When you were a kid, there were a number of stories and fairy tales about coming to a fork in the road and having to choose the right path to take. Of course, you can only choose one. And once you choose it, there’s no turning back. Some of the roads will lead you to safety, and other will lead you to danger! Unfortunately for the teachers of Michigan and my wife, this isn’t just a child’s story – it’s SB1040.
SB1040 (short for Senate Bill 1040) is a piece of legislation that was passed here in Michigan which changes the pension plan options for all state school employees. Basically, each employee has to choose from one of four proposed options before October 26, 2012 that will significantly alter the structure of their pension contributions and future income.
I realize this topic may not be of much interest to you if you don’t live in Michigan or know anyone affected by SB1040. But remember – this same exact thing can (and probably will) happen in other places just as easily. Nobody’s money design or retirement plan is really “safe” when it is NOT controlled by you.
So since a great majority of my readers are personal finance bloggers, I ask you this:
• If this was happening to you, which one of these SB1040 options would you pick?
Even though most of us are not financial advisors (myself certainly included), we’ve still got to deal with this! Even more concerning, all the mothers, wives, husbands, dads, etc out there that make up the bulk of teachers ALSO have to figure this out – whether they are qualified to or not!
Our community of bloggers does a pretty excellent job of handling matters about money and personal finance. So I ask: If this was happening to your spouse, parent, friend, or even yourself, what advice would you give, and what would be your line of thinking to get there? The solution may not be as straight-forward as you think …
Over the next few days, we’re going to be going through each one of these options and analyzing them. At the end of this series, we’ll compare them all and draw a few conclusions.
SB1040 Options – Choose One of the Them:
SB1040 Option 1: Make a higher contribution to the retirement system in order to maintain the current pension multiplier at 1.5%.
Right now, the pension is based on a multiplier of 1.5% given by this equation:
[Final Average Compensation from Last 3 Years] x 1.5% x [Years of Service] = Annual Pension Payment
Selecting this option would keep this the same. But it would mean paying an average of 7% of your gross salary into the pension plan (called the Member Investment Plan or MIP) as opposed to how much we pay now. We pay approximately 4%; but the actual number depends on when you were hired and can vary from 3 to 6.4%.
SB1040 Option 2: Make the higher contributions to the pension plan until 30 years of service, and then revert back to the original contribution amount, but drop to 1.25% on all future years of service.
This option is basically the same thing as Option 1 except that after 30 years of service, your contribution amounts drop down to what you were originally paying and your future credit is calculated at 1.25%. All previous years are calculated at 1.5%.
SB1040 Option 3: Continue to pay the current contribution amounts, but receive a lower multiplier of 1.25% for all future service credit.
With this option, your pension factor multiplier would drop from 1.5% down to 1.25% (using the same equation above) for all the years earned going forward (past years would still get 1.5%). However, you’d continue to keep paying the same amount out of your paycheck that you’re paying now instead of increasing to 7%.
SB1040 Option 4: Freeze your pension and start a 401k. Here you’d stop paying into the pension altogether and it would be frozen at whatever years of service you currently have now (using the 1.5% multiplier). You’d then start a 401k where the State would contribute 4% of your compensation.
Oh, yeah. And one more small catch. With this option, you may not be eligible to receive health care benefits at retirement if you don’t have 15 or more years into the system. That means you’ll be forking out your own cash for health insurance!
The Major Factors:
Even thought the SB1040 choices above seem straight-forward enough, how to you really know which one is the best one? After all, this is your future you’re deciding!
The best way to really compare each of these options apples-to-apples is to break them down into their smaller elements. Those elements are the following:
1) MIP Deduction – Will you be paying what you’re paying now, the flat 7% per paycheck, or nothing from now until retirement?
2) 3% HealthCare Deduction – In case you don’t know it, a few years back the Michigan pension plan was under such hard times that they forced all the employees to pay 3% of their paycheck into the pension plan for the sole purpose of funding current health care for those who were already retired ( … Ponzi Scheme …)? If you don’t need the health insurance or won’t qualify for it if you take Option 4, then you don’t have to pay this 3% anymore.
3) 401k Balance – Will you or won’t you have a 401k balance?
4) Pension to be Earned – At retirement, will your service credit be calculated using the 1.5% or 1.25% multiplier?
5) Health Care Responsibility – Will your health care be covered, or will you be on your own?
Disclaimer: There is actually a lot more rules to SB1040 than we have listed here. This series is meant to show you how we will pick our Option based on our unique situation. Your situation may be entirely different. Please consult an adviser to make sure you know how some of these other rules may influence your choice.
In the following posts, we’ll go through each SB1040 option using these five criteria, and then make some conclusions about which one is the best. For simplicity, we will ignore the effects of inflation.
Readers – What is your gut feeling about which of the SB1040 options is the best?
Post Series Chapters:
Image Credit: Microsoft Clip Art