Current Pension Topics: Why Loans Are a Bad Choice

Current Pension Topics
Why Loans Are a Bad Choice


Q.: I am a city retiree, age 56, with $200,000 in my IRA. I understand if I adopt a withdrawal plan based on Substantially Equal Periodic Payments (SEPP), I will not be subject to the 10-percent penalty tax imposed on withdrawals made prior to age 59-1/2. Please explain how a SEPP plan works.

Mr. Frank is a fee-only Retirement Financial Planner and a retired city high school Teacher of Accounting. He can be reached by telephone at (732) 536-9472, or via e-mail at rollover@optonline.net.

I.T.

A.: First of all, I trust your IRA is with the Deferred Compensation Plan of the City of New York. I trust they will be willing to establish a SEPP for you. If not, you will need to find an IRA Custodian that will. The SEPP plan requires you to withdraw money for the later of five years or until you attain age 59-1/2. You must use one of three life-expectancy tables the IRS has approved for this purpose. Your IRA Custodian will furnish you with these tables. Examples of how long the payout period must last: (1) At age 56, your SEPP must last five years until you reach age 61. (2) At age 49 your SEPP must last 10 years until you reach age 59-1/2. I urge you to seek professional assistance before embarking on a SEPP.

Q.: Why should I not take out a loan from my pre-tax retirement investment plan account?

P.B.

A.: Because the intent of these plans is to save money for retirement in a methodical way (every payday) without interruption. In other words, if you take out a loan of $25,000, that money is no longer in the account growing for your future use. Additionally, you are paying back the $25,000 loan, which went into the account before tax, with after-tax money. If you are in the 25-percent income tax bracket, it has cost you 25 percent to pay yourself back. In my humble opinion, this is plain stupidity, but is allowed because of the lobbying efforts of the financial services industry. Please note that the IRA law doesn't allow for loans. Congress got it right with the IRA and wrong with every other pre-tax retirement investment plan (457(b), 401(k) and 403(b)). I emphatically say: do not take out loans - make believe your pre-tax retirement investment plan is an IRA.

Q.: My husband is one year and 3 months older than me. If I opted for him to receive 100 percent of my pension if I predecease him, my pension would be reduced by about 14 or 15 percent. When I ask immediateannuities.com what I would receive for $1 million just for my life, and what I would receive if I opted for a joint survivor annuity, the difference is only about 7 percent. If you know, can you tell me why the NYS/NYC pension system charges more than twice what any annuity-providing entity charges for the joint survivor option?

E.K.

A.: I come up with a different analytical calculation. According to immediateannuities.com, a 60-year-old who has $1 million to invest can purchase an annual single life annuity (no option) of $74,520. This translates into an annuity-income rate of 7.452 percent. The New York City Employees Retirement System (NYCERS) would guarantee $97,750, or an annuity income rate of 9.775 percent. There is no provision for continuation of income upon the death of the annuitant.

In your case, you want to guarantee the same income for as long as either you or your husband is alive. This option is called Joint Life Income (100 percent to the survivor). The annuity income for a 60-year-old annuitant with a 61-year-old joint annuitant is $65,880, for an annuity income rate of 6.588 percent. NYCERS would guarantee $82,250, for an annuity income rate of 8.225 percent.

With immediateannuities.com, you will receive 88.4 percent (6.588 divided by 7.452) of the single life annuity, should you purchase the Joint Life Income annuity (100 percent to the survivor). With NYCERS, you will receive 84.1 percent (8.225 divided by 9.775).

As you can see, the guaranteed-income amounts are substantially more with NYCERS, even though NYCERS charges 4.3 percent more for the Joint Life Income (100 percent to the survivor) option.

Caution: When you buy an immediate-payout annuity, as E.K. is contemplating, please take into consideration that you are irrevocably transferring the title to your money ($1 million) to the insurance company, in return for a stream of guaranteed-lifetime income. You may not make additional withdrawals. Please also take into consideration the fact that each income payment consists of interest earned on the $1 million, in addition to a partial return of the $1 million. So if you live no longer or shorter than your life expectancy, you will receive your entire principal of $1 million. The joint life expectancy of a 60- and 61-year-old couple is 30 years. Please call me prior to purchasing an immediate lifetime annuity.