CalPERS Question

[bikebum]

Hi everyone.

I am a county employee in CalPERS (2% @ 55 formula). The benefit is based on your max salary. If there is a gap between when you stop working and when you start receiving your benefit, is your max salary adjusted for inflation through the gap period?

Here's an example: Say I stop working at age 35 when my salary is 90K, and I start receiving my benefit at age 55. Will my benefit be based on max salary of 90K (back when I was 35), or will it be adjusted for inflation over the 20 year gap?

I'm guessing it won't be adjusted for inflation, since the system seems to be designed for people to work full time right up to when they retire and start receiving their benefit. Although it seems like a lot of people would be part of CalPERS, then go work somewhere else for the rest of their career and be in the same boat.

[Rust]

Do you have a PPPA provision?

If so this link will help.

http://www.calpers.ca.gov/index.jsp?bc=/member/retirement/your-retire/cola-pppa/pppacalculationexample.xml

[bikebum]

Rust, thanks for the link. But unless I am missing something, the PPPA only protects your benefit from "retirement date", not when you stop working. I have not yet found anything that answers my question.

The closest I have come is if you switch to another retirement system that CalPERS has a reciprocity agreement with, they will base your benefit on the highest salary out of the two systems.

[Another Reader]

No, you will receive the benefit based on the whatever formula your County uses (final or highest x number of years).  There is no indexing.  I get a CalPERS pension, based on my highest three years.  People in the same position today make almost twice as much as I did when I left many years ago.  With the same years of service, someone retiring today at the same age would receive nearly twice as much.

[bikebum]

Another Reader, so your pension does not have PPPA? Did you have the option to transfer your contributions to your own account when you retired? If you did, what helped you decide to take the pension instead?

I'm pretty sure I can take my contributions out of CalPERS when I retire; guess I'll have to make that decision when the time comes.

[Another Reader]

I don't recall the PPPA provision, but the link indicates it should exist.  It's based on the year of retirement, not the year you left service.  Since the annual increases have largely tracked the CPI, there has not been that much loss in purchasing power.  I do know some retirees that retired from a 1937 Act County in the 1980's that are benefiting from increases beyond CPI (something similar to PPPA).

IIRC, interest was originally credited to the CalPERS account at 7 percent.  I think that might have dropped to 6 at some point.  Check your annual statement for the crediting rate.  I never for an instant thought of giving up the pension in favor of rolling over the principal.  CalPERS was (and largely still is) one of the more solid plans around.  Why would I want to take on market risk over a no-cost annuity steadily growing at that rate basically backed by the taxpayers?

This is not bad.  It's as if you deposited money in an account and it compounded at a predictable rate essentially risk free.  If you leave CalPERS and go somewhere else, you join that retirement plan or get a 401k for the time you are employed there.  In the meantime your principal in the CalPERS account compounds.  Consider whatever you get from CalPERS as one leg of the retirement income stool.

[bikebum]

I hadn't considered taking the contributions over the pension either until I read some comments on the Bogleheads forum. Some people over there think CalPERS may become unstable and it's better to take your money and manage it yourself, even though you will forfeit the other funding sources (employer, taxpayers).

Then there's also my original question. If I have a long gap between when I stop working and my "retirement date", won't my pension be worth a lot less after possibly 20 years of inflation? If inflation averages 2%, won't the pension only be worth 2/3 of what it was. Even if the principal is compounding, isn't the benefit still based on a 20 year old salary? There would be no way around that, but it could make taking the contributions more attractive. I haven't run any numbers to compare yet though; I'm young and have a long time to decide.

[Another Reader]

You can also take the money out after 20 years of compounding.  I don't think you will find an annuity as generous if you then try to buy one.

The way pensions work is that small amounts of money are put away and compounded over long periods of time.  If you leave a job after 10 years, there is no way the money in the account will support a pension for the rest of your life starting that day.  The pension is set up like an annuity, with a minimum age to receive it and a benefit based on how much money went in for how long and how old you are when you take the pension.

[arebelspy]

Then there's also my original question. If I have a long gap between when I stop working and my "retirement date", won't my pension be worth a lot less after possibly 20 years of inflation?

Yes.

I expect my pension (NVPERS, similar to yours, but a few differences), when I start to collect it, to be worth about 1/4 of what it would be worth if I could collect right away when I stop working, in real dollars (at which point it does have a capped COLA, but yes, will be based on a number severed eroded by inflation due to the gap in employment and being eligible to collect the pension).

It may, eventually, cover about 10% of my budget.

It's just another thing to factor in, and - for me - mostly another safety net in my plan (especially since I won't collect SS since I've never paid into it).

Ultimately it's all just numbers you play with until you're reasonably satisfied. :)

[Another Reader]

I'm not sure the OP understands the math here.  You have a balance in your CalPERS account.  On paper, it's a combination of your contributions, your employer's contributions, and the "interest" credited by CalPERS, which is loosely based on their investment returns.  If you have worked long enough to be vested, you have a right to your employer's contributions as well as your own if you take the money out when you sever employment.  You are also entitled to the accrued interest "credited" to the account.

You are probably not losing out to inflation if you leave the money in the account when you move on.  As long as CalPERS compounds the money at a rate exceeding inflation, you are winning that battle.  The question is, can you roll this money over and do better than CalPERS' crediting rate?  If you think your compound rate of growth will greatly exceed the CalPERS crediting rate, you can purchase a better annuity or otherwise do a better job of achieving your SWR, AND that the balance you expect based on your compound rate of growth will be the day you retire, then maybe you want to take the money and run.  However, if you need the money and the market has just suffered a 20-50 percent decline, you will have to be able to deal with that.  Keep in mind that CalPERS pays your pension even if the market drops.  The balance in your account will loosely track the principal needed to pay the contracted annuity, but if the balance is too low to fund the annuity, you still get paid. 

In your shoes, I would leave the money in the system and let it grow.  I would watch CalPERS' health and especially the crediting rate.  If the wheels appear to be coming off at some point in the future, then roll the accumulated balance, and thank CalPERS for the many years of steady growth.  In the interim, I would invest in whatever retirement accounts or pensions came my way, plus in taxable vehicles. 

[arebelspy]

If I'm understanding you correctly AR, you're saying the principal amount increases during the gap years?

Example:
Someone FIREs at 35.  Were they eligible to take it (say, if they were 65), they could get $10,000 annually in today's dollars.  Alas, they are not, so they live off their other portfolio income for 30 years.

At age 65, I was under the impression that they'd now get a pension of $10000 annually (which, of course, would be worth a lot less then due to inflation), and now that they started taking it, they'd start getting CPI increases after that, but based on that original amount.

You're saying that the 10k would increase during that 30 years, so that when they started taking it they'd get 30k, or whatever it had increased to by that point, and that would be their base amount?  Is that how CALPERS does it?

[Another Reader]

No.  They will get the $10,000.  Obviously, I haven't done a good job explaining my point.  If I understand correctly, the OP thinks he is getting a very bad deal by leaving the money in the system.   He seems to think he is losing badly because he won't get the same retirement as someone that worked to the same age and made contributions throughout.  He seems to think the cause is inflation.  In fact, he and his employer contributed much smaller total amounts and the compounding over time yields a smaller amount at retirement.  Taking the principal balance out of CalPERS at separation and investing it by itself is not likely to yield an amount that will allow him to purchase the same annuity at the retirement date as the person that worked and contributed over the same period.

The balance shown on the annual CalPERS statement is comprised of your contributions, your employer's contributions, and the amount credited the previous year by CalPERS.   That's the amount you can take out and roll over.  If you separate from your CalPERS covered job, your future statements will show the future credited amounts.  If I start with $100,000 when I leave and earn 7 percent the following year, I have $107,000 in the account.  If CalPERS looks like it's going down the drain, the $107,000 can be withdrawn.

Of course, if CalPERS goes down the drain, it's because the entire world of investments is also going down the drain, and you should have an extra thick mattress to stuff the $107,000 under.

[bikebum]

If I understand correctly, the OP thinks he is getting a very bad deal by leaving the money in the system.   He seems to think he is losing badly because he won't get the same retirement as someone that worked to the same age and made contributions throughout.  He seems to think the cause is inflation.

I haven't said any of those things. I just wanted to know if the max salary would be inflation-adjusted during a gap between end of work and beginning of receiving benefits, which it appears it won't. This does not make it a bad deal, this is just something to be considered when deciding to cash-out or take the pension. Of course, I won't make this decision until much later, but I am having fun figuring this stuff out.

The way I see it is you can take the money right at end of work, leave it in until "retirement date" and then take the money, or leave it in and take the pension. If you want to compare the value of the pension, you would need to know the answer to my original question.

I made a spreadsheet today that treats the estimated pension (based on a 20 year old salary assuming no increase for inflation) as a future series of payments and calculates a present value at retirement date (55 years old). I assumed I would live to be 100. Then it calculates the future sum of my contributions during working years at retirement date. Then I used the solver function to tweak the interest rate until the sums match; comes out 6.7%. This represents the return I would have to get in order for my contributions to equal the pension if I were investing the money rather than putting it in CalPERS. That sounds like a pretty good deal, even though the pension loses value over the 20 year gap. I don't have that choice of course, but I thought this was a good way to compare since I don't yet know what the contributions will be worth at 55. AR, you said if you are vested you can take the employer contributions too? That is something I did not factor in.

I have already started maxing out my 457 and a roth IRA.

[bikebum]

Seems there is some mis-communication here. So just to be clear, the "pension" or "benefit" is the amount you would be paid if you stay in the retirement system, right? So the pension could lose value due to inflation, even though the account principal does not. Again, that does not mean it is a bad deal, just something to consider.

[Another Reader]

Sorry if I misunderstood.  Vested means you are vested in the employer contributions.  Where my pension was, I was vested in 5 years.   The answer to your original question is no, the pension is not adjusted for inflation.  It will be based on the $90k in your example (highest X years, with X being the years in your County's formula.)
 
If you are using the CalPERS pension payments as the future income stream, I think you are overly optimistic.  If you compare what you could buy today with your assumed future value from the lowest cost annuity provider, Vanguard, you will likely find the annuity payments to be substantially less than the pension payments.  Of course, you don't know what interest rates will be in 20 years.  If you post the spreadsheet, you should get some reactions that may be helpful. 

I look at this a different way.  To achieve what CalPERS offers, I would have to withdraw the balance and invest it so it would grow to the same amount as if it were left in the account and grown at the crediting rate.  At the targeted date, I would have to start withdrawing at my safe withdrawal rate whether the income is more or less than the CalPERS pension would have been or go out in the market and purchase an annuity that after fees would give me the same income for life that the pension would.  So the market would have to be at the required value at that time and the interest rate that the annuity would be based on would have to be more favorable than used in the CalPERS calculation.  Too many uncontrolled variables for me.  I would rather take a very safe compounding rate and make the annuity decision later.

The risk is what led to companies switching from defined benefit pensions to cash value plans.  When you retire under a cash value plan, you can go buy the annuity.  The company does not want the burden of the DB pension liability on the books.

[Another Reader]

The pension or benefit is the annuity you will be paid if the money stays in CalPERS.  The principal will grow.  The annuity will lose purchasing power.  However, you are not deferring something you are entitled to collect today so there is no "loss in value" relative to the worth now.  I think this may be the crux of the misunderstanding.   

[bikebum]

Alright seems we are all on the same page now. I wasn't saying it's not fair or a waste of money if the pension loses purchasing power. I just didn't know how to estimate my benefit if I stop working way before 55. All the examples in their literature are of people who work right up to retirement, or get a job somewhere else with another similar retirement plan. I had submitted the question to a CalPERS rep too, and today they confirmed that the max salary will not be adjusted for inflation.

I realize my analysis is a little apples to oranges, but the conclusion is still that the pension is probably better. Although some people think a person so far away from retirement should not count on a defined benefit. I guess it doesn't matter now, because I won't be making any decisions for quite a while. But it was something that popped into my mind fairly often.

Ultimately it's all just numbers you play with until you're reasonably satisfied. :)

I think I'm there now. Thanks everyone for the replies.