Should I buy 2 years of Service Credit for my pension?

[all4kc]

I've been with my employer for a little over 9 years now but only have 7 years of service credit.  My first 2 years of service went towards something called Alternative Retirement Program(ARP) time and didn't count towards service credit for my pension.  After I completed my first 2 years, I was given one opportunity to either receive service credit for my time during ARP or have my contribution transferred into my 401k.  I chose to transfer it to my 401k.

Fast forward to today, I'm wondering whether or not I should pay for 2 years of service credit.  I was given a quote of about 30k for a lump sum or can pay it out of 15 years at a quote of about 280/month(which would be close to 50k).

My pension is 2% at 55 (2.5% at 63).  Without buying 2 years of service, at 55 yrs old, I'll receive  54% of my paycheck.  With buying 2 years, I'll be receiving 58%.  A 4% difference. 

I can pay it off using money from my 401k or take deductions monthly from my check.  Any suggestions on what I should do?

[Goldielocks]

Do you expect that your average 5 years salary (or however the pension payout it is calculated) will increase dramatically after today?  e.g., is a promotion up a level or two likely for you?

If so, you are buying the credits based on salary level similar to today, but will received benefits based on a higher amount at the end.

Also, if you plan to live a VERY long time, a pension can be great.  Depending on yours, it may assume that you will live to 80 or 90 years old.  If you live longer, you win.

Reasons against
Don't buy the credits, however,if you pension is with a mid to small employer and is not fully secured in the event of bankruptcy or chapter 9 restructuring or other buyouts by other companies.

If you plan to leave your employer within a few years -- know that the pension credit costs are valued based on long term fixed rate trends, as are the payouts if you leave.  So you may have to pay a lot for the credits right now, and if you leave, and the interest rate environment increased before then, you will lose out.     (no benefit or loss if there is no change in the prevailing rates)

[Bicycle_B]

Have you calculated return on investment, using some kind of estimate to get an approximate value of the choices?

For example, it seems like you have 17 to 18 years to go before reaching 55 (54% at 2% rate implies 27 years of service, therefore started at 28, add 9 years, seems like you're 37 now).  The benefit of buying service time would be 4% times relevant base salary times expected years to death, modified by some factor to account for inflation if your pension is not inflation-adjusted. 

For example:

$62,500 salary x 4% = base benefit of $2,500/year.  In this example, I mean $62,500 in today's dollars, with the actual dollar figure rising by inflation until the moment of retirement, which I take as 55 for now.

If the online life expectancy calculator says age 81 for you, $2,500 x 26 years = $65,000 total benefit assuming no inflation effects after retiring (read your pension benefits, then modify accordingly.  Not an expert here, but my tiny pension has no inflation adjustment, sometimes I just use current 2% projection from now until death in order to discount the value.  Roughly, that would reduce value to 80% or $52,000).

So the expected return in this scenario is $65,000 on an investment of $30,000 over 17 to 18 years.  By eye, that's a bit more than 4% but you could calculate this as precisely as your assumptions allow.  Roughly comparable to the expected return from investing in the stock and bond markets, so a matter of personal choice.  The no-inflation-adjustment pension would probably be less than 4% return in this example and therefore suggest not doing it.  But the outcome in your real case depends heavily on your expected future salary and the terms of your pension plan. 

Fwiw, since your retirement eligibility occurs at the same age regardless of the investment (at least that's how I read your summary), I wouldn't do it unless the expected return is larger than the market's 4% to 6%.  I would favor an inflation-adjusted pension, but avoid one that is not inflation-adjusted.  Default would be private investment unless the pension investment shows a clear advantage, but that's my personal opinion.

[Left]

While my math is wrong, but my logic is that if the pension is calculated based on years worked, x%/year

if you worked 10 years, each $ you put into pension gets 10%/year ROI, so... better than investing it on my own. If it is 20 years, then every $ that goes into pension "nets" me 20%/year

[TomTX]

For me, buying service time was only worthwhile because it meant I could draw the pension earlier by reaching the age + years-of-service metric. 3 years service time = 18 months sooner.

I could replace the cost by working somewhere else for 6 months (if I actually need the money) - so that means get 12 months for free.