The Art of Pension Hopping

For 18 years of service and a masters degree, her pension would be, in today’s dollars, calculated at ($84,453 + $87,703 + $91,153 + $94,803 + $99,093)/5 =$91,441*.3 =$27,432.30, collectable yearly at age 69. If she worked longer she would collect more, but she would need to work a total of 30 years in New Jersey to collect a 50% pension, way past her age limit of 69.

New Jersey’s rules for purchasing prior service credit, found online here, state that:

Members may be eligible to purchase up to 10 years of service credit for public employment rendered with any state, county, municipality, school district, or public agency outside the State of New Jersey, provided the service rendered would have been eligible for membership in a New Jersey administered retirement system had the service been rendered as a public employee in this state. This service is only eligible for purchase if the member is not receiving nor eligible to receive retirement benefits from the out-of-state public retirement system.

New York’s teacher’s pension plan forbids prior-service purchase except for certain departments and then only for prior service completed within New York State. However, both Pennsylvania and Connecticut do allow the purchase of prior service credit, both inside and outside of their respective states.

Connecticut’s teacher’s pension plan can be found here. Connecticut’s pension plan vests participants after 10 years of service, and participants with less than 10 years of service are refunded their contributions. Furthermore the Connecticut rules state that:

Service credit may not be purchased if the member is receiving or is, or will become, entitled to receive a retirement benefit based upon such service from any governmental system other than the Connecticut Teachers' Retirement System, the U.S. Social Security System Administration, or a military pension in the case of military service.

Connecticut’s other rules are that the participant is at least age 60 with 10 years of Connecticut state service, that the pension be based on the greatest three years of service, and from 10 years to 20 years the pension multiplier is the number of years squared then divided by 10.  For example, a participant with 11 years of service would have a pension multiplier of 11*11/10, or 12.1% while someone with 18 years of service would have an 18*18/10, or 32.4% multiplier. After 20 years of service, the multiplier is simply 2% per year.

Further research regarding the pay in Connecticut for teachers gives, for example, the Stamford’s teacher’s salary schedule as:

If Falta began her career in Connecticut, she would start at $53,463 in Stamford, and assuming she did nothing to increase her education, would end around $92,358 in today’s dollars. With regards to her final pension amount, if she started her career in Stamford and worked 18 years straight she would be entitled to ($92,358 *3)/3 * .324 = $29,923, a 9% improvement compared to working in New Jersey.

Pennsylvania’s rules can be found here. The Commonwealth of Pennsylvania’s Public School Employees Retirement System (PSERS) handbook encourages its teachers to purchase available service credit. In the handbook (p.8) it specifically states:

Purchasing service credit may help you reach eligibility for vesting, a disability benefit, or an increased death benefit. Early purchases also help to avoid processing delays at retirement.

Pennsylvania’s pension plan participants contribute about 10.3% per year, participants can collect at 65 with only three years of service, and the multiplier is 2.5% times the average of the last three years of salary.  A relatively close district in Pennsylvania, East Stroudsburg, has the following salary scale:

If Ms. D’Nero started in East Stroudsburg and taught there for 18 years, her pension multiplier would be 2.5 * 18 or 45%, so she would have a pension, in today’s dollars, of ($79,097*3)/3*.45 or $35,593.65. Compared to working in New Jersey, this is a 29.7% improvement in her pension income.

The pension hopping strategy

Ms. D’Nero could maximize her retirement income by continually re-purchasing service credit, in other words by “pension hopping,” but this only works if she is not vested.  By taking advantage of New Jersey’s, Connecticut’s and Pennsylvania’s allowance of prior-service credit purchases, she can dramatically increase her pension income versus working only in New Jersey.  Due to Connecticut’s prior-service purchase wording, she’d need to begin her career in Connecticut, and in this example she’ll work there nine years. From age 60-64, she would work in New Jersey and buy her Connecticut time in New Jersey.  From age 65-67 she would work in Pennsylvania and again buy her Connecticut time in Pennsylvania.  Finally, at age 68, she would return for one year to Connecticut, and buy back her previous Connecticut service. Below is the calculation, in today’s dollars, of this strategy, and it’s assumed that a localized wage freeze is in effect for the next 18 years in all three states.

Her first nine years will be in Stamford, Connecticut. She will be age 60, and her pension benefit will be $0.

Falta’s next five years will be in Ridgewood, when she will be age 65, vested, and her pension will be based on 14 years of service, as she will purchase the nine years of Connecticut service. As per the New Jersey rules, she is not receiving nor is she eligible to receive a retirement benefit at the time of purchase. Her New Jersey pension will then be 14/60 or 23.33% times a final average salary of ($62,793+$62,793+$63793+$63793+$65793)/5 or $63,793, which gives her a New Jersey pension, collectable at age 65, of $14,885/year.

Her next stop is East Stroudsburg for a period of three years. Falta will be age 68, vested, and her pension will be based on 12 years of service, as she will again purchase the nine years of non-vested Connecticut service. Again, she is eligible to purchase the service credit due to the fact that she is not vested in Connecticut. Her Pennsylvania pension will then have a multiplier of 12 * 2.5 or 30%, and her final average salary will be (44,793 + 45,824 + 45,824)/3 or $45, 136, which yields that her Pennsylvania pension would be $13,541/year, collectable at age 68.

Lastly, Falta returns to Stamford, and ideally would be re-hired in the district. If not, she could work in nearby Bridgeport or another district that would give her salary credit for time served in Connecticut. If she worked for one year in Stamford, she would be vested in Connecticut and would also be able to re-purchase her Connecticut service time. Her final average salary in Connecticut would be based on a three-year average of ($71224 +$ 74910 +$78834)/3 or $74989.  Her pension would then be $7,498/year, collectable at age 69.

Adding up all three pensions, gives $35,925, exceeding what she would have received from New Jersey alone by $8,493 per year; it is a 31% improvement. However, pension hopping only beats working in 18 years in Pennsylvania by $331/year. 

So why pursue this complicated strategy rather than simply working in Pennsylvania? And what are the drawbacks to this plan?

The pros of pension hopping

By pension hopping, Mrs. D’Nero assures herself at age 68 two pensions, Pennsylvania’s and New Jersey’s. Together these total $28,426, which already exceeds what she would have received a year later working only for New Jersey.  Also, she begins to receive her pensions earlier, one at age 65 and the other at age 68.  So by age 69, she has received four years of her New Jersey pension, and one year of her Pennsylvania pension, for a total of $73,081, all in addition to her income as a Connecticut teacher, which she could keep earning if she changes her mind about the age 69 retirement date.

Perhaps the most important benefit to pension hopping is that it assures the participant one or more pensions. This is especially useful if the participant is married or would like to provide a period-certain payment to heirs (usually available up to 10 years). 

This seems counterintuitive since becoming vested one would think that a pension is assured.  In reality, not only does one need to be vested, but many pension plans, New Jersey’s included, require that the participant not be working for the organization at the time of death. If the participant is working, the heirs usually only receive insurance money and a refund of the pension contributions. 

For a person or a married couple with long-lived genes, the value of a pension will easily outweigh the value of life insurance, typically about three times the final salary of the decedent. So if Falta works for New Jersey for 18 years and dies on the job, her heirs only get the insurance. But if she pension hops and dies her last year in Connecticut, her husband or other designees could receive the New Jersey and Pennsylvania pensions, as well as the traditional insurance from Connecticut.

The cons of pension hopping

There are financial costs to purchasing the prior-service credit. Most of the time existing tax deferred monies can be used to purchase prior service, so Falta could use her current 401(k) monies or future 403(b)7 monies, but the years have to be paid for somehow. Usually, it costs what it would have cost had the participant actually worked those years within the state, plus a statutory interest rate, often 4% to 5%.  However, the participant would have paid the purchasing cost regardless of whether or not they actually worked in the state, so the only real extra financial cost is the interest on the purchased time. Viewed another way, the incidental interest costs are being massively offset by the savings in “time” costs as an additional 18 years, nine years in each state, do not have to be “spent” from Falta’s life.

Also, a big negative factor in the pension hopping strategy is the commute. The financial and temporal cost of travel must be factored into this equation or the costs of relocating every few years.  Likewise, there are financial and temporal costs in obtaining and maintaining multi-state certifications.

The biggest criticism of pension hopping is that with every switch, the participant needs to start again at the lowest point on the salary scale. If Falta simply stayed in New Jersey and the amounts from year one to year 18 are added, she would earn $1,360,179 over 18 years in today’s dollars. Compare this to the pension-hopping plan, where she would earn first $573,655 in Connecticut, then $319,965 in New Jersey, then $136,441 in Pennsylvania, and then a final $78,834 back in Connecticut, for a total of $1,108,895.

The difference between these two amounts is $251,000, and it is only offset by the amount of pension income collected starting at age 65 while still working in Connecticut, which was previously calculated to be $73,081. In essence, by staying put in New Jersey, she will earn $178,203 more over the same 18 years.

But it may not be true that with every switch, the participant will start at the first step in the ladder.  Like private industry, public service allows for some prior-service salary credit. In some districts -- for example Bridgeport, Connecticut -- it can be as high as eight years while in others prior salary service credit, if granted, is given solely at the discretion of the local Superintendent. Unfortunately there is no way to determine how much salary credit Falta would be granted since it would range from $0 to “the Superintendent’s discretion,” but my pension hopping calculations are conservative, as I have assumed that Falta started on the bottom of the salary scale with each hop.

Other considerations

No plan is without its drawbacks, and pension hopping has its share. Foremost is that all public pension plans might be totally eliminated as Alaska and Michigan have already done. Pension hopping within the private sector is much more dangerous, as defined-benefit plans are being eliminated daily. Lastly in certain states, including Connecticut, Social Security is not taken out of teacher’s salaries, so a potential pension hopper should incorporate this fact into their plan.

Summary

Pension hopping can be a viable option for second careerists. The best candidates for pension hopping fit the following profile:

• The candidate is between 50 and 60 years old.

• There is no maximum age limit in their chosen field (for example, policemen and firefighters).

• The candidate reasonably expects to live 10-20 years.

• The candidate is willing to commute or relocate every few years.

• The candidate is willing to switch to public employment, as pension hopping works best with public employment.

• The candidate has an easily transferable job skill-set, which is in demand by municipalities or private industry.

Any pension plan under consideration for a pension hopping plan should also fit the following profile:

• Prior in-state or other local service is purchasable and creditable towards a pension.

• Any non-pension requirements are not unduly burdensome, for example a residency.

Finally, for those considering a career that still boasts a defined-benefit plan upon graduation from college or trade school, it would be interesting to evaluate if pension hopping would make sense. But instead of one local year of service being used to buy into two others, perhaps two locales are used to buy into three or four. If one started a pension-hopping program in one’s early 20s and ended in one’s late 50s, pension hopping on a long-term basis might out-perform simply staying in place, but the research for this is left up to the reader.

Antolin Du Bois earned his CFP® certification in 2011 and is president of RichFaith Inc., a fee-only practice. He is currently completing his Masters in Financial Planning in August from the College of Financial Planning and will begin his PhD in Financial and Retirement Planning at the American College of Financial Services. 

References

Connecticut, State of (n.d.). Teachers’ Retirement System. Retrieved 2/15/3015 from here
New Jersey, State of (2011). Teachers’ Pension and Annuity Fund. Retrieved 2/15/3015 from here
Pennsylvania, Commonwealth of (2012).  Active Member Handbook. Retrieved 2/15/3015 from here
Quinn, J. B. (2013). “It’s Time to ‘Power Save’ for Your Retirement.” AARP Bulletin, March. Retrieved 2/15/3015 from here

Read more articles by Antolin Du Bois, CFP®