Deal to restore retirement credit’s a good one - with a caveat
I work for a public employer and have the option to restore retirement credit for times when I withdrew from the system. Basically I will get 2.5 percent of salary for every year of service that I add. This seems like a really good deal. Is it?
The first thing you need to know is that a 2.5 percent replacement rate of final salary costs a great deal to fund. It is significantly higher than typical private-sector pension formulas, and they cost about 7 percent of payroll.
Generally speaking, buying years of service is a slam dunk, compared to alternative paths to the same lifetime income. You can evaluate this for yourself by taking these steps:
■First, calculate the increased retirement benefit for buying one year of service, assuming you retired within a year. If you are currently 60 and earning $60,000 a year, a one-year gain in service would mean an additional income benefit of $1,500 a year, or $125 a month.
■Second, go to the website www.immediateannuities.com, fill in the requested information, and learn how much it will cost to buy a lifetime-only annuity for $125 a month. Then compare this with the amount you will have to pay to gain that year of credit.
Generally speaking, the private annuity purchase option will cost more.
■Third, if your lifetime annuity is adjusted for inflation - as many state pensions are - go to the annuity portion of the Vanguard website. Find out how much it will cost to have an inflation-adjusted life annuity in the same amount.
Inflation adjustment generally costs about 50 percent more than a fixed annuity, so there is a good chance it would cost up to three times as much to get the same benefit from a private source as from your buy-in offer.
That makes your buy-in opportunity a real slam dunk - you are buying lifetime benefits at 50 cents to 33 cents on the dollar. Is there a caveat? You bet.
Public-sector pension funds all around the country were underfunded before the recent market bust. They are more underfunded today. So the real question is whether the public pension funds will be able to make good on all that they have promised.
Scott Burns is a syndicated columnist. He can be reached at scott@scottburns.com. 
