[Sampson]

Hi CMF, been a very long time since I posted or frequented this forum, lurking for about a week now.

Question is about whether to buy back service, but with a twist I haven't seen mentioned yet. I am in a typical gold-plated DB plan, payment is 70% of best 5 consecutive years, indexed to inflation, etc. I will soon have the option to buy back a few years of service, maybe 3 or 4 years max.

I plan or hope to have the ability to stop working in about 5 years, having accumulated 10 years of service (without buyback), and would be able to leave the monies in the plan untouched until 65 yrs to receive the 'full' amount. The twist is that the value of "70% of my best years" will be calculated on my current salary, and that figure will be 'decimated' by inflation over 25 years. Actually with a basic 2.5% inflation estimate, the FV of my current salary would be projected to be half what it is now.

I these gold-plated pension estimates always assume you work the last 5 years earning your maximum salary, however, this is likely not the case for me. In any other scenario I fully believe buying back time is always beneficial, but does my early retirement plan change this? Also, how realistic is the fear that these public pension plans will be severely underfunded 25-30 years from now, and 'austerity' measures will be put into place further reducing the value of the plan?

 

[Woz]

Payment is 70% of your best 5 years after only 15 years of service? That doesn’t seem typical.

 

[cashinstinct]

70% is typically based on 2% per year of Service, assumption on 35 years of service....

 

[Sampson]

Thanks for the correction. So it won't be 70%, but I can't seem to find any information about what the pension amount will be if I chose to leave the funds in the plan and do not continue to contribute.

Without the full service, are payments tied to salary at all?

 

[Woz]

If it’s a typical plan then you’d get years of service * 2% * best 5 year salary unreduced at 65 or when 65 plus years of service equals 85. So if you plan to retire at 40 with 15 years of service you’d need to wait until 65 to get 30% of your salary per year.

One option you may have not considered is that you can buyback the years of service now and then take the commuted value when you retire early. Whether that’s worthwhile depends a lot on how the buyback is structured.

There are a few ways they sometimes do the buyback. One way is you just have to make the normal contributions based on your current salary and the employer contributes their portion. With this way it’s almost always going to be better to take the buyback as the employer contribution is essentially free money. The other common way is they base it on the actuarial value of what the benefit is worth. Whether this is worthwhile will entirely depend on what rate they use.

Most likely the rate they use is going to be favourable as far as guaranteed returns go so I’d probably be inclined to do the buyback and then decide based on interest rates whether I want to take the commuted value when I retire.

 

[NorthernRaven]

I'm not sure what your exact question is? When you leave the employer, they calculate your numbers. So you might leave today at age 45, with 15 years service, and a pensionable salary calculated at however they do it ("average of best 5 continuous years", etc). They would multiply the 15 years by whatever formula (2% per year, say), so you might get an annual payout of 30% of that pensionable salary, starting at age 65, 20 years from now (the feds call this a "deferred annuity"). So if your pensionable salary is $50K, your annual payment would be 30% of that, or $15K. But if your plan is indexed as you say, that $15K amount is going to adjusted by CPI or whatever each year until you actually start paying, so 15 years from now when the payment starts it might be $22K, if inflation runs at 2%. Your payout amount is inflation-protected and won't erode as you seem to fear.

I wouldn't think any of this would affect buyback calculations. Buying back just increases that "years of service" number, and the cost depends on how old the service is, and so on.

I don't know the legal position on public service pension plans, but I would think it would be very difficult to break the basic payout promise for service already accumulated (things like associated health/dental plans might have more room for adjusting). The federal plan was tweaked a few years ago for new hires, increasing ages and employee contributions, etc.

 

[fraser]

I usually assume that the buy back on some of these gold plated pensions is a good deal.

But, does the price of that buyback vary with current interest rates or with your age. For example, I would assume that the service buy back would be most expensive right now given our low interest rates. Not certain if this is so in your case since it may less expensive for you to buy back later on if possible.

I am not knowledgeable in this area...someone else may have the answer at hand. Of course, you always run the risk of them making mods to the plan and eliminating service buy back.

 

[Eclectic12]

... I can't seem to find any information about what the pension amount will be if I chose to leave the funds in the plan and do not continue to contribute.

They didn't give you access to a web site or a guide that provides the formula?

Using the Treasury Board Pension formula to illustrate, the payout formula is:

1.35% x average salary to CPP average max pensionable earnings (AMPE) x years of pensionable service to a max of 35 years
+
2.00% x average salary in excess of CPP AMPE x years of pensionable service to a max of 35 years.

(Note that CPP AMPE for 2015 is $53,600.)


By retiring early, two factors work against you. The first is that ten years of pensionable service does not add to much. The second is inflation, unless the pension is fully indexed.


I don't the time or the back history of CPP AMPE hand so I'll use 2% x average salary x years of pensionable service to illustrate how small the pension could be. For an average salary of $60K, the pension payout = 2% x $60K x 10 = $12K. If your pension uses a similar hybrid formula, the $12K is too big as 1.35% is smaller than 2.00% for a good chunk of the salary.

When one has quit then decides to keep the pension - the average salary number as well as the years of pensionable service number are set in stone.


Are you planning on spending a lot less in retirement than while you are working?
If not, what other sources of income are you depending on as the pension is going to be small?

... Without the full service, are payments tied to salary at all?

Yes ... it is a factor in all the DB pension formulas I have read. For example, the salary factor for my DB pension is "the average of the best five of last seven years worked".


Cheers

 

[Eclectic12]

... I these gold-plated pension estimates always assume you work the last 5 years earning your maximum salary, however, this is likely not the case for me.

I guess it depends on how one views it. Unless one's salary is dropping (say a move to part time hours?) - the last few years working for an employer will always be the higher ones.

I think this also applies to you as you say you plan to stop working. Unless you have hobbies or some other job that is somehow going to pay more than when you were working ... I doubt the employment income after stopping working will increase or be higher.

The big thing is that once you have left the DB pension, no more benefit is being earned plus no more contributions from employer/employee are being put into the plan to pay for the benefits.

... In any other scenario I fully believe buying back time is always beneficial, but does my early retirement plan change this?

Buying back time increases the benefit paid ... the question is whether the $$$ it would cost can be efficiently invested so that the 25 years you talk about would achieve the same or better. This also assumes you are willing to take the time to manage it.

... Also, how realistic is the fear that these public pension plans will be severely underfunded 25-30 years from now, and 'austerity' measures will be put into place further reducing the value of the plan?

Depends on the plan ... some of the plans that were underfunded in 2008 or so are now reporting 110%+ funding where some of the indexing that was dropped is being partially re-introduced. For some other plans, the funding % has improved where the employee contribution rate are on scheduled increased from 10.4% to 11.5% for the up to AMPE and from 12.0% to 13.1% for above AMPE.


Without knowing the plan, it's funding level etc. - it is a crap shoot.


Cheers

 

[Sampson]

But if your plan is indexed as you say, that $15K amount is going to adjusted by CPI or whatever each year until you actually start paying, so 15 years from now when the payment starts it might be $22K, if inflation runs at 2%. Your payout amount is inflation-protected and won't erode as you seem to fear.

This was what I was after. I always assumed the payments indexed to inflation meant only that people already taking the pension will not have that income affected by inflation. Will play with the estimate formula a little while first.

What I didn't mention was that for 2 of those 4 years I can buy back, I have the option of simply taking the employer contributions as cash. Will run the pension estimate numbers with some estimate of longevity, then compare to 'potential' growth if I take the cash, and weigh this against the increase in pension resulting from the extra YOS.

When I look at the problem again, really it amounts to 'how much will my pension be if I retire/stop working for this employer early'.

We will reach 'Findependence' in mid-40's. Income will come from investments, and rental unit(s). No liabilities at that point, and enough funds to cover children.

 

[fraser]

One way to perhaps get a definitive answer might be to engage an actuarial consultant. It will cost you some money but you may end up with a more accurate assessment that will pay you dividends in the future or save you money in the present. I do not think that the fee would be high since this is a fairly common question. The challenge will be to assemble all of the relevant pension plan details so that the consultant spends his/her time analyzing the data and not chasing down the data.

If I was in your position, this is what I would do. I have always been happy to pay for professional legal and accounting advice. In all instances the monetary value of the advice far exceeded the professional fee.

 

[My Own Advisor]

You seem to be in great shape Sampson...

I usually assume, as well, the buy back option for most DB pensions is the way to go...

If you can stop working without the buyback option, and instead, bank that money on your own terms, that might be the best option. You can essentially create your own DB pension-like portfolio if you wish with your own contributions vs. pooling your contributions into the DB workplace plan?

Most DB pensions I know of use a formula of years of service x 2% x the average of your best five years salary. Some offer less than 2% (the silver-plated ones; in the range of 1.5% or so).

If you leave the organization...you are eligible for the pension after age 55, but for an unreduced pension until age 65.

 

[Sampson]

Hi all, thanks for the replies, to add more info, Alberta Provincial Pension Plan, so 1.4% up to YMPE and 2% above and presently reasonably funded.

It seems I was really mixing two issues.

First was the impact of early retirement. Since the pension is not fully inflation-protected, but at 0.6 of Alberta CPI, so there will be some impact on the average salary due to inflation, but not really as severe as I originally feared. Second, value of the buyback vs. taking or keeping money and investing on my own - which IS the typically question.

Since I would like to diversify my nest egg, and hope to live forever, I'm certain the buyback is the best option.

Now to do some PV calculations...and wait 28 years until I can collect my money....

One serious question though, since the salary average is for 5 consecutive years of service, this means if going back to work later at lower salary (part-time), I would need to be careful otherwise it could in fact decrease that average salary amount right? (per eclectic's post#9)

 

[NorthernRaven]

It usually isn't the "last" 5 years, but the "best" five consecutive years, so having some lower values at the end of the string isn't necessarily going to change things. However, be very careful about planning to return to an employer in the same plan after a long absence. At least in the federal plan, doing so resets your calculations, and any indexing on the deferred annuity is wiped out. Say you left early at 45 with a pensionable salary of $40K - by the time it paid out at 65 the indexing might effectively make that a $50K salary base. But if instead you go back to work at say 60 for a year or two, the indexing is reset, and you are back to that $40K amount, but in a world with 15 years of inflation. Unless you can string 5 years of inflation-adjusted salaries to match the old ones, you'll lose out at least to some degree. Make sure you know who uses that plan - for instance the federal plan also covers some crown corporation, territorial governments, etc., all of which can be the same poison-pill for long-gap indexing.

If Alberta is only indexing at 60% of inflation, and you are really planning to defer for 25+ years, it may be worth looking closely at the various commuted/transfer value options. Normally letting things stay inside the plan is a good option, and use any supposed superior investing powers on your own portfolio. But that long a time with only partial inflation indexing might be worth checking to see what return you'd have to make to beat it. Given the guarantee staying in is still probably the wisest move, and the transfer value probably already reflects the partial indexing anyway.

 

[Woz]

One serious question though, since the salary average is for 5 consecutive years of service, this means if going back to work later at lower salary (part-time), I would need to be careful otherwise it could in fact decrease that average salary amount right? (per eclectic's post#9)

Usually it's the max consecutive 5 year average, so returning to a lower paying job wouldn't have a negative impact. In fact your pension would be going up disproportionately as you'd be accumulating service years (pro-rated if part-time). It's somewhat spiking the pension, although it's usually easier to spike it in the last 5 years than the middle. You could work 5 years as CEO with a huge salary and 30 years as a secretary and have your pension based on the amount you were earning when CEO.

 

[Sampson]

However, be very careful about planning to return to an employer in the same plan after a long absence. At least in the federal plan, doing so resets your calculations, and any indexing on the deferred annuity is wiped out.

Very good to know....

Given the guarantee staying in is still probably the wisest move, and the transfer value probably already reflects the partial indexing anyway.

Given how my returns rates have been very good, I could easily make an argument to take the cash, and also not use cash-on-hand to buy back, but ultimately, regardless of how my test calculations turn out, I think this decision would be more about diversifying retirement income sources than maximizing them.

Great advice folks! thanks for the opinions.