Buying Into A Pension Probably Not Worth It

Linda is considering purchasing additional retirement credits to increase her monthly pension. Is it a good deal?

QUESTION: Linda in Los Angeles is considering purchasing additional retirement credits to increase her monthly pension. It would cost $120,000, and she was considering transferring the amount from her 457(b) to pay it in a lump sum. Is it a good deal?

ANSWER: Generally speaking, it’s not. Here’s why. There are two big reasons. One, this is a typical pension plan with government. If you dig into the actual mathematics of your pension plan, most of them are calculated. In other words, the way they figured out how to have you finish this and came up with the figure of $120,000, they backed into that mathematically utilizing a 7% rate of return, which is not a very good rate of return on long term investments. My long term investments have done better than that. Basically, we’re saying we’re going to put $120,000 in at 7% instead of over here in the 457(b), which is probably in a good mutual fund, and that money there is growing at a better rate overall than 7%. That’s problem number one.

Problem number two is what happens to your pension when you die. If you used $120,000 in the income off of that and you die, if you left $120,000 in your 457(b) and it rolls over to your kids or to your beneficiary there, they get $120,000 and the income off of it forever and ever no matter what happens. In other words, there’s a scenario with the pension deal that you’re 75 years old and you’ve used this money. You’re still getting your pension, but you’ve used it the way they calculated and then you die, then the beneficiary gets nothing. If you die by using the income off of your 457(b) and you’re sitting there at 75 years old, the $120,000 is still an asset of yours, it’ll go to your heirs.

Because it dies with you at death and because it pays a substandard rate of return, I typically don’t tell people to buy into pensions. There are a few times you can dig into it that the math works. But most times, it doesn’t.