Valuing Yearly Police Pension Increase

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ofcmetz
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Valuing Yearly Police Pension Increase

Post by ofcmetz »

I'm trying to figure out my financial gain for working additional years at my Police Department after my initial normal retirement date of August 15, 2019. My decision when to leave is only partially based on the numbers, but I want to have a clear grasp of things on the numbers side. This forum has been awesome so far helping me come to decisions with pension questions.

So here are the numbers based on my current salary of $72,500. I make a good deal of overtime each year which doesn't factor into the pension payment at all, but does help me pay things off and save more during each extra year I work.

8-2019: $54,945 a year.

8-2020: $58,008 a year.

8-2021: $61,138 a year.

8-2022: $64,335 a year.

8-2023: $67,599 a year.

My initial thinking is to value the difference of about $3,000 per each extra year worked by valuing the cost of an annuity based on current prices for the ages I'll be if I had retired. So the difference between 2019 and 2020 retirement is $3,063 a year. The difference in the cost of annuities would about $65,000. Does it make since to think that the financial value of working the extra year is as if I had invested $65,000 minus my pension contribution of about $6500? If so then each extra year I work is almost like I'm getting the return of the pension payment that I deferred receiving from the previous year.

Any input is welcomed. If I'm way off in my thinking on this, that's fine too.

Thanks,
Last edited by ofcmetz on Fri May 04, 2018 8:43 am, edited 1 time in total.
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Pajamas
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Re: Valuing Yearly Pension Increase

Post by Pajamas »

Seems like you would be getting almost the same amount of money you are making now if you quit working and took the pension. Taxes might figure into it if your state treats pensions favorably.

Of course that ignores the overtime but couldn't you still pick up some work if you retired? Might not pay as well, though.
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FiveK
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Re: Valuing Yearly Pension Increase

Post by FiveK »

ofcmetz wrote: Thu May 03, 2018 1:44 pm...the financial value of working the extra year is as if I had invested $65,000 minus my pension contribution of about $6500?
Don't understand this statement so can't comment on whether it makes sense or not. E.g., what is the value if you die immediately after working that extra year?

In general, most pension questions are easy to answer if one knows
- the rate of return one will earn on investments, and
- life expectancy.

Will the pension payments increase only if you continue to work, or could your retire but defer the pension in return for higher payments when it does start? That could be useful if you have a large traditional balance you could then convert to Roth at relatively low tax rates.
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ofcmetz
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Re: Valuing Yearly Pension Increase

Post by ofcmetz »

FiveK wrote: Thu May 03, 2018 1:58 pm
ofcmetz wrote: Thu May 03, 2018 1:44 pm...the financial value of working the extra year is as if I had invested $65,000 minus my pension contribution of about $6500?
Don't understand this statement so can't comment on whether it makes sense or not. E.g., what is the value if you die immediately after working that extra year?

In general, most pension questions are easy to answer if one knows
- the rate of return one will earn on investments, and
- life expectancy.

Will the pension payments increase only if you continue to work, or could your retire but defer the pension in return for higher payments when it does start? That could be useful if you have a large traditional balance you could then convert to Roth at relatively low tax rates.
Thanks. I'll try to explain.

So if I bought a annuity at age 40 that paid $54,945 a year it would cost about $1,246,000.

An annuity at age 41 that paid out $58,008 a year would cost about $1,311,000. The difference between the two annuities would be about $65,000.

So I was valuing the difference between the two pension payouts at that amount minus my yearly contribution of about $6,500 a year. I'm not sure if this is a correct way of looking at things hence the post.

The pension will only increase if I continue to work. Once I retire, it's locked and doesn't adjust for inflation until after I'm 55 years old. Even then the adjustments probably won't keep up. I plan on working while drawing the pension in at least a part time capacity doing something.
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ofcmetz
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Re: Valuing Yearly Pension Increase

Post by ofcmetz »

Pajamas wrote: Thu May 03, 2018 1:48 pm Seems like you would be getting almost the same amount of money you are making now if you quit working and took the pension. Taxes might figure into it if your state treats pensions favorably.

Of course that ignores the overtime but couldn't you still pick up some work if you retired? Might not pay as well, though.
That's correct. No state taxes on state pensions in my state. I would get about 83% of my trailing five year average salary if I retire next year. It goes up 3.33% a year and the average salary increases slightly with merit raises.
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FiveK
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Re: Valuing Yearly Pension Increase

Post by FiveK »

ofcmetz wrote: Thu May 03, 2018 2:07 pmI'll try to explain.

So if I bought a annuity at age 40 that paid $54,945 a year it would cost about $1,246,000.

An annuity at age 41 that paid out $58,008 a year would cost about $1,311,000. The difference between the two annuities would be about $65,000.

So I was valuing the difference between the two pension payouts at that amount minus my yearly contribution of about $6,500 a year. I'm not sure if this is a correct way of looking at things hence the post.
Seems as good a way as any for valuing the "purchase" of the pension.

There is still the question of the pension's value to you over your lifetime, and that of course depends on your lifetime.

And then there's the comparison between "retiring earlier with a lower pension" vs. "working longer and receiving a higher pension". That's even more subjective....

Seems you have a good understanding of your options, and that's way more than half the battle.
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Re: Valuing Yearly Pension Increase

Post by student »

ofcmetz wrote: Thu May 03, 2018 2:07 pm
FiveK wrote: Thu May 03, 2018 1:58 pm
ofcmetz wrote: Thu May 03, 2018 1:44 pm...the financial value of working the extra year is as if I had invested $65,000 minus my pension contribution of about $6500?
Don't understand this statement so can't comment on whether it makes sense or not. E.g., what is the value if you die immediately after working that extra year?

In general, most pension questions are easy to answer if one knows
- the rate of return one will earn on investments, and
- life expectancy.

Will the pension payments increase only if you continue to work, or could your retire but defer the pension in return for higher payments when it does start? That could be useful if you have a large traditional balance you could then convert to Roth at relatively low tax rates.
Thanks. I'll try to explain.

So if I bought a annuity at age 40 that paid $54,945 a year it would cost about $1,246,000.

An annuity at age 41 that paid out $58,008 a year would cost about $1,311,000. The difference between the two annuities would be about $65,000.

So I was valuing the difference between the two pension payouts at that amount minus my yearly contribution of about $6,500 a year. I'm not sure if this is a correct way of looking at things hence the post.

The pension will only increase if I continue to work. Once I retire, it's locked and doesn't adjust for inflation until after I'm 55 years old. Even then the adjustments probably won't keep up. I plan on working while drawing the pension in at least a part time capacity doing something.
I think this is a reasonable way to value the pension.
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Pajamas
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Re: Valuing Yearly Pension Increase

Post by Pajamas »

ofcmetz wrote: Thu May 03, 2018 2:09 pm That's correct. No state taxes on state pensions in my state. I would get about 83% of my trailing five year average salary if I retire next year. It goes up 3.33% a year and the average salary increases slightly with merit raises.
You might determine how much more you are making per hour accounting for the pension, the difference in taxes and health insurance, etc. It might be that you are actually only earning $5 or $10 more an hour compared to not working, or something like that. Of course it is more complex because of the overtime, other retirement contributions, Social Security, possibility of pension plan failure in the future, your current age, what your spouse is doing if you have one, how much you enjoy your work, what you plan to do after you quit, etc.

But you might come to the conclusion that you are not really making enough extra from working for it to be worth your while if you will have adequate resources for retirement and would prefer not to work OR perhaps to do some other kind of work that pays more than $5 or $10 an hour. You might even get a similar job with a different employer and double your income.
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ofcmetz
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Re: Valuing Yearly Pension Increase

Post by ofcmetz »

Pajamas wrote: Thu May 03, 2018 3:16 pm
ofcmetz wrote: Thu May 03, 2018 2:09 pm That's correct. No state taxes on state pensions in my state. I would get about 83% of my trailing five year average salary if I retire next year. It goes up 3.33% a year and the average salary increases slightly with merit raises.
You might determine how much more you are making per hour accounting for the pension, the difference in taxes and health insurance, etc. It might be that you are actually only earning $5 or $10 more an hour compared to not working, or something like that. Of course it is more complex because of the overtime, other retirement contributions, Social Security, possibility of pension plan failure in the future, your current age, what your spouse is doing if you have one, how much you enjoy your work, what you plan to do after you quit, etc.

But you might come to the conclusion that you are not really making enough extra from working for it to be worth your while if you will have adequate resources for retirement and would prefer not to work OR perhaps to do some other kind of work that pays more than $5 or $10 an hour. You might even get a similar job with a different employer and double your income.
Thanks. This helps and gives me some math to play with now as well.
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Svensk Anga
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Re: Valuing Yearly Pension Increase

Post by Svensk Anga »

Looks like you are badly exposed to inflation if you take an early retirement option. Every added year cuts that risk a bit, getting you closer to the age 55 COLA. I'm guessing that there is no SS for you so you really need to protect the purchasing power of that pension, come what may inflation-wise. That means narrowing the gap where inflation can ruin you pension purchasing power.

You should run some sensitivity analysis on inflation rates in the gap years. If you do elect to go early, you should probably favor TIPS over nominal bonds.
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Re: Valuing Yearly Pension Increase

Post by ofcmetz »

Svensk Anga wrote: Thu May 03, 2018 4:43 pm Looks like you are badly exposed to inflation if you take an early retirement option. Every added year cuts that risk a bit, getting you closer to the age 55 COLA. I'm guessing that there is no SS for you so you really need to protect the purchasing power of that pension, come what may inflation-wise. That means narrowing the gap where inflation can ruin you pension purchasing power.

You should run some sensitivity analysis on inflation rates in the gap years. If you do elect to go early, you should probably favor TIPS over nominal bonds.
I'm really not counting on the COLA much. The state seems to only pay it when they have excess investment returns/ good years. Even then it's caped at a low rate. We have been building a portfolio (mid six figures right now) of investments that we hope to not start needing to use until we are in our 60's.

So my two way of dealing with inflation exposure.

1. Continue to work and save after leaving the police department.
2. When I'm done working, use our portfolio to give COLA raises to maintain spending power.
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Re: Valuing Yearly Pension Increase

Post by ofcmetz »

Pajamas wrote: Thu May 03, 2018 3:16 pm
ofcmetz wrote: Thu May 03, 2018 2:09 pm That's correct. No state taxes on state pensions in my state. I would get about 83% of my trailing five year average salary if I retire next year. It goes up 3.33% a year and the average salary increases slightly with merit raises.
You might determine how much more you are making per hour accounting for the pension, the difference in taxes and health insurance, etc. It might be that you are actually only earning $5 or $10 more an hour compared to not working, or something like that. Of course it is more complex because of the overtime, other retirement contributions, Social Security, possibility of pension plan failure in the future, your current age, what your spouse is doing if you have one, how much you enjoy your work, what you plan to do after you quit, etc.
My original thinking was: If I make $72,000 and can retire with $60,000 a year pension payment, then I'm just making $12,000 a year ($6 an hour).

My new thinking (which I want people to critique): If I make $72,000 and can retire with $60,000 a year pension payment and my pension payment next year will be $63,000 then I'm making $12,000 a year plus another $60,000 ish in retirement benefits due to the increase in pension payout.
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Re: Valuing Yearly Police Pension Increase

Post by Epsilon Delta »

ofcmetz wrote: Thu May 03, 2018 1:44 pm So here are the numbers based on my current salary of $72,500.
8-2019: $54,945 a year.

8-2020: $58,008 a year.

Any input is welcomed. If I'm way off in my thinking on this, that's fine too.
Assuming the pension is based on final salary, one thing you haven't factored in is the value of any raises (COLA, merit raises, steps etc.) during the extra year of employment. If you get 1% yearly raises then if you retire in 2020 your final salary might be $73,220 rather than $72,500 and the pension perhaps $58,588 rather than $58,008. This somewhat increases the value working an extra year. Of course this depends on getting a raise in the foreseeable future, but you probably have a good handle on the prospects of a raise in the next year or two.
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Re: Valuing Yearly Police Pension Increase

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Epsilon Delta wrote: Fri May 04, 2018 11:07 am
ofcmetz wrote: Thu May 03, 2018 1:44 pm So here are the numbers based on my current salary of $72,500.
8-2019: $54,945 a year.

8-2020: $58,008 a year.

Any input is welcomed. If I'm way off in my thinking on this, that's fine too.
Assuming the pension is based on final salary, one thing you haven't factored in is the value of any raises (COLA, merit raises, steps etc.) during the extra year of employment. If you get 1% yearly raises then if you retire in 2020 your final salary might be $73,220 rather than $72,500 and the pension perhaps $58,588 rather than $58,008. This somewhat increases the value working an extra year. Of course this depends on getting a raise in the foreseeable future, but you probably have a good handle on the prospects of a raise in the next year or two.
Good point. I wanted to keep it simple in my initial explanation. We get 2% merit raises in most years as long as their aren't major state budget cuts. So when I make my final spreadsheet, I'll factor this in.
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Re: Valuing Yearly Pension Increase

Post by Pajamas »

ofcmetz wrote: Fri May 04, 2018 8:49 am $60,000 ish in retirement benefits due to the increase in pension payout.
That's assuming you are around to collect the $60k or that a survivor will receive it instead. 8-)

If that $60k is $3k a year over twenty years, the present value is less than $60k because of inflation, unless your pension is adjusted for inflation.
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Re: Valuing Yearly Pension Increase

Post by ofcmetz »

Pajamas wrote: Fri May 04, 2018 1:26 pm
ofcmetz wrote: Fri May 04, 2018 8:49 am $60,000 ish in retirement benefits due to the increase in pension payout.
That's assuming you are around to collect the $60k or that a survivor will receive it instead. 8-)

If that $60k is $3k a year over twenty years, the present value is less than $60k because of inflation, unless your pension is adjusted for inflation.
The pension pays a yearly income of $60,000 once I'm done working. Wife would get 75% if I croak. Kids get it until they are 18 if we double croak.
Never underestimate the power of the force of low cost index funds.
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