Over the years we have worked with a lot of retired teachers. The type of teacher’s retirement plan you have determines how your benefits are calculated and which components are available to you. Many of the teachers we have met with, who are considering and transitioning into retirement, have benefits based on two parts from the Department of Retirement Systems commonly known as DRS:
- The pension component, which is called the defined benefit program, and
- for those in Plan 3, the retirement savings component called the defined contribution program.
One question many retiring teachers ask is, “Should I purchase the additional service credits?” At the time of this article, purchasing additional service credits is currently available for all TRS Plans 1, 2 and 3.
I’ve learned over the years that retirement is really all about cash flow and not your net worth. Your income will determine your lifestyle in retirement. So we always want to look for ways to maximize cash flow. However, retirement planning is very detailed and client-specific so we are not recommending anyone take action on any strategies we explore here until they have met with a financial professional who can review their entire financial picture to make sure any decision made is best for the them. That being said, let’s take a look at this question regarding the purchase of additional service credits.
Many retiring teachers have an opportunity to purchase additional service credits at the time of their retirement to increase their guaranteed lifetime income. Several clients have asked if this is a good deal, and I’ve found it to be an excellent source for guaranteeing lifetime income at very competitive payout rates.
The DRS website has a great resource that will explain the formula used for determining the monthly retirement benefit as well as how one can calculate the additional service credits and how much they cost. That link/resource can also be found at the end of this article.
You can certainly do the calculation on your own, but you might find it easier to just call DRS and request a benefit estimate.
Below we’ll explore if purchasing the service credits is a good option compared to purchasing an individual annuity from a private insurance carrier.
In the example used from the DRS website the hypothetical retiree named Becky, age 65, would use the following steps for calculating the cost of purchasing additional service credits:
- Calculate estimated monthly retirement benefit without the purchase of service credits.
- Calculate how much estimated monthly benefits will increase when purchasing additional service credits.
- Figure out the cost to purchase additional service credits.
This example illustrates that Becky could purchase 60 months of service credits for a cost of $42,981 and increase her monthly retirement benefit by $300 per month. This is an annuity payout ratio of 8.39%
The question then becomes, “How does this payout ratio compare with an annuity offered by a private insurance company? Will you be better off purchasing the service credits from the DRS system or would you be better off buying your own personal lifetime annuity from a private insurance carrier?
I requested quotes from three of the most competitive and highly rated companies who offer annuity payments in the form of pension payouts that we work with in the private insurance marketplace. Here are the results using the same criteria from the example above (assuming a female age 65 with a lifetime payout, using the same $42,981).
- Company A quoted $234 per month or a 6.53% payout ratio
- Company B quoted $230 per month or a 6.42% payout ratio
- Company C quoted $234 per month or a 6.53% payout ratio
The DRS offer of $300 per month is 28% more income than you could get if you were to use the same dollars to purchase an annuity from a private carrier.
Based on this alone, I’d say that if you are looking to guarantee more income in retirement, buying service credits is a much better deal currently than you will find in the private insurance market place. But remember retirement planning is very detailed and client-specific so we are not recommending anyone take action on any strategies we explore here until they have met with a financial professional who can review their entire financial picture to make sure any decision made is best for the them.
How can the DRS afford to have a payout ratio that is so much higher than an individual private insurance carrier?
I called and spoke with a representative at DRS and asked if it were possible for a retiree to receive lower benefits in the future if the trust fund for the DRS were to get into trouble, and she said no. She said in the event the trust fund were to get into trouble, then the States general fund would have to pick up the slack. While she felt confident that current retirees would not face any cuts on benefits they were already receiving, she did say it was possible that future benefits for future retirees could be reduced in the event the trust fund were ever in financial trouble.
Be aware that with any fixed rate product, over time, your purchasing power will be reduced as a result of inflation. Inflation is always a risk when planning for retirement income, but especially so when buying a fixed annuity as a source of income. When designing a retirement income plan be sure to calculate an inflation factor and determine how much more income is needed from other sources to help cover the rising costs of living.
The other big risk faced with a fixed lifetime annuity, is an early death. The survivor option selected determines if the insurance company will pay any remaining benefit to the beneficiaries. In a worst case scenario, assuming you had selected the maximum single life annuity option and only received income for one month before dying, then your heirs would not receive any additional benefit and any remaining balance would be retained by the trust fund.
The best way to create a great retirement income plan is to start with a really great budget.You may also be interested in my article on how to maximize your social security income.
Below are a few links you may find helpful when researching your retirement benefits from the Washington State Department of Retirement Systems for the Teachers Retirement plans 1-3.
Jason Parker is a financial adviser who helps teachers in Washington State create a Sound Retirement Plan. Jason works with people remotely via Skype and by appointment in his office. You can learn more by visiting www.Parker-Financial.net
Links/Resources:
Formula for calculating monthly retirement benefits:
http://www.drs.wa.gov/publications/member/multisystem/purchase.htm
DRS Phone Number:
(360) 664-7000 or toll free (outside the Olympia area) 1-800-547-6657
DRS Example:
http://www.drs.wa.gov/publications/member/multisystem/purchase.htm
Online Retirement DRS Seminar:
http://ncwctc.com/index.php?option=com_content&view=article&id=183
Washington Teachers Retirement System Handbook for plans 1-3:
http://www.drs.wa.gov/member/systems/trs/
Inflation article:
https://soundretirementplanning.com/inflation-and-your-retirement/#more-72
Budgeting article:
https://soundretirementplanning.com/budgeting-in-retirement/
Social Security Timing article:
https://soundretirementplanning.com/social-security-timing/
An Unbelievable Planning Opportunity for DRS including PERS, TRS & SERS:
https://soundretirementplanning.com/an-unbelievable-planning-opportunity-for-drs-including-pers-trs-sers/
This article was written September 16, 2013. The article referenced from DRS was written in 2011 and it’s possible that the change in the interest rate environment from then until now has skewed these numbers and also consider that rates are subject to change. Today it looks like the payout ratio from DRS is much better than private annuity companies, but to be safe you should request quotes from private companies to see if they have become more competitive.
We highly recommend you contact the DRS directly if you have questions regarding your retirement plan. I’ve found the folks at DRS to be very knowledgeable, friendly and quick to answer the phone. At the time I was researching this article, I used the phone number 1-800-547-6657 and spoke with Lee.
This article was also featured in the October 2013 Kitsap Peninsula Business Journal.
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