Many educators think that the TRS AAI buyout will mean less money for them in the long-run. In some cases, this may be true. However, depending on your goals, taking the buyout may actually give you more savings over time.
At First Glance
At first glance, the answer to this challenging question is yes. Your buyout is technically less money when you take it now. However, there are several other factors that come into play that are worth considering.
The Security of Your TRS Pension
I recently tackled the security of the TRS Pension in this blog post. The sad truth is that the TRS Pension is currently anything but secure. Right now, they only have enough funds to cover 40% of future pension obligations. That could mean that if you continued to take a monthly benefit, it could eventually be reduced or eliminated (depending on how TRS ends up working to solve their funding problem). The buyout you have available to you now is guaranteed as a lump sum, making it the more secure option (even if it looks like less money in the short-term).
Compound Interest Is Your Friend
The annual increase you’d receive in your pension isn’t necessarily higher than the rates of return you could earn on the lump sum payout if it’s invested. Even if you looked at a modest rate of return of between 6-8% over the course of your retirement, you could potentially “beat” the total annual increase returns that your monthly pension plan benefit would have offered you.
Of course, it’s important that you don’t use your lump sum payout to chase inflated returns, or invest in high-risk funds. Investing for your risk tolerance is always a key part of retirement planning. Still, it’s worth considering that your investments could potentially perform better than if you had stuck with TRS for the long-haul. Additionally, when you manage your own investments, you have the flexibility to invest them in a way that reflects your unique lifestyle goals during retirement. You also have the flexibility to adjust your investing strategy as your goals shift and change.
Retirement can be a long chapter in your life, and with more and more retirees living longer, compound interest has even more time to do its magic and to grow your nest egg.
Understand Your Break-Even
I’ve helped several Illinois teachers through their break-even analysis since the program was originally announced. Truth be told, determining whether or not the buyout is the right option for a client is 100% dependent on their unique financial goals during retirement.
You can view the break-even analysis in two different ways. The trick is that, to truly be the “best option” for you, the analysis has to work in both test environments.
The first way I have tested a client’s break-even with the buyout is by looking at the raw numbers. I take the total amount that you’d receive with your pension COLA of 3%, and compare it against what would happen if you took the buyout with the 1.5% COLA. Assuming that the funds from your lump sum payment are invested and gain a reasonable return, I then determine if we can get you the same amount of money in each scenario. Most times, it works out.
Part two of my analysis looks at more than just the raw numbers. A straight break-even analysis is based on a lot of assumptions. After we compare what would happen if you stuck with your pension, and what would happen if you took the buyout, we can look at how each option plugs into your overall financial plan. If, for example, you need all of your pension in order to live comfortably, your decision (and your ability to take a risk in investing the lump sum from your buyout) will be different from someone who isn’t wholly dependent on their pension.
It’s important to take your unique financial situation and goals into account before moving forward with a decision, so there is no blanket answer for all situations.
Ready To Talk?
Trying to decide about the TRS AAI buyout can be tough – especially if you’re going it alone. The good news is that you don’t have to. As a fee-only financial planner in Barrington, Illinois, I specialize in working with both retirees and educators. I’d love to help you work through the best option for you and your family in this situation, and help to develop a comprehensive retirement plan that takes your TRS pension into account. Schedule a call with me today by clicking here!