Buy years of service for retirement?

[CardMinger]

I am asking this question for my mom who asked me about it. I told her I could ask the financial geniuses on my poker forum and that they would be able to give some exact details so please don't let me down! [img]/images/graemlins/tongue.gif[/img]

Basically my mom is getting ready to retire in a few years and she has the option of buying some extra service years so that her monthly retirement pay goes up.

She is in good health and her father lived to be 85 and her mother is still living on her own and extremely healthy at 95.

My mom is pretty conservative with her money and likes to stick with local banks so keep in mind that she won't always be getting 5% (or whatever the top paying CD's are at the time) rates on her money.

Here are some of the numbers:

[ QUOTE ]
60 years old 9/29/1947
employed by PERS organization 12.056 years at 6/30/2006
Would like to retire at either 63 or 65
Retirement at 63 would be $1,362
Retirement at 65 would be $1,524

I can buy back service credit from one to 5 years
purchase price would be
1 yr........$8,511.90
2 yrs......$17,023.81
3 yrs......$25,535.71
4yrs.......$34,047.62
5 yrs......$42,559.52

This can be paid in installments, can be a roll-over from deferred
comp, which is what I am considering mostly because it is making very
little interest right now.

If I buy back 3 yrs, retirement goes from $1,362 to $1,608 at age 63
at age 65 it becomes $1,933 versus $1,524

If I buy back 5 years, retirement goes from $1,362 to $1,770 at age 63
at age 65 it becomes $2,096 versus $1,524

[/ QUOTE ]

I think we will probably need a little more info so just let me know what else is needed and I will have her dig it up.

Overall I am just wondering if you think this is a good investment for her given all the variables or if she would be better off saving (and investing) the 45k vs. buying the 5 years of service.

How long will she need to live to be break even on each deal?

Thanks for the help guys...Please show your math and assumptions if possible so that I can repeat your process if the variables change.

CM

[Evan]

[ QUOTE ]
I think we will probably need a little more info so just let me know what else is needed and I will have her dig it up.

[/ QUOTE ]
First of all, get all the possible cashflows (buying nothing, 1 year, 2 years, etc.).

Assuming these dollar amounts are monthly payments, the three year buyback has an IRR of 7% after 8 years, which is probably a fair point to call breaking even for a quick calc like this. After that it goes 9, 11, 12, 13, 14, 15 then stays flat mostly.

The 5 year plan hits 6% in year 9 and stays pretty much 2-3 points lower than the 3 year throughout.

[CardMinger]

Evan,

These are the amounts she would recieve monthly for the rest of her life:

[ QUOTE ]

If I buy back 3 yrs, retirement goes from $1,362 to $1,608 at age 63
at age 65 it becomes $1,933 versus $1,524

If I buy back 5 years, retirement goes from $1,362 to $1,770 at age 63

at age 65 it becomes $2,096 versus $1,524


[/ QUOTE ]

So if she retires at age 63 and she doesnt purchase any additional years she will get $1362 per month. If she waits to turn 65 and doesnt purchase and years she will make $1524 per month.

Are you including interest earned on the ~44K in your calcs?

I will ask her for the rest of the data tomorrow!

I also assume it might be helpfull to know what kind of payments could be made toward the ~44K and if there would be interest owed etc., I will try to find this out as well.

Thanks for the help!
CM

[CardMinger]

Evan and all,

Here is some more info that hopefully will be helpfull:

If I buy nothing, I can retire at
63 yrs...........$1,362
65 yrs...........$1,524

One year of service credit
63 yrs..........$1,445
65 yrs..........$1,608

Two years service credit
63 yrs.........$1,526
65 yrs.........$1,689

Three years service credit
63 yrs.........$1,608
65 yrs.........$1,770

Four years service credit
63yrs..........$1,689
65 yrs.........$1,852

Five years service credit
63 yrs........$1,770
65 yrs........$1,933

This can be paid in a lump sum, partial payment and installments or
all installments. Installments are limited to 390 payments. There is
interest, but I can't find the percentage amount on their web page.
You can continue making installments after you retire and it is taken
out of your retirement, so from that I assume that you start drawing
the higher amount from your retirement date.

Thanks again for all your help!
CM

[maxtower]

I haven't done any math on this, but buying into one of these plans isn't a bad idea, since she'll receive the money for life. If she dies earlier then she won't need the money anyway, but if she lives a long time, then the 42k won't last very long.
The thing to do I guess would be to compare the cost of these plan increases to what a similarly priced annuity would yield in income. If the PERS is a better deal then go with that.

[Evan]

You never answered my question about these being monthly payments, but I've got to figure that's what they are. I'm just going to assume you make the buyback payment 1 year before you start receiving the benefits because it will make everything easier.


Basically this plan is a steal. Assuming she lives at least 3 years after retirement all of these options blow anything else out of the water, so she should invest as much in them as she possibly can. Below is a graph of each option's internal rate of return. I threw in a line called "Mkt Return" at 10% just for context. The results are so strongly in favor of pouring as much money as you can into these plans that I am tempted to think either my math is wrong or the I misunderstood something about the setup.

Retiring at 65, of course, gives you a higher return than retiring at 63, but the choice between those options really depends on what she wants to do more than the returns.



I know it's almost impossible to see which color goes with which number. From top to bottom the lines are: 1_65, 1_63, 2_65, 2_63...

[maxtower]

Evan I think your math might be wrong. I just looked at one example to see what the return might be.

If she buys one year credit it costs $8,511.90.
Retiring at 63 with this additional credit gives her $1,445. Without the additional credit, she gets $1,362.
The increase is 1445 - 1362 = $83 extra benefits per month.
Annualized thats 83 x 12 = $996.
$996/$8511.90 = 11.7%.
In other words, she would have to invest that $8500 in something that yields better than 11.7% to be better than purchasing the credit. The stock market averages about this return. I would think that she would benefit by taking the maximum service benefit the plan allows since it will be hard to find these kinds of returns in the stock market given the risks.

[mosdef]

[ QUOTE ]
The increase is 1445 - 1362 = $83 extra benefits per month.
Annualized thats 83 x 12 = $996.
$996/$8511.90 = 11.7%.
In other words, she would have to invest that $8500 in something that yields better than 11.7% to be better than purchasing the credit.

[/ QUOTE ]

This is wrong because you are not taking into account that she will only receive the additional pension to her death rather than indefinitely.

[Evan]

Oh, oops. I read it too fast and I just took the total amounts, thinking these were all in addition to the amount she'd get by default, not including it. Looking at the post again, this is obviously wrong.

[Evan]

I just fixed my spreadsheet and now these plans look a lot worse, obviously. While the actual rate of return (11.something%) might look good compared to the market, it's a lot different because as far as I can tell this investment is totally illiquid, meaning your principle is pretty much gone on day 1 and all you have is the annuity payments. Because of this you have to look at IRR.



Considering the type of investments appropriate for a 60+ year old retiree, the 10% "benchmark" is probably too high, but it's really just there for context.