I am going to depart from my usual question-and-answer format in this issue of The PBA Magazine to discuss an issue of vexing importance: the decision on whether or not to take the final pension loan, which has to be the single most-asked pension-related question in the New York City Police Department. This article is intended to provide information to assist you in making this decision. Some members say that I always recommend taking the final pension loan. That’s not entirely accurate. I do firmly believe that most members should take the loan but there are times when I believe they shouldn’t. I personally took the maximum loan at my retirement in 2000 and today I’m very glad I did. That, however, is no reason for you to take it. It’s an individual decision that each member will have to live with for the rest of one’s life. It’s also a decision your family will have to live with after you’re gone. We should give considerable thought to this choice because it’s irrevocable after retirement.

To start, it should be noted that the final loan is not really a loan. It is a loan when it becomes effective on your last day on the job, but at midnight of that day it ceases being a loan and becomes a shortage in your pension annuity account instead. Retirees by law are not allowed to have pension loans. That is why the “loan” is never paid back, because it is not a loan but a shortage. That’s the same reason the Fund doesn’t go after your estate if you die shortly after retirement —there is no loan!

To better understand the effect of having a shortage when you retire, I’ll explain how our pensions are funded. Many of us labor under the misapprehension that we are entitled to a 50% pension from the city after the completion of 20 years of service in the department. That is not literally the case. Yes, we are entitled to a 50% pension, but only part (the greater part) is paid by the city. Our pensions are funded first from an annuity, which is generated by our pension contributions, and the interest paid on them over our 20-year career. The city must then add to that annuity an amount to bring our pensions up to 50% for our first 20 years.

Take the cases of two pensions, both for officers with exactly 20 years of service who retire at 45 years of age. The two have pension annuity accounts of $100,000, which is the total they are required to have (this amount varies from member to member depending upon one’s age when hired and the amount earned during one’s career). In both cases, they paid into their pension accounts their entire careers and never took a pension loan, so neither has a shortage prior to taking the final loan. The city actuary determines the value of the money based on your age when you retire. That value for a 45-year-old hired after 8/19/85 is $81.78 per $1,000.

OFFICER A:

In his or her final year of service earned $70,000 in pensionable income. If that officer doesn’t take a final loan and leaves $100,000 in the pension fund, he or she will receive a pension of $35,000 (50 % of $70,000). The $35,000 is funded by (a) $8,178 from an annuity based on the member’s $100,000 left in the pension fund (100 X $81.78) and (b) an additional $26,822 paid by the city to bring the pension to 50%.

OFFICER B:

In his or her final year of service earned $100,000 in pensionable income (obviously a high overtime earner). If he or she also didn’t take a final loan and left $100,000 in the pension fund, that member will receive a pension of $50,000 (50 % of $100,000). The $50,000 is funded by (a) $8,178 from an annuity based on the member’s $100,000 left in the pension fund (100 X $81.78) and (b) an additional $41,822 paid by the city to bring the pension to 50%.

OFFICER A:

By taking the loan, this officer is leaving only $10,000 in the fund ($100,000 balance minus $90,000 pension loan) and would then receive a pension of $27,640. The $27,640 is funded by (a) $818 from an annuity based on the member’s $10,000 left in the pension fund (10 X $81.78) and (b) an additional $26,822 paid by the city. The city pays the same amount whether or not the member takes the loan.

OFFICER B:

By taking the loan, this officer is also leaving $10,000 in the fund and would then receive a pension of $42,640. The $42,640 is funded by (a) $818 from an annuity based on the member’s $10,000 left in the pension fund (the same as officer A) and (b) an additional $41,822 paid for by the city. Again, the amount funded by the city is unchanged by the final loan.

These two examples show clearly how the final loan is not really a loan, but what it does is reduce the annuity you were going to receive that was funding part of your pension. The question you must ask yourself then is whether the amount received in the final “loan” is worth the pension reduction over a lifetime. In the above examples we must ask: is it better to have $90,000 today than $7,360 a year for the rest of your life ($7,360 being the amount the above pensions were reduced due to the $90,000 loan)? I have had members tell me that they have to be retired for only 12.2 years to receive the $90,000 back with the larger pension ($90,000 divided by $7,360 per year). That’s true, if you bury the money in your backyard. But we’re not foolish enough to do that, are we? The money should be invested, most of which should go into an IRA or 401-k to avoid tax penalties. I personally will not advise anyone to put their money in stocks or mutual funds —I’m not a financial consultant. But I do highly recommend that you talk to one. The Standard and Poor’s 500 has done over 10% per year going back to 1925, and the right mix of stocks, bonds and cash for your risk tolerance could give you the potential to grow your money over inflation and maintain purchasing power in retirement (impossible if the money stays in the annuity). Even if you took a very conservative approach and opened an IRA with a savings bank and put the money in a five-year CD you would receive, as of this writing, a 5.5% return on your investment. Your annual pension reduction of $7,360 would be partially offset by the $4,950 your money would be earning in the CD, resulting in a cost to you of $2,410 per year. At that rate, you would have to be retired 37.3 years before recovering the $90,000 you left in the pension fund by not taking the final loan ($90,000 divided by $2,410). And that is if five-year CD rates stay at this level. There was a time in the late 70s and early 80s when banks were giving 15% on five-year CDs. Of course, it wouldn’t be proper for me to suggest that we will see those rates again, but who knows? The average return on a five-year CD going back to 1960 is just over 7%. If you rolled the CD over every five years and received the average return of 7%, you would have to be retired nearly 85 years before recovering the $90,000 you left in the fund by not taking the final loan.

I have had members say to me that they need the larger pension upon retirement —which is another point you should be considering. Most of us retire from the NYPD in our 40’s or very early 50’s. At such a young age, most of us go on to a second career. When you then look at your pension, which for service retirees is subject only to federal taxes, you will see that it’s really much more than 50% of your current take home pay. The amounts deducted from your paychecks for state and city taxes, Social Security, Medicare and union dues will not be deducted from your pension checks. Then when you add in the Variable Supplement payment of $12,000 per year in 2007 and beyond, which by the way is also subject only to federal tax, you will see that your pension after deductions is very close to what you are taking home while active. When you add the salary from your new job you will see that maybe for the first time in your life you’re not living from paycheck to paycheck any more and can afford to take the final loan and roll it over into an IRA or 401-k. That money will then continue to grow, tax-deferred, and you should have a very large nest egg to start withdrawing from when you reach 59 1/2 years or older and decide you don’t want to work any longer. And God forbid anything happens to you before then, that money will be there for your family instead of the city keeping it!

As I have said, most, but not all, should take the final loan. One case in point: I recently spoke to a 48-year-old female police officer who was unmarried with no children. I explained to her that by taking the loan and putting it into an IRA she would have a large amount to supplement her pension later in life. She informed me that when she retires from the NYPD she doesn’t intend to work any longer and, although she knew that by taking the final loan she would have more income in her sixties and seventies, she said she preferred to take the larger pension so she would be able to do more in her forties and fifties. Since she had no children, she wasn’t concerned about the city keeping the money. I had to agree that in her case not taking the loan was probably the right decision.

I’ve spoken to members who come up with all sorts of reasons not to take the pension loan. The most common plan is to leave the money in the system and take out a home-equity loan for the same amount. When I ask what will happen if they pass away, the response is usually that they will take out a life-insurance policy. I tell them to not forget to go to church and light a candle (it costs only $1). Whatever plan you come up with doesn’t change the basic premise. If you leave the money in, you’re receiving an instant annuity for the rest of your life and when you die the city keeps the money you left in the system. It’s the same as if your local bank were offering a lifetime CD at the rate told to you when you retire, with one catch — they get to keep your money when you die. With officers A and B, that rate was 8.178% ($81.78 per $1,000). If you think it’s a good idea to put your money in a lifetime CD knowing that the bank will keep all the money you deposited when you die, then you should not take the pension loan and leave the money in the system. If you think that’s a foolish course, (as I do in most cases), then you should take the final pension loan. The bottom line, as I said before, is that it’s an individual decision that requires considerable thought. Please talk to a financial consultant. Remember, once you make your decision at retirement, you can no longer change your mind. I hope that I’ve provided the insight that will help you make the right choice.