendations: 0
The state pension fund is conservatively managed and fully funded. We live in Colorado, with a stable and growing economy, so I think the pension is a very secure asset.

Each year, up to 6 years buys a 3-4 percent increase in pension payout. Pension is a percent of highest average salary, so for each year purchased, her payout increases by 3-4%.
Print the post Back To Top
No. of Recommendations: 6
The state pension fund is conservatively managed and fully funded. We live in Colorado, with a stable and growing economy, so I think the pension is a very secure asset.

Even so, how much of your retirement income will this pension represent? And how much will this 6 year buy in equal?

You could be putting yourself in a position of someone buying company stock and it representing 80% of their retirement. Strong company, massive market share, etc., etc., etc., until it doesn't. And then retirement is delayed or totally disappears. I'm sure Illinois and California pensions looked good at one time.

I lean toward keeping the money in my own name.

JLC
Print the post Back To Top
No. of Recommendations: 6
JLC writes,

Even so, how much of your retirement income will this pension represent? And how much will this 6 year buy in equal?

You could be putting yourself in a position of someone buying company stock and it representing 80% of their retirement.

</snip>


JLC makes a good point.

A retiree hopefully has a three-legged stool of a pension, Social Security, and an investment portfolio holding up his or her retirement. You don't want to let the pension leg get so large that a failure of the pension would sink your retirement. Unlike private pensions which are backstopped by the Pension Benefit Guaranty Corp (PBGC), state and municipal pension don't enjoy an equivalent guarantee.

Somebody mentioned the Detroit bankruptcy and possible loss of pension benefits. Like some 6 million other state and municipal workers Detroit employees don't pay FICA and don't get Social Security benefits. They started with a two-legged stool at best.

I believe Colorado is among the states where most public sector workers don't pay FICA or get Social Security.

intercst
Print the post Back To Top
No. of Recommendations: 1
It is impossible to answer such a question in a void. The first thing I looked up, which may or may not be reliable, listed Colorado as the 37th most secure state pension fund, about 66% funded:

http://www.chicagobusiness.com/article/20130110/NEWS07/13010...

Another factor is your age and job security. In Virginia, pensions start making sense if you reach the 20, 25, and 30 year marks. If you have to retire before that, the pension is very modest.

In my wife's case, she is one or two years away from the 20 year mark, at which point the monthly number jumps from about $1000-1100 per month to $1700, and if she makes it to the 25 year mark it jumps to over 2300 per month, and at thirty it jumps to over $3000 per month.

My wife bought 4 years about 15 years ago. In my wife's case it may work out because she is nearing the 20 year mark and her pension provided a nice hedge against the crashes of 2000-2, and 2008-9. At the moment, the money she put into the pension will produce more income than an equal amount of money in her IRA based upon a withdrawal rate of 4%.

Whether that will be true five years from now, is unkown. And of course she owns the corpus of the IRA and not just the monthly income, which provides a measure of flexibility that the pension does not offer.

If possible, I recommend both - buy the years and max the 403(b).
Print the post Back To Top
No. of Recommendations: 0
One advantage of a state pension fund over a municipal pension fund is that a state cannot declare bankruptcy. So comparisons to Detroit are unwarranted. Some state pension funds are protected in the state constitution, making changes to promised benefits more difficult (can only affect new hires). Unfortunately, Colorado isn't one or them. That said, you're likely more familiar with the Colorado state pension, state politics and what they might do for pension changes.

So what it comes down to is the cost for the extra 3-4% per year purchased. You can perform a simple IRR or NPV on the cash flows to determine the rate of return on the purchase. If it's relatively good, that is, better than or equal to what you could do yourself, then I'd lean toward purchasing the years. If the pension is inflation protected, I'd just ignore it and assume the number is the real rate of return.

Many here tout the benefit of delaying SS until age 70, to get an additional 8% per year. I find buying pension years to be no different than that. So if the return makes sens to you, I'd buy the years.
Print the post Back To Top
No. of Recommendations: 4
Is there any pressing need to make this decision now?

My assumption is that once you choose to buy some years in the retirement plan, you can't change your mind and get your money back. Can you buy the years of credit later? Ideally, you could buy them just before retirement and choose whether to increase her retirement benefit then or just use the money during her retirement.

If you have to choose now, you also have to factor many uncertainties into your decision. Not just the uncertainties of investment returns, but also the uncertainties around life. Will she continue to work there until retirement? Will you get a new job in a different city and want to move, ending her employment before retirement? Will there be a disability or injury or illness that prevents her from working?

This strikes me as the kind of decision that is best delayed as long as possible.

--Peter
Print the post Back To Top
No. of Recommendations: 1
Well, the question is not well formed. "Buy stocks" can mean just about anything. You need a strategy of timing and selection - when to buy and then what to buy. Also, how to know when to sell a stock whether it is a winner or a loser.
Print the post Back To Top
No. of Recommendations: 0
JLC, yes, you're right, colorado state pension employees do not contribute to Social Security.

The comments and perspectives I've received have us carefully evaluating our position and looking into how to invest the same "purchase" money to balance her retirement income streams.

Thank you.
Print the post Back To Top
No. of Recommendations: 0
Peter, the time pressure is that she recently got a very large promotion and raise. Buying years now means the purchase would be based on her lower salary and the payout would be based on her higher salary.

Lower salary is 75k, higher salary is 115k. If we buy now, the cost of the years is as low as it will ever be. But the unpredictability of life is another strong rational for keeping the purchase money in an investment account vs. buying years. She has approximately 8 years left until retirement, but there's no way to know if she will serve all 8 of those years in the Colorado school system.

So much to consider! I'm leaning toward a split decision buy a few years and invest the rest. But I'm still evaluating all the angles and ideas generated here from Fool replies.
Print the post Back To Top
No. of Recommendations: 0
Joel,

My investment strategy is well aligned to the SA and MDP strategies. I'd invest the money long term in strong companies I believe in and sell when I no longer see a long term investment potential for the holding.
Print the post Back To Top
No. of Recommendations: 0
IRR and NPV - more things to look up, learn and use to evaluate our decision. I'm so glad I posted this question! Thank you.
Print the post Back To Top
No. of Recommendations: 0
Here are the numbers. It currently costs 27k to purchase 1 year. She plans to retire in 7-8 years.
The purchase price is based on current salary, 75K, and the pension benefit is based on highest average salary(HAS). She recently had raise/promo to 115k which should grow modestly over the next 7-8 years by 1-3% per year.

By purchasing years, she increases her pension benefit payout percent as follows
no purchase, pension = 27.5% of HAS
purchase 3 yrs, pension = 37.8% of HAS
purchase 6 yrs, pension = 50% of HAS

One essential consideration is the risk that she will not be able to or want to work in the system for 7 years. If a better opportunity presents itself, we would hate to be locked into this commitment.
Print the post Back To Top
No. of Recommendations: 2
Do you have ANY idea how fast 8 years will fly by?

AM
Print the post Back To Top
No. of Recommendations: 0
It currently costs 27k to purchase 1 year.
By purchasing years, she increases her pension benefit payout percent as follows
no purchase, pension = 27.5% of HAS
purchase 3 yrs, pension = 37.8% of HAS
purchase 6 yrs, pension = 50% of HAS


Just doing some quick calculations: purchasing 6 years, it would cost $162k and take 6.26 years to get that money back via increased pension payout. 3 years, $81k and 6.83 years. This is very rudimentary and doesn't take into account investing that money on your own, survivor benefits, etc.

To really help decide how good an option this is, how much would it cost if you waited a year or two? I know you said current buy back is based on lower pay scale, what would it be at her newer pay scale?

JLC
Print the post Back To Top
No. of Recommendations: 13
Here are the numbers. It currently costs 27k to purchase 1 year. She plans to retire in 7-8 years.
The purchase price is based on current salary, 75K, and the pension benefit is based on highest average salary(HAS). She recently had raise/promo to 115k which should grow modestly over the next 7-8 years by 1-3% per year.

By purchasing years, she increases her pension benefit payout percent as follows
no purchase, pension = 27.5% of HAS
purchase 3 yrs, pension = 37.8% of HAS
purchase 6 yrs, pension = 50% of HAS



Okay, a quick IRR (internal rate of return), shows that the added income stream produces a 14-15% return on your initial investment. This was assuming she'd get an additional 10.3% with 3 years, 22.5% with 6 years, retirement in 7 years and payout for 20 years. It's also based on a HAS of $115,000, so the return will be greater assuming her pay increases.

I think a guaranteed 14% return is worth it. I'd go over the numbers with her and encourage her to stay long enough so her HAS is over $115,000. At some point, the retirement benefit plays a bigger role in career decisions and hopefully she'll stay long enough to lock in a higher HAS.

I know if I had an opportunity to lock in that return on my pension, I'd jump on it.
Print the post Back To Top
No. of Recommendations: 3
I think a guaranteed 14% return is worth it.

Again, a guarantee is only as good as whoever stands behind it. All the laws & state constitutional requirements mean nothing if/when the state has no money.

I'd look at it from the "eggs in one basket" viewpoint. You are voluntarily shifting retirement money that's in your name (IRA, etc.) to an account that is not in your name nor under your control.

Yeah, 14% is great. Kinda too good to be true. From a risk standpoint, I'd rather have some of my retirement income coming from my own accounts rather than having most of it coming from a pension.

A big part of making this decision depends on how much of your retirement income would come from different sources.
I'd look at it from the "what if things go terribly wrong" aspect. What would happen if you paid all that money by buying years, but when it came time to collect on the pension, they said, "Sorry, we've had to change the deal."?
Print the post Back To Top
No. of Recommendations: 6
akck:

<<<Here are the numbers. It currently costs 27k to purchase 1 year. She plans to retire in 7-8 years.
The purchase price is based on current salary, 75K, and the pension benefit is based on highest average salary(HAS). She recently had raise/promo to 115k which should grow modestly over the next 7-8 years by 1-3% per year.

By purchasing years, she increases her pension benefit payout percent as follows
no purchase, pension = 27.5% of HAS
purchase 3 yrs, pension = 37.8% of HAS
purchase 6 yrs, pension = 50% of HAS>>>


"Okay, a quick IRR (internal rate of return), shows that the added income stream produces a 14-15% return on your initial investment. This was assuming she'd get an additional 10.3% with 3 years, 22.5% with 6 years, retirement in 7 years and payout for 20 years. It's also based on a HAS of $115,000, so the return will be greater assuming her pay increases.

I think a guaranteed 14% return is worth it. I'd go over the numbers with her and encourage her to stay long enough so her HAS is over $115,000. At some point, the retirement benefit plays a bigger role in career decisions and hopefully she'll stay long enough to lock in a higher HAS."


I do not recall whether there are survivor benefits to you after she dies, but the IRR calculation assumed that you wife would live for another 27 years.

According to the SS Actuarial Life Table:
http://www.ssa.gov/oact/STATS/table4c6.html

Average life epxectancy for a is 26.87 years, less than the 27 years assumed, and IIRC the table correctly, means that there is roughly 50% chance that se will not live than long.

You know her health, and her gene pool, but I am certain that the IRR would decrease if the assumption was "retirement in 7 years and payout for 10 years".

Unless you get 100% survivor benefits, without a reduction in her initial payment amount, her death would end the income stream and leave you without the assets used to purchase the years.

In addition, unless you get 100% survivor benefits were without a reduction in her initial payment amount, it is possible that the IRR calculations above are off. And I even never seen a pension that pays 100% survivor benefits without reducing the amount that would be paid if paid only to the pensioner for his or her life.

Regards, JAFO
Print the post Back To Top
No. of Recommendations: 0
Again, a guarantee is only as good as whoever stands behind it. All the laws & state constitutional requirements mean nothing if/when the state has no money.

The financial stability of a pension plan is always a concern and as I questioned earlier, the OP and other Colorado pension recipients should be well aware of its viability and what legislators can and can't do to it. One protection is that the state can't declare bankruptcy to get out of paying benefits.

What would happen if you paid all that money by buying years, but when it came time to collect on the pension, they said, "Sorry, we've had to change the deal."?

I agree that there should be another source of retirement income, but it's unlikely they'd be able to change the deal since it's the employees contributing from their salaries. The likely outcome is that the deal is changed for new employees. That's what happened in my state where there are 4 pension tiers, changes affecting new hires with each tier change. However, pension benefits are protected in the constitution (I believe only 9 states do this).
Print the post Back To Top
No. of Recommendations: 0
I do not recall whether there are survivor benefits to you after she dies, but the IRR calculation assumed that you wife would live for another 27 years.

The fun thing with spreadsheets is that you can do what-if scenarios to better fit your situation. Hopefully the OP will do so. One potential error in your analysis, is that she may be able to retire earlier than your assumption. I believe 60 is a possibility.
Print the post Back To Top
No. of Recommendations: 0
akck:

<<<I do not recall whether there are survivor benefits to you after she dies, but the IRR calculation assumed that you wife would live for another 27 years.>>>

"The fun thing with spreadsheets is that you can do what-if scenarios to better fit your situation. Hopefully the OP will do so. One potential error in your analysis, is that she may be able to retire earlier than your assumption. I believe 60 is a possibility."

Possibly. It was not clear in my earlier post (unless you clicked ont he linked table), but the 26.87 life expectancy was for a 57 year old woman.

If instead OP's wife can retire at sixty, she may be only 52, in which case average life expectancy would be 31.24, which would clearly change the analysis, but still subject to the wife's general health and gene pool, and still subject to the questions regarding payout choices previously noted.

Regards, JAFO
Print the post Back To Top
No. of Recommendations: 3
We live in Colorado, with a stable and growing economy, so I think the pension is a very secure asset.

I'd suggest doing some research on the soundness of the pension. Is it Colorado Public Employees' Retirement Association? Here are two articles:

http://www.denverpost.com/ci_22101268/report-colorados-publi...
"The Colorado Public Employees' Retirement Association is one of 21 state pension funds that are not "fiscally sound," according to a national investment research firm."

http://gazette.com/future-of-colorado-retirement-plan-in-dou...
"The financial stability of Colorado's $42 billion state pension fund will get worse before it gets better."
Print the post Back To Top
No. of Recommendations: 1
The financial stability of a pension plan is always a concern and as I questioned earlier, the OP and other Colorado pension recipients should be well aware of its viability and what legislators can and can't do to it. One protection is that the state can't declare bankruptcy to get out of paying benefits. ...
However, pension benefits are protected in the constitution (I believe only 9 states do this).


Let me highlight the crucial part of what I said earlier: All the laws & state constitutional requirements mean nothing if/when the state has no money.

I recall reading a couple of years ago that California paid income tax refunds with VOUCHERS rather than cash. They didn't declare bankrupcy but they didn't have the money, so they gave out Monopoly money.

FWIW, looking at it from the viewpoint of a citizen & taxpayer, I'd call "pension benefits are protected in the constitution" a scam perpetrated upon the citizens by the people who ran the government. I read it as, "I've got mine Jack, and you peasants just have to suck it up and pay me." And it can be nullified if/when the citizens get sufficiently motivated.

But aside from all that political stuff, it's vital to look at the issue from the risk & asset/income allocation viewpoint. Money in your own account titled in your own name is YOURS. Money that the government has promised that they'll give to you is NOT yours.

Buying years is not the same as buying an asset (stocks). You are giving them money in exchange for them promising that they'll give you a larger monthly check in the future after you retire.
Print the post Back To Top
No. of Recommendations: 0
it's unlikely they'd be able to change the deal since it's the employees contributing from their salaries.

You are joking, right? Or maybe you don't remember the 1986 tax reform? That's when Social Security benefits became subject to income tax -- so your SS benefits got taxed both when you paid in and when you took out.
Print the post Back To Top
No. of Recommendations: 0
I live in CO and have been in the system at various times.

I don't think it is as simple as some of the replies portray.

If you are covered by social security and you have been married at least 10 years, you have more scenarios to cover. The coordination of benefits as well as the health insurance scenarios are all part of it. You also need to look at what would happen if each of you dies at what point.
Print the post Back To Top
No. of Recommendations: 1
Let me highlight the crucial part of what I said earlier: All the laws & state constitutional requirements mean nothing if/when the state has no money.

A state having no money does not relieve them from the obligation. If push came to shove, the pension fund would be first in line to be made whole. While I don't believe that's the case in Colorado, it is in 9 other states.

FWIW, looking at it from the viewpoint of a citizen & taxpayer, I'd call "pension benefits are protected in the constitution" a scam perpetrated upon the citizens by the people who ran the government. I read it as, "I've got mine Jack, and you peasants just have to suck it up and pay me." And it can be nullified if/when the citizens get sufficiently motivated.

But, that doesn't change the end result. In 9 states, government worker pensions are protected and the state cannot get out from under them. Legislatures can certainly change pension laws, but those changes can only affect future hires. Even if the state constitution is changed, the state can't reverse prior pensions. At least in Alaska, court cases have ruled against the state in changing current employees pension benefits.

But aside from all that political stuff, it's vital to look at the issue from the risk & asset/income allocation viewpoint. Money in your own account titled in your own name is YOURS. Money that the government has promised that they'll give to you is NOT yours.

Buying years is not the same as buying an asset (stocks). You are giving them money in exchange for them promising that they'll give you a larger monthly check in the future after you retire.


I think it's been clear that having several sources of retirement income is a must and I believe the OP does have retirement investments. In essence, the OP is investing in a managed fund that will give them a specified return upon retirement. Is it riskier than any other managed fund? No, in fact it is safer because the OP will be entitled to all of their principal plus 4-5% interest at minimum. Any arguments that if the state runs out of money are not applicable since the money doesn't belong to the state in the first place. They are in a separate fund that cannot be used to run state operations.
Print the post Back To Top
No. of Recommendations: 1
A state having no money does not relieve them from the obligation.

Wanna bet? Try to get these thieves in Detroit to regurgitate the "13th checks" they received for two decades.

$1 billion in pension bonuses
http://www.freep.com/article/20130908/NEWS01/309080062/Detro...

Detroit is doomed and there's nothing your fantasy scenario can do about it.
Print the post Back To Top
No. of Recommendations: 1
I recall reading a couple of years ago that California paid income tax refunds with VOUCHERS rather than cash. They didn't declare bankrupcy but they didn't have the money, so they gave out Monopoly money.

Which vouchers were eventually redeemed in real cashola.
Print the post Back To Top
No. of Recommendations: 1
Detroit is doomed and there's nothing your fantasy scenario can do about it.

When did Detroit became a state? Cities can declare bankruptcy. States cannot. All my references were dealing with state pensions only. Detroit references don't apply here.
Print the post Back To Top
No. of Recommendations: 0
10 Most Threatened State Pension Plans

http://finance.yahoo.com/news/10-most-threatened-state-pensi...

Apparently Colorado is not in the bottom 10.

Regards, JAFO
Print the post Back To Top