Author Topic: 4% interest pretax pension credits worth it?  (Read 485 times)

getmoneyeatpizza

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4% interest pretax pension credits worth it?
« on: August 04, 2021, 08:48:48 AM »
I can purchase "Years of service" from another job. This money goes into the cash value of your pension if you choose to leave before your retirement date.  I plan to leave before then (because FIRE duh) but wondering if it is still worth it.

I'm sitting on 66k of cash. I want to invest 60k of that. Since I'm maxing IRAs and 457s I could just plow the 60k into VTSAX. Or...

I hadn't though about purchasing the 18 months of service before now.

This would cost $18500, but it would be set up as $518 pretax deduction from each paycheck. Using the case study tax calc this saves me $1500 total in federal taxes over two years (22% bracket). EDIT: Also saves $1013 in state taxes over two years.

The kicker is this cash pension account only accrues interest at 4% per year. Its a guaranteed 4% vs unknown in VTSAX.

I just refied my mortgage, but rates have dropped and my other thought was doing a breakeven from day 1 cash out refi of at least the $18.5k that is 2.6% or so would be a good move since I'm tapping equity currently earning nothing. I'm unsure if this would make sense based on refi costs.

So I could :

1. All 60k into taxable VTSAX
2. 41.5 into VTSAX and 18.5 into pension
3. Use mortgage to get 18.5k out of house equity and put 60k into VTSAX
4. Your better idea

Thoughts?

« Last Edit: August 04, 2021, 09:41:33 AM by getmoneyeatpizza »

reeshau

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Re: 4% interest pretax pension credits worth it?
« Reply #1 on: August 04, 2021, 10:37:19 AM »
How far away are you from withdrawing from your pension?  The further away that is, the more the safety of the fixed return costs you in lost potential stock market gains.  Beyond that, you are proposing a 70/30 mix of stocks and bonds (fixed income) for this money.  Is this consistent with your overall asset allocation?  If not, you need to understand how it impacts your overall investment allocation.

But in general, I wouldn't go chasing 4% fixed.  A pension is a nice cushion.  (I myself have a partial pension)   But it also ties up that money into limited payback options, so there are downsides too.

I also don't believe 4% will be as remarkable 10 years from now as it feels at the moment.

getmoneyeatpizza

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Re: 4% interest pretax pension credits worth it?
« Reply #2 on: August 04, 2021, 11:47:03 AM »
I'm 20 years away right now. 19 years away if I do the buy back. If you leave before you are eligible and choose not to withdraw your cash I'd have to wait until 2050 (29 years from now) to receive the payouts. Also no COLA until 2050.

But if I get another job or FIRE I can withdraw that cash and roll over to an IRA. I think the FIRE date is the more important timeline than the pension date. FIRE not set it stone but probably is at least 9 years out.

4% isn't great. But 4% pretax seems to make it an attractive option to me, that gives me a $2500 tax savings over 18th months that can be put back into the market too.

And borrowing money at 2.6% to get a guaranteed 4% seems even better if I could find a zero closing cost, breakeven from day 1 mortgage out there but i don' think that exists for cash outs. 


reeshau

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Re: 4% interest pretax pension credits worth it?
« Reply #3 on: August 04, 2021, 12:41:10 PM »
I'm 20 years away right now. 19 years away if I do the buy back. If you leave before you are eligible and choose not to withdraw your cash I'd have to wait until 2050 (29 years from now) to receive the payouts. Also no COLA until 2050.

But if I get another job or FIRE I can withdraw that cash and roll over to an IRA. I think the FIRE date is the more important timeline than the pension date. FIRE not set it stone but probably is at least 9 years out.

So, how does this impact your planned and actual asset allocation?  This step must be considered as part of a whole, not in isolation.

Quote
4% isn't great. But 4% pretax seems to make it an attractive option to me, that gives me a $2500 tax savings over 18th months that can be put back into the market too.

This is a 13.5% bonus in the first year, so It's up to 4.54%.  Good thing to consider, but incremental.

Quote
And borrowing money at 2.6% to get a guaranteed 4% seems even better if I could find a zero closing cost, breakeven from day 1 mortgage out there but i don' think that exists for cash outs.

This would be a good consideration, if you could pay off the loan with the interest you earn.  But you can't, because the money is tied up in the pension.  So, this is still a problem if it siphoned off money from your cash flow that you would otherwise invest in stocks.

My way of thinking about my pension is as a different sort of fixed asset, like bonds.  I know it will be there when I reach retirement age, and I know the payouts.  With that information, I can either derive a net present value, or I can research the equivalent fixed income investment needed to make those cash flows.  Once it is equated into an investment amount, it is easy to then work into my target asset allocation.  In your case, if you have enough in bonds, including the pension value, then your plan says do nothing.  If not, this could be an option to increase your bond holdings.

One other risk of a pension is the asset concentration in your employer.  If the plan gets into trouble, not just in the next 20 years, but the next 50 (i.e. your life expectancy, not your retirement date) then you could find the value cut, and you have no control over it.  Rolling it over into an IRA is a way to minimize this risk, at least until the time you actually pull that trigger.

JJ-

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Re: 4% interest pretax pension credits worth it?
« Reply #4 on: August 06, 2021, 09:43:48 PM »
My way of thinking about my pension is as a different sort of fixed asset, like bonds.  I know it will be there when I reach retirement age, and I know the payouts.  With that information, I can either derive a net present value, or I can research the equivalent fixed income investment needed to make those cash flows.  Once it is equated into an investment amount, it is easy to then work into my target asset allocation.  In your case, if you have enough in bonds, including the pension value, then your plan says do nothing.  If not, this could be an option to increase your bond holdings.

I understand the logic behind trying to put a value to pension to help decide a tradeoff, but why wouldn't you consider more of income like SS and lowers the need for a bigger stash? Kind of the same thing but a different perspective. That way your asset allocation is optimized for your withdrawals without having to continually refactor the bond value of a pension. The equation would essentially be portfolio>=(yearly expenses-pension yearly - SS)*25 and then you manage bonds in your portfolio at 80/20 or whatever.

getmoneyeatpizza

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Re: 4% interest pretax pension credits worth it?
« Reply #5 on: August 07, 2021, 07:35:18 AM »
I view this an an independent decision. I don't think the decision has anything to do with whether this fits in with my asset allocation, as I can just change the asset allocation in my 457 at anytime to adjust it to whatever I need.

Additionally, the cash value can be withdrawn if I leave this job. So the pension may never materialize.

18500 invested at 4% and 2500 and 5% matches 18500 invested at 5% in about 15 years. Tax rate in retirement probably matchs the cap gains so I don't think that makes a difference. If the stock market stays on a tear then it won't make sense but its not a ton of money.

I'm not even calculating whether I leave early but keep the pension with this buyback. Flexible retirement planner often has a higher success rate if I do not cash out the pension and FIRE in 8 to 10 years.

I think I'll do the buy back. If I do have to end up working another 19 years at least I'll save 9 months of my life. And if I withdraw the pension money the opportunity cost seems low.



reeshau

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Re: 4% interest pretax pension credits worth it?
« Reply #6 on: August 07, 2021, 10:54:46 AM »
My way of thinking about my pension is as a different sort of fixed asset, like bonds.  I know it will be there when I reach retirement age, and I know the payouts.  With that information, I can either derive a net present value, or I can research the equivalent fixed income investment needed to make those cash flows.  Once it is equated into an investment amount, it is easy to then work into my target asset allocation.  In your case, if you have enough in bonds, including the pension value, then your plan says do nothing.  If not, this could be an option to increase your bond holdings.

I understand the logic behind trying to put a value to pension to help decide a tradeoff, but why wouldn't you consider more of income like SS and lowers the need for a bigger stash? Kind of the same thing but a different perspective. That way your asset allocation is optimized for your withdrawals without having to continually refactor the bond value of a pension. The equation would essentially be portfolio>=(yearly expenses-pension yearly - SS)*25 and then you manage bonds in your portfolio at 80/20 or whatever.

Yes, you can think about it either way--whichever way is easier for you to keep it straight, and to explain it to whoever in your life might also be concerned about it.  There is danger in mixing the two methods, though.

reeshau

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Re: 4% interest pretax pension credits worth it?
« Reply #7 on: August 07, 2021, 11:01:12 AM »
I view this an an independent decision. I don't think the decision has anything to do with whether this fits in with my asset allocation, as I can just change the asset allocation in my 457 at anytime to adjust it to whatever I need.

Right--exactly.  If you do buy in to more pension, then you should adjust your asset allocation to take into account this larger fixed income item.  So, it's not independent.

Neither decision threatens your financial situation; it is very much a personal preference decision.  Do please make sure to consider the long-term financial health of your company.  Also, understand The limits to the PBGC's insurance coverage and what that would mean to you, in the case your pension goes into default.  And it's not just monthly payout limits, but also components of your pension.  My former employer went bankrupt, so my pension is with the PBGC.  While my partial pension is fully covered, a lot of early retirees (meaning, offered a package by the company) found out through the process that these early payouts were not insured.  Many lost 50%.

stashing_it

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Re: 4% interest pretax pension credits worth it?
« Reply #8 on: August 13, 2021, 12:34:28 PM »
I'll weigh in on the  "Don't buy more pension"  side, for the reasons of

-  4%  isn't a great return worth chasing.  That is a pretty standard long term Bond return I believe
-  As others have mentioned,  you're lumping all your risk with a single company,  and you're not getting paid a premium to take that risk.   Companies going under and defaulting on their pensions is very common.  The recipients end up with 30-80%  reduction in benefits.

For my part,  I left a company in 2018  (I'm in my 30's) and had to opportunity to cash out my accrued pension,  which I would otherwise not be eligible for another ~25-30 years.   I played with the calculator they had before for what the pension value would be now vs later, and as best I could tell it was growing in value about 4% every year.

I opted to cash it out,  approximately $50,000 and role it into my 401k.      In my 401k it's invested in SP500 index funds.   When I checked  DQYDJ  SP500 total return calculator from ~Jan 2018 to ~July 2021  the total return was  +70%  vs  ~15%  that would have accrued in pension value.    So that decision to cash out my pension and invest it has been worth  +55% or ~ $27,000 in the past 3.7 years.