State of Virginia – VRS Retirement Benefits Analysis

Did you just start working for the state (commonwealth) of Virginia?  Then this is the post for you!

This analysis is primarily about faculty at state universities but if you recently opened a new-hire packet with acronyms like VRS, ORP, ORPHE, DCP, TIAA then I am here to help!  I did this analysis more generally for another person in my first post here.

The plans we are reviewing are the from this website.

“Choosing Your Retirement Plan
• Optional Retirement Plan for Higher Education Plan 2 (ORPHE)
• VRS Hybrid Retirement Plan
Membership Date: On or after January 1, 2014”

Essentially these two plans are a comparison of “defined benefit” vs. “defined contribution” retirement plans.  Defined Benefit = Pension & Defined Contribution = 401k/401a/403b type plans.  Defined Benefit plans have a defined amount a retiree will receive regardless (maybe?) of market conditions, Defined Contribution plans have a defined amount you receive now, and it is up to you to invest wisely.  An easy way to compare a big lump sum of money in a 401k account to a pension amount is something called the 4% rule.

The short version of the 4% rule is that it can be safely withdrawn from a principle of savings and effectively never run out. This is a pretty good way to compare the “lump sum value” or total account value of a 401k balance to a pension (or annuity) value because a pension also never “runs out” at least until you die or the company providing the pension goes bankrupt.

The 4% rule also works in reverse, so a $20,000/yr pension is worth about the same as a $500,000 lump sum in your 401k according to this rule (500,000 * .04 = 20,000). As always, I’ll post the spreadsheet at the end so you can change if you prefer.  There is a ton of discussion about what rate to use for this calculation, but I prefer 4% for many reasons which are backed up by solid research.

So the spreadsheet is setup with key details in yellow and orange.

I’ve made the following assumptions:

  1. Starting Salary = 50k/yr
  2. Starting Age = 30
  3. Will Retire at age = 62
  4. Full Social Security Age = 67 (this is the age you can take pension, in most cases)
  5. Raises per year = 2%
  6. Returns Expected / yr = 8%
  7. Equal Total Contributions from Employee (9%) which are broken up differently between the plans.  This makes for an easy comparison.

I’ll post the spreadsheet at the end so you can make changes, but I believe these are all very reasonable assumptions, the Voluntary contribution levels I chose for the two funds are meant to make for an easy comparison where both plans take 9% of your paycheck, HOWEVER, i strongly recommend you do everything you can to put away a LOT more.  Especially if you are young, plow some money away now and you can always reduce contributions later.  You should not think of these “deductions” to your 401a/403b/457 accounts as being deductions at all.  IT IS YOUR MONEY just in another account.  And you get to put it away tax deferred, which is awesome.  If you are eligible for a 457, it is a retirement plan where you can take the money out at anytime, penalty free, if you leave your current job.  Put as much money there as you can, it’s basically a tax deferred investment/savings account.

So what is the result for our hypothetical 30 year old?  This graph explains it really well:

The plans end up providing almost the same level of income at retirement but during your working years the value of the ORP plan will vastly surpass the pension value.  When you start working young the power of compounding really crushes the slower pension growth.  The large sum saved in the ORP accounts (401/403/457) will also continue to grow in retirement while the pension is a fixed income.  The reason you do still see some growth in the Hybrid plan after retirement is that your 5% in defined contribution portion of the Hybrid plan is still growing but it it is smaller than the 9%+8.5% match in the ORP account.

In addition to the actual dollar amounts calculated here, the ORP plan provides better flexibility if you ever leave your job and the ability to pass on the FULL account value to a child or spouse if you pass away.  Where a pension amount will be reduced by 40-100% when the primary earner passes away, the 401/403/457 accounts belong fully to those who inherit it.  The lump sum for our 30 year old in retirement is something between $1.2 and $1.7 Million dollars that belongs to them and any beneficiaries, where the pension does not.

I must recommend to any 30 year old that they strongly consider the ORP plan and invest wisely in simple low cost index funds.  Here are your provider options.

  1. DCP VRS / ICMA-RC – lowest fee ($30/yr) with a great BlackRock Equity Index fund F (exp. ratio .01%, called the help-me-do-it “stock fund” here)
    • The do-it-for-me Target Date Funds (exp. ratio .09%) at DCP are also solid if your retirement date is closer than 15 years these might work for you for a higher fee ratio.
  2. Fidelity – Middle Fee ($60/yr) but no good index funds, see your choices here. Do Not Recommend.  Laughably high exp ratios >.57%!!!
  3. TIAA – highest fee ($66/yr) with several complex annuity offerings.  I am suspicious of annuities because the person selling them almost always gets a “sales load” or fee to sell it to you.  I read about them and don’t recommend over low-fee index funds.  TIAA does offer one vanguard fund with a good expense ratio (.06%) but not as good as the DCP stock fund above.  See the TIAA investment offerings here.

Wait, you say, not everybody is 30?!?  Good news, the spreadsheet allows for easy adjustment (again I will post at the end for you to play with if so inclined) and I have generated the charts for starting at 40 and 50 also.

At 40 you can see we have a bit of pickle.  The pension will provide MORE income at retirement but will be surpassed by the growing ORP accounts at about 71.  We are looking very far into the future so by this time markets could be returning 10% or 5% annually.  Also trying to target a specific year is essentially impossible because in a given year the market can be + or – 25%.  I still think that due to the flexibility and inheritance considerations our 40 year old friend should stick with ORP.

At 50 we see the pension start to break away as the option that would provide clearly more income when retired.  In my opinion this is the tipping point, if you are over 50 you can claim your pension MUCH sooner and so the years of compounding are much fewer.  The hypothetical “overtaking” of the ORP income (red line) you see around 75 at this point is a wild guess.  As predicted, the closer you are to your full social security retirement age the more likely a pension is right for you.

Now in addition to my math problem above there is a risk factor to consider with both types of retirement plan.  Many arguments against the 401k self investment system usually involve a discussion of risk, with breathy articles like this one: 401(k)s are retirement robbery.

It’s hard to find a balanced view but my in opinion either system can work just fine if managed properly.  However, I think the risks between trusting a market based self-directed approach (401a/401k) are probably somewhat similar to trusting that your company or organization will be in a position to pay your pension in 50 years, as we see in the news now, pensions are not sacrosanct. Your mileage my vary but I prefer the self directed approach for younger people.  Specifically, Virginia’s pension system, the VRS is about 60-70% funded which isn’t the worst state but isn’t good.  It hasn’t lost ground in recent years (article from 2012) but it hasn’t made up much ground either.

I hope the post was helpful for anybody starting in virginia with the complicated ORP vs VRS choice and for anybody who wants to understand the underlying difference between a pension and a 401k/403b type account!

 

401k-vs-pension-table (v3)

Buy vs. Rent in rural area

Ok, So this post is in response to a great question I saw in Mustachians in Practice private facebook group.  As usual I tried to type into a little box in facebook and it got very long, then I wanted a spreadsheet, etc.  so i came over to post it on this page.

The Question from our friend is posted below:

Anyone have experience with living situations in rural areas? Boyfriend and I both work in rural areas but far apart from each other. 30 mins drive for me 5x a week, 40 mins for him 4x a week, best case scenario. Problem is there are so few rentals in this area, but a lot of houses for sale. Many are under $100k which we could easily afford. Plus a ton of modular homes if we wanted to be ultimately cheap. But I know we wouldn’t live here forever (nothing tying us down here), so I’m hesitating to buy a house. We aren’t totally opposed to being landlords later on so should we just buy?

We are currently renting rooms in other people’s houses for a total of $850 a month combined, but the situation doesn’t look too good on either end and we both might need to move out. Apartments are hard because most are income-limited here and that would make his commute up to an hour, if we even found availability.

I only have one year of experience and he has two years. We would have to both relocate and find new jobs in a different city or state to be able to live within biking distance of work like a lot of y’all do. It’s basically impossible to find engineering jobs in each other’s towns (like I said…very rural). I don’t think our type of work is something that could be telecommuted.

So like many things, the real world has gotten in the way of our Ideal-Mustachian-Way-of-Life which has us all employed in high paying engineering jobs with our spouse also employed nearby and we’d all bike to work everyday.

However The-Real-World sometimes interferes and above we have a tough one…. commutes are bad, very bad. They suck a lot more of your money and time than you realize! Your max driving time should be 10 minutes and then you should try to bike to work.  I do OK, but not Full Mustache Level, I bike 12 miles roundtrip about 85% of my work days. Highly recommend an e-bike because it takes away all the excuses, I’ve had mine about a year and have ridden something like 3,000 miles.  So we need housing close to work – simple right?

Enter The-Real-World, above you have jobs not close together in an area where the normal rent-to-price ratio is messed up.  $850 a month in rent is crazy if there are sub 100k houses around.  But I live in a somewhat rural part of the US and I know exactly what you mean, some of our local areas have the same problem.

I would think about it this way. If your credit is OK you can get a loan around 4.75% and the interest on a 100k loan per year is $4750 OR $396/month. This is the “lost” part each month that you carry the 100k debt. Then a house in decent shape might cost 1% per year of it’s value in maintenance and another 1% in property taxes depending where you live.  There are other costs to consider related to “the closing” which is the final buying of the house including fees to register the title, get the loan, etc. these are usually called “closing costs” and can be 2-5k.

Checkout this amazing calculator. I plugged in a 100k house, 3 years, 4.75%, 20% down payment, 0% home price appreciation and left the rest at default, it said all things being equal you would break even at 3 years with 874$/month rent and then owning would be cheaper.  If you can find a good little house, pay about 100k, and plan to stay/using a 3yr estimate i would recommend you buy. These numbers are pretty conservative.

You’ll notice some of the variables impact the calculation more than others: pay attention to those variables carefully and be conservative.  For instance, the potential for home price appreciation is an important variable but 0% home price growth in your area might even be too high, it might need to be negative!  

This assumes both living situations have the same commute which they don’t!  We need to calculate cost of commute.

Below is a quick calculator I made, change the cells in yellow to calculate the cost of your 2 commutes (i’ll attach it at the end).

COMMUTING IS EXPENSIVE. LIKE REALLY EXPENSIVE.

If you can find a house close to whatever job each of you likes better, go ahead and buy if you plan to stay 3yrs ( make sure one of you can bike) and then the other person tries to find a new job that is closer.

 

Good luck with your decision.

tldr: commuting is REALLY expensive. Do the math on your commute, it’s almost certainly better to get closer to work whether you buy or rent.

 

However, it sounds like you guys are young and geographically flexible.  But with 1 or 2 years of work experience it can be hard to make a change, you guys will have to figure out how much you want to move.  My math above assumes you’re kind of tied to the area, but if you can move:::

Colorado is beautiful and has great engineering jobs.  I also recommend the suburban parts of north carolina and virginia, and pennsylvania or new york state if you like more snow.  Bikeable areas/towns in those regions include asheville, and outside raleigh in north carolina, OR roanoke, blacksburg, and charlottesville in virginia.  I’d stay away from car crazy or super expensive cost-living areas like san franscisco.  An analysis of great places to live could be a whole blog, so i’ll leave that for another time!

commute calc . xlsx

401k vs Pension Plan

So this post is in response to a very normal question I saw in Mustachians in Practice private facebook group.  I legit made this site in 5 minutes, so forgive all the little default items you might see around the page, please don’t hack into the page because i left the admin username password as the default.  Shout-out to Eric, who admins the group for us on FB.

The Question at hand -> one of our friends posted a question that has come up in various posts around the internet and is conveniently a question i have answered recently for a family member.  I started to type my answer into the little comment box in facebook but then i felt the urge to make a spreadsheet.  This is a feeling i get from time to time… but more on that later.  So after making this spreadsheet i continued to type my answer and it started to get very long winded, and i wanted to post some graphs (i love graphs!), hence the website which you are now reading which will hopefully provide a much better and long answer for our friend and possibly for other people facing this choice.

The 401k is a part of the US tax code that allows employees to set aside money in a special tax-sheltered account for retirement.  Most companies also provide a “match” as a percentage of the employee’s salary where they will contribute an equivalent % to this account as a perk and as encouragement for employees to also save their own money.  Above our friend has the AMAZING potential of a 13% match if she contributes 13% of her own salary.  Most companies are in the 3-6% match range.

The 401k is replacing the older system of a pension where a defined benefit in retirement is accrued with years of service.  Typically 1-2% per year times ending salary.  This means that if you have a 2% pension plan and work for 30 years at the same company you would retire with 60% of your salary for the rest of your life in retirement.  There are usually a lot of details like calculating ending salary with an average and there are various survivor benefit details, etc.  Above our friend is eligible for 1.45% times years of service AND a small 401k benefit match.  These are commonly called hybrid plans.

So the  question above has morphed into a comparison of defined benefit (pension) vs. defined contribution (401k).

Warning Spreadsheets ahead!

So our starting assumptions for each plan look this this.  The key points are highlighted in yellow.  I assumed our friend will contribute enough to get the full match.  In the pension plan you can see i assumed the same contribution from our friend to the 401k of her pension plan of 15%.  This is to make the comparisons easier and equivalent.  I also assumed a 10%/yr return which is generous (but historically accurate! see Dave R’s fabulously data-driven post on the subject)  but i’ll attach the spreadsheet at the end so you can change this assumption if you want.

Below are two tables that calculate (based on the rules above) 1. how much will be saved each year 2. how much is saved in total (returns on prior year’s savings + current year’s savings), and 3. the 4% Rule column which is a rough rule of thumb that has been posted about exhaustively, my favorite post is by Our Savior and Ironic-Fake-Cult-Leader MMM himself, read it here.

The short version of the 4% rule is that it can be safely withdrawn from a principle savings and effectively never run out.  This is a pretty good way to compare the value of a 401k balance to a pension (or annuity) value because a pension also never “runs out” at least until you die or the company providing the pension goes bankrupt.  More on that below!

So the two tables compare the 4% rule of the 401k vs the 4% rule + pension amount.  As you can see the pension is worth more in the early years but gets overtaken by 401k around year 25 (the table has to year 50 so you can see how much it grows).  This is really important!  If you are able to take your pension somewhat soon (for example if you are 55 and can take it in 10 years) the pension might actually be better!  However, if you are 35 you cannot take any pension benefit for 30 years, by that time at 401k money will grow to vastly surpass the value of the pension benefit.

The answer to the 401k vs. pension benefit is basically a question of age.  Can you take the pension benefit anytime soon?  If you cannot then the power of compounding in the market will crush the slower growth of the pension plan.  Also, in my mind the inflexibility of a pension plan to retire early, take a loan, convert to a roth, etc. is a big downside.

A 401k is sometimes bashed as being too risky, or a result of corporate greed or some other stuff but in my humble opinion it is a much much better system.  A properly invested 401k can be invested in the entire stock market (go VTSAX, woohoo), a pension relies on the solvency of a single company (or entity) many decades in the future.  As people in Illinois and California are finding, just because you work for “the government” doesn’t mean they can’t go bankrupt.   Several small municipality’s have defaulted on their pension agreements (great but frustrating and sad read from jack dolan here).   While it is possible to imagine a apocalypse where the stock market becomes meaningless (great book about EMP-post apocalypse) in that situation your pension isn’t likely to fair better than an index fund of the stock market.

 

tldr;  a 401k is probably better if you’re under 55 and invest in simple low fee index funds like VTSAX

 

 

PS: WOW i typed a lot there, sorry for everybody who read that mess, FYI i didn’t proofread much and apologize for errors, etc.  i probably won’t fix them.

401k vs pension table

Hello world!

Mynamar Fisherman is a painting by Myra Evans
Mynamar Fisherman is a painting by Myra Evans

This blog will be my small contribution to the FIRE community.  The plan is to cover various topics about personal finance & life optimization.

FIRE = Financially Independent Retired Early (or something like that).  My take on the FIRE movement is pretty well summed up by this excellent graph (i love graphs!) from lifehacker.  It comes from the idea that once we have enough, having too much actually reduces our happiness and fulfillment.

Plot Your Purchases Along the Fulfillment Curve to Know When It's Worth It via lifehacker. click to link

I belong to several active online groups on other websites and when answering questions for those friends I frequently have the urge to type WAY too much into the little box, to make spreadsheets, to over-analyze, etc.  This website will be my outlet for a lot of those excessively long posts about interesting financial and personal situations in need of optimization.

The great bloggers of the FIRE community like Jacob at Early Retirement Extreme and Pete at Mr. Money Mustache have covered most of the topics I’d ever want to discuss on this blog.  However, I think a huge part a community’s success is to have smaller groups discussing and rehashing and reapplying concepts to their personal situations.

A relative FIRE blogging newcomer is Mad FIentist who does some really good podcasts.  He recently interviewed Author Vicki Robin, whom the FIRE community generally considers one of the founders of the financial independence movement.  Many years ago she and her late husband Joe Dominguez wrote the first FIRE book called “Your Money or Your Life“. During this interview she talks about how she felt her anti-consumerist message fell flat in the 90s and she kind of gave up and went to live on a pacific island.

All the indicators were that even though, tangibly, you could say a million people had read the book, was in a dozen languages (when it came out in Spain, I traveled to Spain, and it became an instant bestseller in Spain; same with Taiwan), even all of that, even the best Humpty Dumpty efforts—the savings rate in the United States was down, opportunity was too consumed, had multiplied out of control—I went into a sense of despair. I mean, I had repeated myself for the cause, I can’t tell you how many times. -Vicki Robin, transcript credit to MadFIentist

However, while she was gone a new blog & internet based FIRE movement had begun with guys like ERE and MMM.  And she takes heart in our new online-based community

what I see now is that you all are naturally collaborative because the environment is naturally collaborative. You all hyperlink to one another. You […] another’s stuff. You understand how to do this … Which we didn’t understand back then—we didn’t have the tools, we didn’t have the Internet. Can you imagine? I mean, we just had books and we had writing an op-ed for one of the three main newspapers. Really, it was a very different environment.

So, there’s an environment now where there can be a spread strategy for financial common sense, freedom, happiness and service, purpose, service to the whole. There’s a better opportunity for this to spread.

And that’s one of the reasons not only that I like y’all, but one of the reasons I’m excited to convene with you all is to talk about how do we be a collective force in the collective conversation, not just be a sidelight for a small number of people who wake up. -Vicki Robin, transcript credit to MadFIentist

So thanks Vicki, MMM, MadFI, and ERE.  Let this blog be my little hyperlinked part of our new community.

 

I’m gonna end with one of my favorite stories about living a good life.  Thanks for reading, and be welcome.

There was once a businessman who was sitting by the beach in a small village.

As he sat, he saw a fisherman rowing a small boat towards the shore having caught quite few big fish.
The businessman was impressed and asked the fisherman, “How long does it take you to catch so many fish?”
The fisherman replied, “Oh, just a short while.”
“Then why don’t you stay longer at sea and catch even more?” The businessman was astonished.
“This is enough to feed my whole family,” the fisherman said.

The businessman then asked, “So, what do you do for the rest of the day?”
The fisherman replied, “Well, I usually wake up early in the morning, go out to sea and catch a few fish, then go back and play with my kids. In the afternoon, I take a nap with my wife, and evening comes, I join my buddies in the village for a drink — we play guitar, sing and dance throughout the night.”
The businessman offered a suggestion to the fisherman.

“I am a PhD in business management. I could help you to become a more successful person. From now on, you should spend more time at sea and try to catch as many fish as possible. When you have saved enough money, you could buy a bigger boat and catch even more fish. Soon you will be able to afford to buy more boats, set up your own company, your own production plant for canned food and distribution network. By then, you will have moved out of this village and to São Paulo, where you can set up HQ to manage your other branches.”

The fisherman continues, “And after that?”
The businessman laughs heartily, “After that, you can live like a king in your own house, and when the time is right, you can go public and float your shares in the Stock Exchange, and you will be rich.”

The fisherman asks, “And after that?”
The businessman says, “After that, you can finally retire, you can move to a house by the fishing village, wake up early in the morning, catch a few fish, then return home to play with kids, have a nice afternoon nap with your wife, and when evening comes, you can join your buddies for a drink, play the guitar, sing and dance throughout the night!”

The fisherman was puzzled, “Isn’t that what I am doing now?”

Mynamar Fisherman is a painting by Myra Evans
Mynamar Fisherman is a painting by Myra Evans