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Ask Dave

Risking Government Insolvency

Sherry has a husband who owns a government pension. She wants to know about buying years on that pension.

QUESTION: Sherry in California has a husband who owns a government pension. She wants to know about buying years on that pension.

ANSWER: The answer I usually give is that it does not make sense. It seldom makes sense to buy into years on a pension because most pensions are calculated in the 7% range. You can do better than that in the open market.

When you retire, you’re not going to pull all of your money out that day. You’re going to live off just the growth of it. If you calculated 5%, the pension is going to be better if that’s all you’re willing to invest in. I would rather invest in good growth, growth and income, aggressive growth and international—even after I retired. I’m going to be thinking long term.

Here’s the problem: Inflation continues to run, and you’re not that old. You’ve got 30 years. Think about what stuff cost 30 years ago. You go from 65 to 95, you really can’t make it on 5% during that time. You’ve got to at least make 6% on your money in a long-term investment to break even with taxes and inflation.

My point is again that the money you’re investing, you’re not going to be pulling out at retirement, so how close you are to retirement doesn’t matter. We’re talking about investing this money for 15, 20 or 30 years—not for five months or five years.

You can calculate it whichever way you want. If you want to go über conservative, buying the years on the pension is going to work because it’s a 7% rate of return, give or take, if the pension survives. That’s the other thing. You’ve got a government pension in California. You guys have a serious financial crisis there. I don’t know how much of this pension stuff is going to make it 10 or 20 years if California keeps spending like it’s spending. I think to assume that’s a zero risk as opposed to the other is risky is probably not accurate. But if you want to use a 7% rate of return and you want to take the risk of the insolvency of a California government pension fund of some kind, then buying it is going to make sense because that’s what you’re doing. I tend to move into the open market and try to make more than that. Then I’m not dependent on the government managing its money well for my future. That’s why I have a tendency to not do those kinds of things. If I were in your shoes, I would not do it, but that’s the set of assumptions I’m using to make that decision, and you’ve got a different set of assumptions you’re considering, so that’s fine.

That’s how you look at it. You say, do I want to take the risk on the government pension staying solvent in California? If so, am I okay with a 7% rate of return? If the answer to both of those is yes, then buy the time up. Buy the years back. Otherwise, I’m going to move into the open market because I’m scared of the solvency more than I’m scared of the open-market fluctuations, and I think I can make more in the open market. That would be the answer I would go with. Either one is okay. Nothing is intellectually wrong with either one. It’s just what your belief is about the future that causes you to make those decisions.