Should I Do a Transition Year?

Note: This post is specifically for members of Colorado PERA. If you are in a different pension system, you may have a similar option, but every pension system is different. Each pension has unique “return to work” requirements, so make sure you understand those before considering returning to a work for an employer that is covered by your pension.

Much of this post is excerpted from the book.

Because school years conveniently break roughly half and half across two calendar years, Colorado PERA members who are approaching retirement often have the option to do a Transition Year (sometimes called 93/93 or 110/110). While not every school district offers this option, many do.

As an aside, there is no reason why every Colorado school district couldn’t offer this, as whether you are drawing a benefit from PERA is completely separate from you working for the school district.

Since most public school employees choose to retire at the end of the school year, it opens up the opportunity to retire in May (or June), start drawing your retirement benefit, but then continue to work the next school year. If you retire in May (or June), and then don’t work in June (or July), then you satisfy PERA’s “not working in the month of your retirement” rule for working after retirement. Then when you start working in August, you typically will not work more than 110 days (as a salaried employee) or 720 hours (as an hourly employee) before the end of the calendar year (which is PERA’s working after retirement limit in any calendar year, with some exceptions). Then a new calendar year starts, and you typically won’t work more than 110 days/720 hours during the second semester. At the end of the school year, you will then stop working and not run afoul of the working after retirement rules.

Note: There is nothing stopping you from taking a year off and then doing this again – one school year off, then one school year on – and then repeating that pattern multiple times. Some school districts may not allow this so you might have to move districts.

Many folks really like this option and think it’s a “no brainer” (this is what I was told by veteran teachers when I first started teaching), because it’s almost like getting paid double that last year of work – you get your PERA benefit and your regular paycheck (typically for 14 months). But I say almost because it’s not really double, it’s usually somewhere between 1.25 and 1.75 times your regular salary.

First, your PERA benefit is not going to be equivalent to your salary, unless you have 40 years of service which equates to 100% of your Highest Average Salary (HAS). For example, if you have 30 years of service, you’ll receive 75% of your HAS.

Second, most (all?) school districts stop paying for your benefits during this transition year, which means you’ll have to pay those out of pocket. You’ll also lose things like employer-paid life and AD&D insurance. You typically don’t get your full allotment of sick and personal days which, in many districts, if you don’t use them you will get a payout when you retire. So unless you have hit the maximum number of accumulated days, you will receive a slightly lower payout if you take a transition year.

Again, as an aside, losing your benefits doesn’t make any sense to me, this should be independent of your PERA retirement. Why should the fact that you are getting income from somewhere else impact whether you are getting benefits from your employer? But, again, I digress.

Third, many school districts also “freeze” your salary at the end of your last non-transition year, so you forgo any yearly raise that you normally would receive by moving one more step on the salary schedule and whatever yearly cost-of-living increase there is to the salary schedule itself.  When you take these three factors into account, then your income will definitely be less than double, but will still be higher than if you didn’t “retire.”

Again, many folks have considered this option a “no brainer”, but I would caution you that it is not quite so simple and, for many people, it would be better to not take a transition year. As with all things, this very much depends on your personal situation, but let me try to lay out some of the factors you should consider, and I’ll even given a specific example from someone I recently helped think through their options.

In some ways, taking a transition year is the opposite of the decision of purchasing a year of credit. It’s not a perfect comparison, but it’s a pretty good way to think about it.

By working a transition year, you have one year where you have a fairly significant boost in income, which is a nice way to start off retirement. But what you are giving up – in addition to paid benefits, which is pretty significant on its own – is the additional year of service credit you would receive if you didn’t retire with PERA and start receiving your benefit. That means you are giving up an additional 2.5% of your HAS, and your HAS would likely be higher. This is because you would include this year in your HAS, and it will be presumably higher than the year it is “replacing” in your HAS calculation from four (or six) years ago (the number of years used to calculate your HAS depends on whether you were vested before January 1, 2020).

One other thing, if you take the transition year and then decide, for whatever reason, that you don’t want to retire, that is problematic because you have already retired from PERA. If you just work that last year like normal and then change your mind, nothing changes. While that could be considered a negative, as it could play into the “one more year” syndrome, overall I think it’s a positive because it gives you increased flexibility.

Many people will try to run a “break even” analysis on this. They’ll calculate how much “extra” income they will have if they take the transition year, receiving their salary and receiving a PERA benefit, and then they will compare that with the additional benefit they would receive if they didn’t take the transition year, and then do the math to try to figure out how long they have to live to “break even” in order figure out which one is “higher.” They often will also try to factor in how much they can earn on their investments if they take the “extra” money from the transition year and invest it, which is a legitimate factor to consider, but only if you actually invest that money.

But their are several problems with this break even analysis (in addition to the fact that most folks forget to subtract out the cost of the benefits they have to pay that last year). There is a huge behavioral aspect of this. Yes, if you do the math, and if you take the extra additional income you would make during the transition year and invest it in all equity portfolio, there is a decent chance you will eventually come out “ahead” compared to the increased monthly benefit if you worked one more year and got that additional service credit. But that “if” is doing a huge amount of work in that sentence. Theoretically you should be able to save and invest your entire PERA “paycheck” that year, since you are still working and earning the same salary as you previously were, and that presumably was enough to pay the bills. But behaviorally, most people are likely to spend at least some of it (and perhaps a lot of it) during that year. When you effectively are getting somewhere between a 25% and 75% raise for one year, few people will be disciplined enough to invest all of it. (And there’s even the potential to be bumped into a higher tax bracket if you don’t shelter some of it.)

In addition, for many people it is much harder psychologically to actually spend the money in their investment portfolio during retirement as compared to the monthly benefit check they get from PERA. For many folks, they have spent years saving and investing and building up their nest egg and then, suddenly, they have to decide how much they are comfortable withdrawing from their investments and spending on something. You may think that’s not you, that you have no trouble spending money. That may be the case, but it’s different in retirement because you no longer have an earned income in the future to plan on. And even the most free-spending people have the “what if” concerns, particularly around future medical and long-term care expenses, that often make them hesitant to spend down that nest egg too quickly. No one wants to outlive their money.

On the other hand, the check you get in retirement from PERA each month (as well as your spouse’s check from their retirement plan or social security), is something that you can count on coming this month, and next month, and the next…for the rest of your life. It is much, much, much easier to feel comfortable spending that money because you know it will be “replenished” the very next month with another check, and that will go on until your death. (And, with PERA, if you take Option 2 or 3, it will go on until the death of the second one of you.) And this also helps mitigate “longevity risk”, providing income for life even if you (and/or your partner) live for a very long time in retirement. So, even though mathematically (and assuming what your investment return will be on any invested money is correct) it might be the better bet to take the transition year, behaviorally it may not be. You may actually have a higher standard of living in retirement by not taking the transition year because you will actually be comfortable spending more money each month, even though (mathematically) you might have more total money by taking the transition year.

And, as I talked about when discussing purchasing service credit, this is also de-risking your retirement. While it’s certainly possible that you will earn a high rate of return on your transition money if you invest it, there is no guarantee (and, if you withdraw some of it to spend, you are subject to sequence of return risk). Whereas your benefit from PERA is guaranteed, so you have shifted the risk from the market – and your own behavior – to the state of Colorado, and you are not subject to any sequence of return risk on this portion of your retirement income/spending. This can also, at the margins, allow you to invest your existing portfolio in a slightly more aggressive manner, because you will have a larger defined benefit, and that more aggressive allocation should result in higher long-term returns.

Note: If the thing you value the most is leaving the largest inheritance possible for your heirs, then taking a transition year and investing the extra will possibly increase the size of that inheritance when compared to not taking the transition year. If you think you’ll be able to invest it for the long term and not draw on it, you will possibly end up leaving a larger inheritance than what you would be able to from the increased PERA benefit.

Another consideration would be if you have a terminal illness. If you do not expect to live very long in retirement, then taking the transition year – or simply retiring outright now – might be the better choice.

One more thing to consider about doing a “break-even” analysis. The goal here is not to die with the most money (at least I hope that’s not your goal). The goal is to live your best life in retirement and make decisions that allows that to happen. Obsessively worrying about whether you might “die young” and therefore “lose” on the break-even analysis is very much missing the forest for the trees.

For what it’s worth, I did take a transition year and my wife did not. This was partially due to the math calculations and partially due to circumstance. During my transition year we were able to essentially invest my entire paycheck and my wife’s entire paycheck and live solely off my PERA benefit during my transition year. Because my wife was still teaching, our daughter and I were able to be on my wife’s employer’s insurance which, while not cheap, was still less expensive than if we were getting it on our own. We also knew that we would likely be able to live solely on our PERA checks whenever my wife decided to retire. My wife ended up retiring at the end of the 2019-20 school year due to the pandemic. Because that wasn’t “planned” (she likely would’ve taught for a couple of more years if the pandemic hadn’t happened), there was no opportunity to take a transition year even if we had wanted to. But most likely we would have chosen not to even if we had had the choice (because of the combination of one more year of paid benefits, another year boosting her HAS, and the additional 2.5% of HAS, combined with the behavioral aspects mentioned above.)

Now, I want to be clear, this doesn’t mean that you shouldn’t take a transition year. For many people that will be the decision they will end up making and it will be the right one (the good news is that either option is great). But it does mean that you need to think about this a bit more carefully than perhaps most people have, and be very thoughtful and intentional about your decision.

I recently helped someone who is approaching their last year of teaching think through their options, so I thought it might be helpful to share some specific numbers to illustrate some of the above concepts. This example is for someone who works for Littleton Public Schools, so is based off of their salary schedule and their benefits. (As always, personal finance is “personal”, and part of that is the specifics of your district’s salary schedule and benefits.)

Here is a spreadsheet that is slightly modified (to protect their identity, so some of the numbers are a bit different) from the one I created for the discussion that I had with this person. Here is some relevant information:

• This person is currently on step 32 in the MA+90 lane of the LPS salary schedule (will be on step 33 next year if they don’t do the transition year) and also earns roughly $10,000 extra each year from coaching and other paid activities like class coverage. I am guesstimating their total salary for the 24-25 and 25-26 school years, but it should be pretty close.
• They have health, dental and vision insurance through LPS for just themselves (no dependents). They are in an HSA-qualified HDHP and the district contributes $1,250/year into their HSA. They pay a total of $1,164 in premiums yearly for health, dental and vision so, with the district contribution to their HSA, they actually net $86/year from benefits.
• For the cost of insurance in retirement I am using the current cost for PERACare, for which they can get up to a $230 monthly subsidy for pre-Medicare coverage (if they have 20 or more years of service; prorated if they have less) and up to $115 per month subsidy once they are on Medicare.
• As part of their benefits (if not taking a transition year), they also get 2x their salary in employer-provided life insurance, 8 additional days a year of sick leave, and 4 additional days of personal leave (and the personal leave rolls over to sick leave if it’s not used each year).
• When they retire they are eligible to get paid for unused sick leave at a rate of $53.25 up to a maximum of one year (defined as 187 days), so working an additional year could add up to 12 more days to this payout (if they don’t already have 187 days accumulated).
• Sick leave payout is paid in the month following their last paycheck and is PERA-includable salary, so for most folks this gives them an extra month of service credit and sometimes can raise their Highest Average Salary (HAS) which is used in the calculation of their PERA benefit.
• The formula for a full retirement, Option 1 benefit from PERA is years of service x 0.025% x Highest Average Salary (HAS). (There are also two other options that pay 100% or 50% survivor benefits, with a pop-up if the survivor beneficiary dies first.)
• While not really included in this analysis, PERA does have an annual cost-of-living increase which is currently 1% and has a delay of three years before kicking in.
• Colorado PERA members do not pay into Social Security, but many of them do have enough Social Security credits to earn a small Social Security benefit. With the repeal of the WEP and the GPO, this benefit might be slightly larger and they may also qualify for a spousal or survivor’s benefit.

The break-even analysis (even with all of its flaws) works out to be about 10-11 years. If they take the transition year they would make ~$129,000 from employment in 25-26 and ~$107,000 from their PERA pension. But they would pay ~$9,100 more for their benefits and would “lose” the bump to the $135,000 salary they would get if they advanced on the salary schedule. That totals ~$92,000 “extra” they get if they take a transition year (This works out to earning ~1.64x their salary by taking a transition year). If they don’t take the transition year, their HAS would increase by ~$6,300 and when you combine that with one additional year of service credit (an additional 2.5% of HAS), that increases their monthly benefit by ~$8,800. When you take the ~$92,000 “extra” and divide by the ~$8,800 yearly difference in their pension amount if they don’t do the transition year, that works out to the 10-11 years for “break-even” (not factoring in any possible investment gains on the “extra” from the transition year).

With a break-even of 10-11 years and being age 57 when they retire, they should handily come out “ahead” by not doing the transition year since their life expectancy is 25+ years. As I said before, I think the break-even is way too simple of a way to look at this. Working one more year will increase their monthly check by $733, which allows for significantly more spending without having to worry about it “running out” like they would if they withdrew it from their portfolio. When you add in all of the other factors (longevity risk, investment risk, behavioral risk, sequence of return risk, etc.), my advice was definitely to do another regular year instead of a transition year. (Having said that, if they decide to do a transition year anyway they’ll be fine.)

Here’s a table that summarizes (some) of the pros and cons of taking a transition year. But it’s really helpful to “do the math” for your specific situation and then align your decision with your own values and goals.