Is There Arbitrage in a PLOP?

Before we use the financial term, let's explain it like you're five years old. 

Imagine one store sells candy bars for $1, and another store across the street will buy the same candy bar for $1.25. Wouldn't you want to buy the candy bar at the first store and immediately sell it to the second store for a profit? That's called arbitrage. 

In finance, arbitrage means finding two markets that value the same thing differently and profiting from the difference with little or no risk. 

So, the question becomes: 

Can an Ohio STRS, SERS or OPERS retiree take a PLOP, use the lump sum to buy a personal Single Premium Immediate Annuity (SPIA), and end up with more guaranteed income than the pension reduction they gave up? 

That's the arbitrage question. 

Since Ohio retirement systems calculate PLOPs to be actuarially equivalent, they are generally trying to make the trade fair. In theory, you're not gaining or losing value. You're simply exchanging some future monthly income for cash today.

However, theory and reality are not always identical. 

Insurance companies and pension systems often use different assumptions regarding interest rates, mortality, survivor benefits, and administrative costs. As a result, there can occasionally be situations where a retiree can purchase a SPIA that replaces much, or even all, of the pension income surrendered through the PLOP.

If that happens, the retiree may have effectively created a form of arbitrage: 

• Take the PLOP.

  
  

• Purchase a SPIA.

  
  

• Restore most or all of the reduced pension income.

  
  

• Potentially retain additional flexibility, liquidity, or beneficiary value.

  
  

Those opportunities are not common, and they are rarely dramatic, but they can exist. 

That's why I believe many retirees should not automatically assume a PLOP is either good or bad. Instead, they should compare the pension system's actuarial calculations to what the private annuity market is offering at the time they retire. 

Sometimes there is no arbitrage. 

Sometimes there is. 

And finding out which situation you're in can be worth thousands of dollars over a retirement that may last 20 to 30 years. 

After 44 years of helping Ohio retirees evaluate income options, I've learned that the most important question isn't "Should I take the PLOP?"

It's: "Can I use the PLOP to create a better retirement income plan than the pension alone?" 

That's where the analysis begins.