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Pension vs. Optional Retirement Plan

If you have ever changed jobs as a university employee then you should be familiar with the choice of enrolling in the pension or the optional retirement plan.  This is an important decision with lifelong ramifications and should be discussed with your advisor prior to making the irrevocable decision.  In order to determine which is right for you, it is important to understand the differences between the two options.

The primary difference between the two is who carries the risk.  In the pension plan the risk is assumed by the university while in the optional retirement plan you assume the risk.  Pension plans have a defined benefit in the form of lifelong income during retirement based on your salary and years of service.  Optional retirement plans have a defined contribution and your retirement income is based on the performance of your retirement assets.

The retirement income benefit of the pension plan is often determined by you three highest year’s salaries, your number of years of service and a multiplier.  This multiplier differs from school to school and differentiates high quality plans from low quality ones.  Be aware of what your school’s multiplier is before making an informed decision and be aware that the multiplier can always change.  The formula is illustrated as:

3 Highest Year’s Salary X Number of Years of Service X Multiplier, or

$ 200,000 X 10 X 2.25% = $ 45,000 Annual Retirement Income

In theory, if you manage your investments wisely then you should be able to generate a higher retirement income using the ORP.  This is because the assumed rate of return on the pension plan is below the long term average of a well diversified portfolio.  With that said, if your investments do not perform well there is the possibility of a lower retirement income so be sure to discuss the risks with your advisor.

Another difference to consider is the vesting schedule or the minimum number of years you must be employed in order to receive the employer contributions to the retirement plan.  Pension plans often have a longer vesting schedule then the ORP so if you are uncertain as to how long you may be employed you may be best served to enroll in the ORP.  Vesting schedules can be as short as two years and as long as ten and can be graded (i.e. 20% per year ) or cliff (0% to 100% at set date.)

Choosing between the pension and the ORP usually pertains to mandatory retirement contributions.  Contributions may be made by employer, employee, or both.  The contribution rate is often stated as a percentage of your income and is subject to certain limits.  It has become common place for the ORP to have a smaller net contribution with a small percentage retained by the pension plan to help cover expenses.

Choosing between these two retirement options can make a significant difference in your long term financial picture.  Be sure to discuss your particular circumstance with your advisor to understand your options before making your election.

For more information on understanding your retirement option, please contact Scenic Wealth Management.

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