Your Pension Already Answered a Question Most Retirees Are Still Asking

​Note: The examples and case studies in this article are hypothetical but represent real situations I have encountered in my practice working with Washington State public employees.

Tracy’s real question

Tracy is 54, a permitting supervisor for a county planning department, and has 27 years in PERS 2. She wants to retire at 58.

On our call she shares her screen. Someone at a retirement workshop suggested she move a chunk of her DCP into an annuity, and she’s been sitting with it for weeks.

Her question isn’t really whether the math works.

It’s whether she’ll be able to watch an account balance fall in a bad market and not do something she regrets.

Two preferences that shape everything else

A few years back, researchers Alejandro Murguia and Wade Phau went looking for why well-informed people reach completely different conclusions about how to fund a retirement.

They ended up with 2 preferences that account for most of the difference1.

The first is where you want the income to come from. Some folks are comfortable relying on market growth over a long horizon. Others want essential spending covered by contractual income that arrives no matter what stocks do. The researchers call that probability-based versus safety-first1.

The second is how willing you are to lock a decision in. Flexibility matters enormously to certain people. Others would rather commit once and stop revisiting it1.

Combine them and you get 4 approaches: total return, income protection, time segmentation, and risk wrap1. Preferences also held steady as people aged, and they didn’t shift once people actually retired1.

About two-thirds of people want more certainty than a withdrawal plan alone can offer1.

She already owns most of what she’s being sold

For Tracy, a lot of work is already done.

PERS 2 pays 2% times her average final compensation, every month for the rest of her life with a cost-of living adjustment2.

Let’s assume her average final compensation is $8,200/month. Retiring at 58 puts her at 31 years of service credit, and because she started before May 2013, her early retirement factor is 0.892.

That puts her pension at roughly $4,525 a month.

Now let’s add in Social Security which will be $2,500/month at 67.

That puts her total income at $7,025 before factoring any income that can be generated from her DCP.

If her essential spending runs $6,000 a month, Tracy isn’t short, she’s covered with room to spare.

An annuity can still be the right call for some people. It’s just that the gap being sold is usually smaller than it looks, and for someone with Tracy’s service credit it may not be there at all.

Washington’s own annuity option

If income protection is Tracy’s instinct, there’s something inside DRS I’d want her to look at first.

When you retire, you can use pre-tax DCP savings to buy a plan annuity that gets added to your pension payment2.

You give something up for that. Once the purchase is complete you can’t get those dollars back, and you have 15 days to cancel2.

Seven years that need to stay flexible

Retiring at 58 means seven years before Medicare.

Those are the years I’d be the most careful about committing money permanently.
PEBB retiree coverage has a hard deadline. The enrollment or deferral form must reach the program within 60 days after your employer paid COBRA, or continuation coverage ends3.

Her DCP is unusually flexible during that same stretch. Distributions from a 457(b) generally aren’t subject to the 10% additional tax on early distributions, before 59 ½ 4. That exception doesn’t extend to dollars she rolled into the plan from a 401(k), 403(b), or IRA4.

Those DCP dollars are doing 2 jobs at once. They can bridge her income before Social Security, and they can create room for Roth conversions while her taxable income is low.

Money put into an annuity losses important flexibility.

Where to start

Before you look at any product, get clear on which expenses you want covered no matter what markets do. Housing, groceries, insurance, and healthcare.

Then ask which dollars might need to do a completely different job ten years from now, whether that’s a move or health event.

And be honest about the risks you’d rather pay someone else to carry than hold yourself.

Once you have those answers, use the DRS benefit estimator or request an official benefit estimate and set your covered income next to your essential spending.

If there’s no gap, you have your answer. If there is one, you at least know what you’re solving for.

​Sources
1.Murguía, Alejandro, and Wade D. Pfau. "Risk Tolerance Questionnaires and Retirement Income Concerns." Retirement Income Institute, Alliance for Lifetime Income. December 2022. https://www.protectedincome.org/wp-content/uploads/2022/12/RP-18C_Murguia_Pfau_Dec_v3.pdf
2.Washington State Department of Retirement Systems. "PERS Plan 2." https://www.drs.wa.gov/plan/pers2/
3.Washington State Legislature. "WAC 182-12-171: When may a retiring employee or a retiring school employee enroll or defer enrollment in PEBB retiree insurance coverage?" https://app.leg.wa.gov/wac/default.aspx?cite=182-12-171
4.Internal Revenue Service. "Retirement topics — Exceptions to tax on early distributions." https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-exceptions-to-tax-on-early-distributions

-Seth Deal