Which PSERS Pension Option Should I Select? An Article For PSERS Employees
Updated: Oct 28, 2021
When handled correctly, the PSERS pension's monthly income and lump sum benefits can be a great combination to protect the long-term financial security of PSERS employees.
The monthly income lasts for life, and potentially a survivor's life if one of the survivor options is selected.
While the monthly income provides the benefit of consistent, predictable lifetime income, the income does not increase with inflation.
This article discusses:
1 - Inflation's impact on the PSERS pension and what to do about it
2 - A word of caution about financial salespeople and annuities for PSERS employees
3 - PSERS lump sum "Direct Rollover" to your own IRA for inflation protection
4 - PSERS Survivor Options
5 - Meet Jane: Selecting a PSERS Pension Option Example
What is Inflation?
Prices increase over time. For example, a gallon of gasoline cost an average of $0.36 in 1970. As of this writing, the national average is about $3.34. The price increases due to inflation.
From the early 1900s to the time this article was written, inflation has averaged about 3% per year.
During periods like the 1970s, inflation has been higher than 10% per year.
It's been lower than 3% per year from the early 2000s until very recently, but that could change in the future at the rate our national debt is expanding.
Inflation can be a real threat to your long-term financial security during retirement.
During your working years, salaries often get a "cost of living increase" to help offset the impact of inflation. In retirement, however, if you're living primarily on pension income, much of your income will stay flat while expenses increase due to inflation.
Retirement may be the first time you'll feel the full force of inflation.
How Will Inflation Impact Expenses In Retirement?
To summarize the data from the table below...
At age 65 when they retire, this family needs about $5,000 per month, or $60,000 per year.
At age 75, they'll need about $80,000 per year to maintain the same standard of living assuming only 3% inflation. Retirement got about $20,000 per year more expensive in just 10 short years, assuming only 3% inflation.
At age 85, it would take about $108,000 per year to maintain the standard of living that $60,000 per year provided at age 65 assuming 3% inflation. Retirement got about $48,000 per year more expensive over 20 years!
At age 95, it would take about $145,000 per year to buy what $60,000 per year bought at age 65 assuming 3% inflation. Retirement got about $85,000 per year more expensive over 30 years!
True, it's possible you may spend less on certain activities as you can get older.
However, two points to consider...
1 - On average, people are leading healthier lives and staying active longer during retirement today than in years' past. I regularly see clients today in there 80s who are just as active, in some cases more so, than they were in there 60s. Not having full-time employment opens up a lot more free time, and more free time can lead to more expenses.
2 - Depending on the specific expense, you don't always have a choice to spend less later on in retirement. Property taxes generally go up over time, and they may go up faster than they have in the past in a very inflationary environment. To reduce this expense, you'd have to move. Healthcare costs have been increasing at an annual rate that exceeds 5% per year. The more of your budget that goes to healthcare costs, the higher the rate of inflation you may experience in retirement.
What Can You Do To Protect Yourself From Inflation?
Own assets that increase in value over time.
For one, your home may be a good source of inflation protection.
Second and more relevant to this article, your PSERS pension lump sum can provide inflation protection if it's moved by "direct rollover" into your own Traditional IRA. As long as the "direct rollover" is performed correctly, it is not taxable.
The money in your Traditional IRA can then be responsibly invested for long-term growth to help protect your money's purchasing power from inflation over time.
Stock vs. Bond vs. Inflation: 1928 - 2019
To summarize the data from the table below...
1- Returns on the S&P 500 have averaged about 11% per year from 1928 - 2019
2 - Returns of US Treasury Bonds have averaged about 5% per year.
3 - Inflation has averaged about 3% per year.
4 - Large US company stock (measured by the S&P 500 Index) has beaten inflation by about 8% per year since the 1920s.
*Full data set from NYU Stern School of Business linked here: Data Set
Although stock has beaten inflation by a wide margin over time, it's very important to invest retirement money, including the PSERS lump sum, responsibly to protect from the risk of long-term loss.
These two steps help reduce the risk of long-term loss (more detail in Chapter 4 of my book Rolek Retirement Planning)...
1 - Own high-quality investments. This generally includes high-quality US stocks and US investment-grade bonds. High-quality stock investments will experience down days, weeks, months, and years from time to time, but they're also very likely to produce the long-term growth your plan needs to beat inflation and maintain your money's purchasing power over the long-term.
2 - Keep enough money in cash and high-quality bond to fund expenses so that you won't need to sell stock at bad times. The appropriate dollar amount to keep in cash and bond to minimize the risk of loss is based on your unique retirement cash flow needs and is determined through comprehensive retirement planning. More details about comprehensive retirement planning here: retirement planning
A Word of Caution About Financial Salespeople and Annuities for PSERS Employees
Many financial salespeople, who sometimes use titles like "advisor", get paid commissions to sell financial products to you. They often love annuities because annuities usually pay big commissions to them. However, they might not make sense for you at all...especially because you'll already have consistent lifetime income from your PSERS pension!
Here are two related comments...
1 - Avoid taking advice from people who get paid hidden commissions to sell products to you. This creates a clear conflict of interest between what's financially best for you and what's best for the financial salesperson. How do you know if someone gets paid commissions? This article discusses how to use investor.gov to verify this for yourself: How to Find a Fiduciary
2 - We discussed the importance of establishing a retirement plan that protects you from long-term inflation risk earlier. As a PSERS employee, the monthly income component of your pension provides consistent lifetime income, but it's subject to inflation risk. Buying an annuity is kind of like buying more pension. You already have a pension. If you buy an annuity, you're taking money the could have been invested for long-term growth to protect you from inflation and using it to buy more fixed income. This only adds to your inflation risk. Each situation is unique, but it's usually better to have the lump sum invested for long-term growth to hedge against inflation risk, especially because you already have a pension*.
*A related comment...Some financial salespeople will tell you they have annuities with a "cost of living increase". That sounds great conceptually, but you pay a hefty price for this "benefit". For example...
Hypothetical Annuity #1 pays $1,000 per month with no cost of living increase.
Hypothetical Annuity #2 pays $700 per month with a 2% annual cost of living increase.
It would take over 18 years for the $700 per month, increasing at 2% per year, to be greater than $1,000 per month assuming compound interest. It would take even longer (over 21 years) if the cost of living increase uses simple interest, which some annuities do. This is likely a very rotten deal for you.
It also doesn't mean you'd be better off with the cost of living increase if you live more than 18 years because you would have missed out on 18 years of larger payments AND the interest earned on those larger payments during the first 18 years.
It's very possible that neither annuity is good for you especially because you already have a pension, but the "cost of living" version in this example is likely even worse.
The conceptual sales pitch of "guaranteed lifetime income with a cost of living increase" sounds great. Who wouldn't want that? But when you analyze the actual numbers, you'll likely find these products are not in your best interest.
Don't buy into concepts and don't take a commission-driven salesperson's word for it.
Never buy a concept without analyzing the numbers.
It's important to slow down and analyze the actual numbers because your financial security in retirement may depend on it.
PSERS lump sum "Direct Rollover" to your own IRA for inflation protection
You can choose to rollover the PSERS lump sum into your own personal Traditional IRA account without tax consequences by performing a "direct rollover".
Your PSERS lump sum can go directly into your own personal Traditional IRA, it does not need to go to one of the school vendor's 403b's. Sick pay often needs to go into a school vendor's 403b, but the PSERS lump sum can be rolled over into your own Traditional IRA.
Google search "PSERS Authorization for Direct Rollover", locate the PSERS rollover form, and view "Part B" to verify this for yourself.
Once the lump sum is successfully moved by "direct rollover" into your own Traditional IRA, you can invest the proceeds for long-term growth and inflation protection. This inflation protection complements the fixed income pension nicely.
You can also perform periodic Roth conversions once the money is in your IRA (Roth conversions are beyond the scope of this article. See the end of the article for instructions on how to get in touch to speak individually.)
You also have a lot of flexibility with setting up beneficiaries once the money's in your IRA account. You can also change your beneficiaries at any time if your preferences change later.
"Primary beneficiaries" will get the money when you die. For married couples, it's common to name the spouse as the "100% primary beneficiary" but it doesn't necessarily have to be that way.
You can name multiple beneficiaries. You can choose the specific percentage to allocate to each individual beneficiary.
You can add "Contingent Beneficiaries". Contingent beneficiaries will get the money if there are no living primary beneficiaries at your death.
The bottom line is that your IRA account will provide you with a lot of flexibility once the PSERS lump sum gets there by "direct rollover".
PSERS Survivor Options
PSERS participants can select a monthly income option with a survivor benefit. This means that, if the PSERS participant pre-deceases their named survivor, some benefit would potentially continue for their survivor depending on which option they select.
Here's a summary (survivor options are also defined on psers.gov):
The "Maximum Single Life" Option provides no survivor benefit. When the original pension recipient dies, monthly payments stop.
With Option 1, each monthly payment subtracts from a death benefit. You can run these numbers for your specific situation because this won't apply in all cases, but usually if the original pension recipient lives until around normal life expectancy, the Option 1 death benefit will no longer exist because the monthly payments received to that point will exceed the death benefit by that time. This means there would be no additional payout to the survivor at death. To estimate this for yourself, divide the Option 1 death benefit by the monthly payment amount to see how many payments you'd need to receive before the death benefit runs out. These figures are on your PSERS retirement estimate. For example, if your Option 1 Death Benefit = $500,000 and the monthly payment = $2,500...then after 200 months (500,000/2,500) or about 17 years, there would be no more death benefit.
Option 2 provides a 100% survivor benefit. When the original pension recipient dies, the monthly payments will continue in the same amount per month to the named survivor. The named survivor is usually a spouse but it doesn't necessarily have to be. For example, some have considered naming a child as a survivor beneficiary on the pension. This is possible, but if you name a child as a survivor, the monthly payments will be reduced significantly because the payment amounts are based on their long life expectancy. Rarely would this make sense.
Option 3 provides a 50% survivor benefit. When the original pension recipient dies, the monthly payments will continue for the named survivor, but they're reduced by 50%.
There are also other custom survivor options that don't appear on PSERS estimates but that can be elected when actually going to claim the benefits, such as a 75% survivor option.
Meet Jane: Selecting a PSERS Pension Option Example
Jane is a PSERS participant.
She understands that taking the PSERS lump sum probably makes sense for her to protect against long-term inflation and she knows that she can roll that over by "direct rollover" into her own IRA.
But she's unsure which survivor benefit option makes sense for her specific situation.
If Jane selects the Maximum Option, she gets $3,000 per month for life. When Jane dies, the payments stop entirely.
If Jane selects Option 2 (the 100% survivor benefit option), Jane gets $2,500 per month for life. Jane takes a $500 per month pay cut vs. the Maximum option. If Jane lives for 30 years, the $500 per month pay cut adds up to $180,000 in reduced benefits ($500 x 12 x 30). In exchange, if Jane dies first, the named survivor gets 100% of the $2,500 per month that Jane was receiving for the rest of their life too.
If Jane selects Option 3 (the 50% survivor benefit option), then the monthly benefit is $2,750 per month. The pay cut isn't as bad as Option 2...it's $250 per month less vs. the Maximum option for Jane's life. But the pay cut is still meaningful. If Jane lives for 30 years, the $250 per month pay cut adds up to $90,000 ($250 x 12 x 30). In exchange, if Jane dies first, the named survivor gets 50% of the $2,750 per month that Jane was receiving for the rest of their life ($1,375 per month).
The numbers above are hypothetical. It's important to analyze the specific numbers being offered to you. The numbers vary widely depending on your age, the named survivor's age, years of service, final average salary, service class, and other factors.
Generally, the larger the survivor benefit percentage selected and the younger the survivor, the larger the reduction in monthly income while the original pension recipient is alive.
In this example, Jane now needs to analyze her overall financial situation to determine which survivor option is best for her.
Here's a question...if she took the "Maximum" option, would the survivor be financially devastated if she died unexpectedly young?
If the answer is yes, then the Maximum Option would probably be irresponsible and she should evaluate a survivor option so the survivor isn't financially devastated if she dies unexpectedly young. Under this set of circumstances, Option 2 or Option 3 may be more appropriate than Option 1 because, as stated above, the Option 1 survivor benefit eventually runs out. Option 2 and Option 3 provide more predictable survivor benefits.
On the other hand, if the survivor would be in a financially strong position even if Jane died young and the pension was lost unexpectedly early, the circumstances are different. Remember, with survivor options, Jane takes a pay cut during her life. A survivor option could still make sense depending on their individual circumstances (such as if Jane had poor health compared to the survivor) or preferences (such as not wanting to risk Jane dying young and leaving a lot of pension benefits on the table). However, due to the survivor's strong financial position even without the pension in this scenario, the Maximum Option is at least on the table for consideration.
By developing a comprehensive plan that carefully considers her overall situation including other assets, debts, income sources, and expenses, Jane determines that taking the lump sum and Option 3 (the 50% survivor option) instead of Option 2 (the 100% survivor option) would be best for her family's overall situation.
She takes the lump sum partially for inflation protection and partially for flexibility.
After rolling her PSERS pension lump sum into her own Traditional IRA, Jane will name her spouse as the 100% primary beneficiary of the account. (Why her own IRA?... Again, Jane knows her lump sum doesn't need to go into one of her school vendor 403b's. It can go directly into her own Traditional IRA without tax consequences if she performs a "direct rollover" as previously stated. See instructions earlier to verify this for yourself by performing a simple Google search.)
As a result of her naming the spouse as primary beneficiary of her IRA, her spouse would receive 100% of her IRA account if Jane dies first. This helps protect her spouse's long-term financial security.
In addition to that, because she took Option 3, her spouse will receive 50% of Jane's monthly pension income if Jane dies first.
In this hypothetical example, with 100% of the IRA and 50% of the pension, Jane's spouse will be financially secure if Jane dies first.
Of course, this won't apply in all cases. Whether the spouse would be financially secure or not requires thorough, comprehensive planning that considers all aspects of your unique retirement planning situation. See the "Process" tab on my website www.rolekretirement.com to learn more about the items that thorough, comprehensive planning must address.
Another benefit of Jane's choice in this example is that by taking the lump sum and Option 3 (50% survivor benefit), she'll receive $250 more per month every month she's alive compared to what she would have received in she selected Option 2 (100% survivor benefit).
As stated above, if Jane lived for 30 years, this would be an extra $90,000 over the course of retirement by taking Option 3 instead of Option 2.
Option 2 (100% survivor) makes good sense in some cases, but if the spouse would clearly be financially secure with a lower survivor benefit such as Option 3 (50% survivor), Option 2 may be sort of like purchasing insurance that you don't really need because of the additional monthly "cost" in the form of lower payments.
Also worth noting is that, in this example, if Jane lives for 30 years her spouse would have had to outlive her by about 6 years for Option 2 to have paid more in survivor benefits than Option 3 to make up this $90k difference. If Jane lives a long time, it's very possible Option 3 is best for the survivor too because both spouses' benefit from the additional income each month that Jane's alive.
This hypothetical example with Jane was included to illustrate a thought process used to make an informed PSERS pension decision in a fairly common planning scenario.
However, this will absolutely not be appropriate or applicable in all cases and was not intended as advice. Your unique, overall situation needs to be considered to make an informed choice.
Speak with a fiduciary advisor, one who does not get paid commissions to sell products, to determine which option makes the most sense within the context of your overall, unique retirement planning situation.
Should I take the Lump Sum?
In most cases, yes.
The PSERS pension monthly income provides you with consistent lifetime income. This is a great benefit, but it will lose value over time due to inflation.
Taking the lump sum, rolling it over to your own Traditional IRA, and investing it responsibly for growth (not into an annuity, you already have a pension and don't need more inflation risk), helps protect you from inflation risk.
The lump sum also has beneficiary flexibility, which has benefits discussed earlier.
Which survivor option should I select?
If you're single, the "Maximum Single Life" option is very likely the appropriate choice with some exceptions.
If you're married or have a financial partner, you need to evaluate your overall situation to determine the best option because the answer depends on your survivor's financial position if you died unexpectedly young.
If the survivor would be in a terrible financial position without the PSERS pension income, you should probably consider selecting Option 2 or Option 3.
If the survivor would be in a strong financial position even without the PSERS pension income, all options are on the table.
When handled correctly, the PSERS pension monthly income combined with the lump sum can work very well together to provide you with consistent lifetime income, inflation protection, and a solid foundation for your long-term financial security.
Contact me at email@example.com or 267-427-5667 to discuss anything covered in this article individually.
Learn more at www.rolekretirement.com
This article is not intended as personal advice in any capacity. For a full list of disclosures, see this page: Disclosures
This article uses information believed to be accurate on the date it was written. It is not intended to provide information or advice about what benefits are available in your specific situation. Speak with your employer for more information regarding your benefits. For example, newer employees may not have these benefit options available to them.
We are a Pennsylvania state Registered Investment Adviser. We are not affiliated with or endorsed by your employer, PSERS, or the state of Pennsylvania.