In this post we’re going to take a look at Option 3 of SB1040 (known as Senate Bill 1040), a piece of legislation passed here in Michigan which forces all state school employees to change their retirement pension plans by selecting from one of three options. If you’re just now joining us, you may want to read my SB1040 Introduction post first.
SB1040 Option 3 – Recap
To summarize SB1040 Option 3, our pension benefits are reduced, but we keep on paying the same contribution level each paycheck.
Right now, the pension is based on a multiplier of 1.5%. Selecting this option would reduce all future credit down to 1.25% given by this equation:
[Final Average Compensation from Last 3 Years] x 1.25% x [Years of Service] = Annual Pension Payment
All credit earned to date plus any purchased credit would still be calculated at 1.5%.
The trade-off however would mean keeping your contribution to the pension fund (called the Member Investment Plan or MIP) at the same level you pay now.
• Our current MIP payment percentage: 3.6%
• 15 years of credit earned, 2 more years of purchased credit to earn, and 13 more physical years to go until 30 years of total credit are earned. My wife’s current age is 35.
• Estimated Final Average Compensation (from MEA website): $72,936.43.
1. MIP Deduction:
First things first, if you choose this option, you keep on paying the same amount that goes into your MIP contribution per paycheck and not the proposed 7%. Given our gross pay and current MIP deduction:
• Current: $2,466.58 x 3.6% x26 pays = $2,308.80
Since there is no change from what is happening now, the net change will be $0.
2) 3% Healthcare Deduction:
Since we want health care at retirement, we will continue paying the same 3% we always have. Therefore, the net change will be $0.
3) 401k Balance:
With this option, you will not have the option to start a 401k plan. Therefore, your balance will be $0.
4) Pension to be Earned:
Using the equation above, we can easily calculate what our pension income will be. Estimating a Final Average Compensation of $72,936.43, we have:
[$72,936.43 x 1.5% x 15 years earned so far] +
[$72,936.43 x 1.5% x 2 years purchased] +
[$72,936.43 x 1.25% x 13 years yet to go]
= $30,450.96 of pension income per year
Note that the plan offers a 3% increase per year for inflation.
Comparing that to the Option 1 amount of $32,821.39 per year, that’s a loss of $2,370.43 per year for the rest of retirement.
5) Health Care Responsibility:
With this option, you’ll be covered for health care benefits at retirement. With a 20% responsibility and an estimated cost of $500 per month, our out of pocket contribution would be:
• $500 x 20% x 12 months = $1,200
SB1040 Option 3 – Summary:
To summarize the results of SB1040 Option 3 (and ignoring the effects of inflation for simplicity), we’d be starting off retirement as follows:
• Gained $0 since we made no change in how much we pay into MIP
• Gained $0 since we made no change in how much we pay into the 3% retiree health care fund.
• Gained $0 in 401k benefit since this Option doesn’t give us one.
• Commit to receiving a reduced benefit of $30,450.96 each year in pension income for the rest of our lives.
• Commit to paying an estimated $1,200 each year for health care benefits for the rest of our lives (or until Medicare).
This plan is the best thing for the short term because it keeps the most amount of money in your pocket now! But what about your future retirement benefit? Sure, $2,370 doesn’t sound like a lot, but that would be a difference of $200 per month. Plus, once you’re on a fixed income, will you regret not having maximized your benefit?
In the next chapter, we’ll look at how these factors affect the last option. Then we’ll conclude by putting it all together.
Image Credit: Microsoft Clip Art