Need Answer by Sunday, Dec 30 8pmPST..Time Value of Money/Financial Planning Question

[BillyIdol]

Hey guys,

I have a deadline to meet on an important decision. I'm a special education teacher and I'm in CAL STRS. The last day for me to purchase nonqualified service credit is Monday, December 30, 2012 at 3pm(PST). But I want to have an answer by Sunday, Dec 30 at 8pm PST. After Dec 30, I can't buy any service credit ever again. I can buy up to 5 years of nonqualified service credit. My example here will be for buying 1 year. So, buying 5 years would be the same, but X 5. So this is a big decision for me. I am very good at math, but don't have a whole lot of experience with the financial calculator. I could learn it online, but it might take me about a week, but I don't have a week to make that decision. So, I'd appreciated your help on this.

This example is for buying 1 year of service credit.

This is based on me retiring in June of 2030, and I'm 46 years old now. My birthday is Sept 18, 1966. I will be retiring in about 17 years.

Ok, here it is. This is all through CAL STRS which is the teacher retirement system for California.

1-Is is worth it for me to take $15,797.628 cash now to for an ANNUAL increase of $1,849.49 of retirement income when I retired 17 years from now? Of course, I don't know how low I'll live. The return in guaranteed.

If I invested $15,797.628 cash NOW, and get an ANNUAL increase of $1,849.49 NOW (this is hypothetical), it would take 8.5 years to get my money back because $15,797.628/$1,849.49=8.5 years. And my return on investment calculated on a percentage basis would be, 11.7% because $1,849.49/$15,797.628=0.117. Of course, I'm not making that income now, but 17 years from now. So factor that in. I'm making about 0.8% in IngDirect Electric Orange right now.

2-If I took $15,797.628 now, what return would I have to make (for 17 years) to be equivalent to earning 11.7% 17 years from now.

3-This is example is for buying 1 year of service credit. 1 year of service credit is like working a year for the purposes of calculating retirement income. I can buy up to 5 years at the same price and rates.

4-If you could show me how to plug these numbers into an online financial calculator. I would be greatful because I can swing buying about 1-3 years right now.

John
626-710-0973
[email protected]

- - - Updated - - -

Ok, to make this simpler. I would be retiring in 2030 at the age of 63, and let's assume that I pass away at age 78. So, I would need income for 15 years in retirement. Whoa....closer than I thought!

John
626-710-0973
[email protected]

 

[Daedalus]

Sounds like a strong tilt toward a raw deal to me. As with any financial planning answer, "it depends". But by making some reasonable assumptions, the numbers would compel me to hold on to the cash. And this of course is assuming you have the discipline to not do anything foolish with the money (if not, then buy the credit or find some other way to keep the money safe from yourself). As you know interest rates are very low now, and that's certainly a factor in the offer extended. The answer will be affected by your beliefs on interest rates in the future. If you think they will stay low for many years (like Japan), then it might be a good deal. The question is, "what does your money have to do from now until 2030 in order for you to get the same benefit as buying the credit?" There are 2 parts to the answer, and we have to work backward from your retirement. My numbers are also for 1 credit.

The retirement payout is a present value annuity calculation. The question is how much money do you need in the bank in 2030 to give you 15 annual payments of $1849? Don't forget you'll be making interest each year on the remaining money not yet paid out. Assuming you make 3% from 2030 through 2045, you'll need $22079 come 2030.

How do you get to $22079 in 2030 from $15798 today? This is a compound interest question. The answer is 2%. Granted you only make .8% now, but will that change for the better in the next 17 years? If you can earn an equivalent 2% compounded on your money over 17 years, then you'll get to $22079 in 2030. And, if you can make at least 3% from there on out, you'll be able to withdraw $1849 per year for 15 years.

What about taxes? Is the credit bought with after-tax money? If so, does the pension get taxed at distribution?

The biggest doubt I have is with your 15 year retirement time frame. Seems the odds are good you would live longer than that. But if you don't, your beneficiaries would be better off if you *don't* buy the credit, and instead have the money in the bank.

Other thoughts: The intangible loss with buying the credit is the opportunity cost or loss of flexibility you get with having money in the bank. What if you are presented with a very good investment opportunity within a year or 2 from now? What if there is a dire emergency that comes up that requires $$$ to fix? Do you have other fallbacks besides the money you're thinking of puting toward the credit?

More thoughts: Sounds like a legal scam to me. Just like you and me, pension funds also have to make certain assumptions about future returns for financial planning. Even before the last 5 years, their assumptions tended to be closer to 10% annual returns than 2% returns. Maybe I'm a conspiracy theorist, but why would they offer you an investment with low single-digit returns when they assume they'll make more than that? The anwer, I think, is because their actual returns aren't anywhere near what they've projected, they are woefully underfunded, and they are desparately hoping people buy these credits to fill their coffers and make their books look better. They are hoping you swallow it, hook, line and sinker.