Friday, November 27, 2015

How Much Is Your Pension Reduced By Taking A Loan Out At Retirement?




















Some educators believe its a good idea to take a loan from their pension just before retirement and use that money to fund a large ticket item or invest it into the equity market.  These educators can take up to 75% of their pension money (QPP) out of the pension system and still get a good pension.  However, before an educator should take money out of their pension contribution, they should know how much their pension would be reduced on an annual basis.

Since most educators who want a full pension retire at 60 or later and want to get Medicare (65) and Social Security (62 to 70), I used the range from 60 to 70 years of age to calculate the amount an educator's pension will be reduced by taking out a loan just before retirement.

Age....Annual Reduction Factor.....% Reduced per $1000
                   
60...................57.36.............................5.736
61...................59.80.............................5.980
62...................61.33.............................6.133.....FRA
63...................62.99.............................6.299
64...................64.80.............................6.480
65...................66.75.............................6.675.....MED
66...................68.85.............................6.885.....FSS
67...................71.12.............................7.112
68...................73.55.............................7.355
69...................76.17.............................7.617
70...................78.98.............................7.898.....MSS

FRA   Full Retirement Age and Reduced Social Security.
MED  Medicare
FSS   Full Social Security.
MSS  Maximum Social Security (32% greater than FSS).

 Let's look at three examples and how each would have their pension reduced by taking out a loan just before retirement,

For example let's look at educator #1,  She has reached retirement age of 62 years old and gets a full 25 year pension ($50,000).  She takes the maximum pension, with no beneficiaries.  However, she decides to take 75% of her QPP ($40,000) and use it to put a down payment on a retirement condo in Florida.

Pension - (QPP loan x % reduced) = Adjusted pension.

$50,000 - ($40,000 x 6.133%) = $47,547 .

 Therefore, her pension is permanently reduced by $2,453 annually. Moreover, unless the educator puts the QPP money she withdrew in a tax deferred account (IRA), she would need to pay taxes on the money.  Consequently, short term gain will result in long term pain from a reduced pension during her lifetime.

Then there is educator #2  who is 66 years old and he waited so that he could retire with full Social Security benefits.  He worked 20 years as a second career teacher and decided to rollover 50% of his QPP to an IRA so as not to be taxed on the withdrawal.. He will use the IRA to fund a custodial account for his grandchildren.  He took the option (option #1) that gives his spouse 100% of his pension if he dies.  Therefore, his pension is as follows:

(Pension x 0.85) - (QPP loan x % reduced) = Adjusted pension

($40,000 x 0.85) - ($20,000 x 6,885%)  =  $32,623

Therefore, his pension will be permanently reduced by $1,377 annually.

Finally, there is educator #3.  She has 30 years in the system and retires at the ripe age of 70.  She takes the maximum 75% QPP loan which, in her case is $50,000.  She wants to use the money to travel the world and doesn't care about reducing her pension or the tax consequences since she waited to this age to collect Social Security and will be subject to the RMD anyway next year.  She has no beneficiaries.

Pension - (QPP loan x % reduced) = Adjusted pension

$60,000 -($50,000 x 7.898%) = $56,051

Therefore her pension will be permanently reduced by $3,949 annually.

All three educator FAS was assumed to be $100,000 for simplicity.

I take no position on the taking of a QPP loan at retirement.  It's a personal decision that every educator must decide on.

7 comments:

Anonymous said...

Chaz:

You are a wealth of information. Because of you I understand many aspects of our pension system that the union seems to omit.

You are like having my own personal pension consultant. Thanks.

retired teacher said...

The union is the first place to start. Every UFT member is entitled to one free pension consultation every year. I don't understand why more folks don't take advantage of this service. After all you pay for it with your dues.
The union also has pension speakers who will come to your school. They will hold a group session or sit in the lunchroom to answer questions.Your chapter leader can arrange it.
Be wary of private pension guys who represent themselves as pension experts. That may be the case but they'll try to get you to sign up for things that you may rue later in your career.
UFT pension specialists never make any recommendations. They do as Sergeant Friday of the old TV show "Dragnet" used to say,"Just the facts please."

Anonymous said...

Not understanding why the loan money would be taxable since we would be paying the loan back at a reduced pension. Please explain. Thanks for your information.

Chaz said...

Anon 3:39

Once you take the money out of the pension and don't open up a tax deferred account, the money will be taxable by the Feds, State, and City.

Anonymous said...

How can a person leaving after 30 years, age 55 with qpp at approximately 43,000 calculate how much extra each year in pension?

Anonymous said...

http://nypost.com/2015/11/29/principal-fixes-failing-grades-behind-teachers-backs-staff/

THEY MUST DO THIS TO SURVIVE. THERE ARE NO OTHER ALTERNATIVES FOR PRINCIPALS.

Polly Molton said...

Thank you to the post. It is really useful as it has numbers and explanations, not just general information we all know. It was also very interesting to read the comments. The fact is that the things we criticized and couldn’t accept years ago have become common nowadays. Loans are just a part of our life and we need to have a special attitude and be ready to make them the part of our plan. People seek for faxless payday loans online when they need cash and do not want to visit offices and so on. It’s ok as we are always in a hurry but first we have to think about next steps we need to make.