If you are a state employee looking at retirement benefits and are having to choose between PERS 2 and PERS 3, you only have 90 days to make a decision before you are automatically enrolled in PERS 3. This article should help you understand both plans so you can make an informed decision.

What’s the difference between a PERS 2 and PERS 3 Plan? **PERS 2 is a defined benefit system meaning that your retirement benefits are defined as 2% x service years x Average Final Compensation (AFC). PERS 3 is a partially defined benefit. It uses a defined 1% x service years x (AFC) + investment options which depend on market performance.**

These two plans are actually incredibly different. It important that you fully understand what you are getting with the plan that you select so I want to really dig into these two plans separately and then compare them against one another.

When it is time to retire, maybe you see yourself sipping wine overlooking a beautiful lake! If so, choosing your path towards retirement may be a very important decision. By the end of this article, you should be well versed with both plans and be able to understand how they work so that you can make the right decision for yourself.

## What is PERS 2 and How Does it Work?

PERS 2 is the simplest of the two retirement plans. It offers a single defined benefit of 2% and can be considered a standard pension. You and your employer both contribute to the plan but the actual benefit amount isn’t directly tied to how much you put into the fund in dollar amount.

PERS 2 is calculated using the following formula:

2% x Service Credit Years (SCY) x Average Final Compensation (AFC)

Service Credit Years are calculated by determining how many months you’ve worked and dividing by 12. So, if you worked for 72 months, it would count as 6 SCY. Average Final Compensation is calculated by the monthly average of your highest consecutive 60 months (5 years) service.

**Example of PERS 2 in Action**:

Luke worked for several years before PERS 3 was available. When it became available, he decided to keep PERS 2 rather than shift his retirement plan. He has worked a total of 252 months and his highest average pay for a consecutive 5 year period was $5,000. Since 252/12 = 21, we know he worked 21 years. Let’s calculate his monthly benefit.

2% x 21 SCY x $5,000 AFC = *$2,100 in monthly benefits*

**Contribution Rates: **The current rate for PERS 2 is 7.90% which is shown on your pay statement. Contributions are required by you and your employer to fund the retirement fund which is managed by the Washington State Investment Board (WSIB). The rates are subject to change as the needs of the plan may fluctuate.

**Vesting:** The only vesting requirement is that you have a minimum of 5 years service credit in order to withdraw a monthly benefit.

**Retirement Age: **65 years of age (provided you meet the vesting requirement of 5 years service credit)

**Early Retirement:** Retirement as early as 55 years of age is permitted as long as you have 20 years of service credit. The Early Retirement Pay is reduced to reflect that you have not given the funds as much time to grow and you will be receiving it for a longer period of time. It will be reduced less if you have 30 years of service credit.

Early Retirement is calculated by:

##### 2% x SCY x AFC X Early Retirement Factor (ERF)

Early Retirement Factors are based on your age and are split based on if you have 20 years or 30 years of service credits.

To see the ERF Factors for both plans, refer to DRS Website.

So in the example, we showed above regarding Luke, let’s assume he’s 58 years old, and he wants to retire early. We can still use the same information that he worked 21 years and has an average payment compensation of $5,000. When we add in the ERF of 0.507, we get:

2% x 21 SCY x $5,000 AFC x 0.507 ERF = $1064.70

He would have received $2,100 at 65 so now he will receive $1,035.30 less than what he would receive if he waited until 65 years of age. Although it may seem like a big loss, it may be worth it to him since it will yield him $89,434.80 in benefits by the time he reaches 65 years of age and he can access it sooner.

**What If You Have to Leave Employment?** There are a lot of reasons you may wish to leave service. Whatever your reasons are, these are your options.

If you wish to withdraw your contributions and the interest it has accrued, you may but you will forfeit your right to future retirement benefits and you cannot withdraw your employers contributions.

If you are vested with at least 5 years of service credit and you leave the retirement contributions alone, they will continue to grow in the plan and you will be able to withdraw monthly benefits of the 2% defined plan when you turn 65.

If you withdraw your contributions but later decide to return to public service again, it is possible to recover your withdrawn service credit but will cost you a considerable one-time purchase fee.

### Is PERS 2 a Pension?

This is a common question. PERS 2 is a pension. It offers a defined benefit system that pays you monthly for the rest of your life once you start retirement.

## What is PERS 3 and How Does It Work?

PERS 3 is a two part plan. The first part is a defined 1% benefit that is funded by contributions from your employer only and managed by the Washington State Investment Board (WSIB). The second part of the plan is defined by contributions that you select and investment portfolios that you select. It is dependent on market performance and its value can fluctuate up or down as the market also fluctuates.

To calculate the defined benefit, we use the following formula:

1% x Years of Service Credit (SCY) x Average Final Compensation (AFC)

We mentioned in the PERS 2 example that SCY is calculated by how many service months you worked divided by 12 and AFC was calculated by your average monthly pay of the highest 5 consecutive years of service.

The second part of the calculation is dependent on how much you decide to contribute and how the market performed over the period of time before its withdrawn for retirement.

Sound confusing? Don’t worry, we’ll cover an example.

**Example of PERS 3 in Action**

Leia has worked as a public employee for 30 years starting at age 35. Her average monthly pay over her highest 5 year period was $5400. She decided to contribute 7% of her wages for all ages which is Plan D (we’ll cover this later).

Defined Benefit: 1% x 30 SCY x $5400 AFC = $1620 monthly defined benefit

Although it’s impossible to calculate how the market would respond to 30 years of changing pay, I’ll give you a hypothetical scenario. I’m going to assume Leia started working at $3400 a month and got a $400 raise every 5 years, so her last years were $5400, and she dedicated 7% of her pay to retirement contributions.

In this example, she will have amassed over $409,000 over the 30 year period. If you were to withdraw the industry standard of 4% annually, this would equate to $16,360/yr or $1363.33/month

Therefore her total monthly income during retirement would be $1620 + $1363 = $2,983

Where did I get that bogus $409,000 number?

I crunched it in Excel which took me a lot longer than I expected to dedicate to this part of the article. I did make the market assumption that each year it increased in value 8% based on the fact that is the historical average market return.

**Contribution Rates: **Contribution rates are a little more confusing in Plan 3 but don’t worry, I’ll explain it here. You have 6 options (A-F) which are:

- Option A: 5% all ages
- Option B: 5% up to age 35, 6% from ages 35-44, and 7.5% age 45 and older
- Option C: 6% up to age 35, 7.5% ages 35-44, and 8.5% age 45 and older
- Option D: 7% all ages
- Option E: 10% all ages
- Option F: 15% all ages

If you do not select an option, the Plan will automatically enroll you into Option A which is 5%.

**Investment Choices:** You can two different types of plans for the investment portion of your retirement. You can either manage it yourself or let the WSIB manage it for you. It’s really up to you. If you are more hands-on and want control of your investments, you can do so by selecting the Self Directed Investment Program. If you want it fully managed by the WSIB, choose the WSIB Program.

The Self Directed Program gives you options as well. You can build and monitor your entire portfolio by selecting and adjusting the funds as you see fit or you can choose the One-Step Investing option which places your investment into “target date” funds which automatically adjust the portfolio to manage risk as your target date of retirement approaches.

**Vesting:** In order to receive monthly benefits, there is a vesting period of at least 10 years of service years. The only exception is that the period may be reduced to 5 years if the employee has 5 years vested and at least 12 months vested after the age of 44.

Vesting only applies to the defined benefit and not the invested portion from the employee contributions.

**Retirement Age:** 65 years or older and meets the above vesting requirements.

**Early Retirement:** Retirement as early as 55 years of age is permitted as long as you have 10 years of service credit. The Early Retirement Pay is reduced to reflect that you have not given the funds as much time to grow and you will be receiving it for a longer period of time. It will be reduced less if you have 30 years of service credit.

Early Retirement is calculated by:

##### 1% x SCY x AFC X Early Retirement Factor (ERF)

Early Retirement Factors are based on your age and are split based on if you have 20 years or 30 years of service credits.

To see the ERF Factors for both plans, refer to DRS Website.

So in the example, we showed above regarding Leia, let’s assume she’s 60 years old, and she wants to retire early. We can still use the same information that she worked for 30 years and has an average payment compensation of $5,400. When we add in the ERF of 0.75 (found at the DRS website), we get:

1% x 30 SCY x $5,400 AFC x 0.75 ERF = $1215.

She would have received $1,620 at 65 so now she will receive $405 less than what she would receive if she waited until 65 years of age. Although it may seem like a big loss, it may be worth it to her since it will yield her $24,300 in benefits by the time she reaches 65 years of age and she can access it sooner.

**What if You Have to Leave Employment: **Since your employer contributed the defined benefit portion of your retirement plan, you will not be able to withdraw that portion. Any of your invested funds from the Investment portion of PERS 3, can be withdrawn. You also have the choice to allow it to remain in the fund and continue to accrue interest.

### Is PERS 3 a 401(k)?

This is a common question for PERS 3. PERS 3 is considered a 401(a) which is similar to a 401(k). Although there are quite a few differences between the two, a 401(a) is generally given to employees of the government whereas a 401(k) is provided to private business employees.

PERS 3 is also a pension though since it offers the defined benefit portion which is a monthly disbursement for the rest of your life once you retire.

## PERS 2 vs PERS 3 – What are the Key Differences

Hopefully, you have a good understanding of how each plan works based on all of the information above. If not, don’t worry, I’ve created a mini cheat sheet with the key differences summarized.

PERS 2 | PERS 3 | |

Guaranteed Income | Yes | Yes (half of PERS 2) |

Personal Investments | No | Yes |

Contribution Rate | 7.90% | Varies (You Choose 1 of 6 Options) |

Standard Retirement Age | 65 with five years vested | 65 with 10 years vested (5 years if 12 months service after age 44) |

Early Retirement Age | 55 with 20 years service | 55 with 10 years service |

Vesting Requirement | 5 years | 10 years (5 years if at least 12 months service after age 44) |

Withdrawal Options Upon Leaving Prior to Retirement | Allow funds to remain or withdraw your own contributions | Allow funds to remain or withdraw your own contributions |

Does it Offer Cola (Cost of Living Adjustment)? | Yes | Yes (Defined Benefit portion) |

## Does PERS 2 or PERS 3 Offer the Best Monthly Payout?

Since PERS 3 depends heavily on market conditions and contribution percentages selected, it’s impossible to say for certain which will give you the best monthly payout.

One thing I can do is show you the example of Leia above in which she chose PERS 3. Had she chosen PERS 2, it would be easy to calculate and compare the two. Let’s give it a shot.

I would like to caution that these examples were made up based on educated guesses as to market performance and salary raises. Please use this as education only and not financial advice.

If you remember, Leia had a defined benefit of $1,620 and an investment withdrawal of $1,363. This meant her monthly retirement pay would add up to $2,983.

Had she chosen PERS 2, she would not have amassed the $409,000 retirement account that she was withdrawing the $1,363 from but she would have had a defined benefit of 2% instead of the 1%.

Under PERS 2, her defined monthly benefit would have been:

2% x 30 (SCY) x $5,400 (AFC) = $3240.

Although this is a higher payment, the investment portfolio can be adjusted so that a 5% withdrawal from $409,000 would yield $1,704 and bring up the total monthly distribution to $3,324.

As you can see, there a lot of things to consider but the easiest way to put it is as follows:

With PERS 2 you have a defined benefit that is higher. As long as the Fund is funded properly and managed properly, you will have that distributed income each month of your retirement.

With PERS 3, you are relying on only half of that distribution from the defined benefit fund but will receive less. You will rely more heavily on managing the distribution of the wealth you created in your own retirement account which is dependent on your asset allocation and portfolio management with regards to the market.

Both plans have some risk. PERS 2 has no market risk but does have the risk of the pension fund running dry to mismanagement (although unlikely). PERS 3 has market risk which depending on how you manage your portfolio can vary due to the volatility of the market.

PERS 2 is non-adjustable and PERS 3 is adjustable by managing withdrawals. For some PERS 2 is enticing because you just collect a retirement check and don’t worry about the investing side of the house. For others, PERS 3 is enticing because it offers more control and the ability to accrue a nest egg that you can leave behind to your loved ones.

Everyone’s circumstances are different. Whatever the case, I hope this helped you understand both plans better.

If you want to learn about other ways to invest, please check out the rest of this site. Until next time, let’s start investing!