10 Reasons to take your pension annuity over a lump sum

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g$$
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10 Reasons to take your pension annuity over a lump sum

Post by g$$ » Sat Jan 04, 2014 2:42 am

A common request on this board is for advice when faced between an annuity and a lump sum in a pension plan. Below I provide some context around why I think an annuity is usually the right choice. Of course, every pension plan is different, and so is every participant. This advice may be more or less helpful based on your own situation.

One suggestion is to compare the annuity offered by the pension plan with an annuity you could purchase on the open market for the price of the lump sum. If the annuity from the pension plan is bigger, then the pension is a better deal.

There are a few forces working in your favor that would cause the annuity to be a better deal. First, a few assumptions:
(+) This assumes your pension is a qualified plan provided by a single employer in the private sector. Not a public/government plan.
(+) All annuities purchased on the open market are Single Premium Immediate Annuities (SPIAs). You send the insurer one big check and they will pay you one amount monthly until you die. Just like a pension.
(+) This is mostly meant for rank and file employees. Highly paid employees that have some skin in the game (like a partial owner) may have a different perspective.

Onto the arguments...

(1) Interest Rates
The interest rates that the plan sponsor uses to calculate your lump sum are mandated by the IRS. These rates have been low in recent years but not as low as those used by the insurance industry. Insurance company rates are not mandated and low rates = expensive annuities. The plan sponsor will probably calculate your lump sum with a higher interst rate assumption than the insurer would use to calculate the premium. Note that by "premium" I mean the amount that an insurer would charge for the annuity.

(2) Mortality Tables
These are also mandated by the IRS. The mortality table used by an insurer is probably more up to date, and therefore more conservative, meaning that they expect you to live longer than the current IRS table would suggest. A longer life expectancy = more expected payments = a more expensive annuity. The insurer would therefore charge more for the liability than what your company would have offered you as a lump sum.

(3) Expenses
The expenses in a pension plan are paid by the plan sponsor, not by plan participants. The insurer needs to pay these expenses somehow so they include it in the premium.

(4) Profit Margin
The plan sponsor isn't making a profit on these annuities, but a life insurer is. By running a pension plan, your plan sponsor was effectively running a life insurance company at cost. A life insurer exists to make money and they included their expected profit in the initial premium.

(5) Demographic differences
Most people buying an annuity on the open market expect that they will live a long time. Life insurers know this and price the product accordingly. In other words, annuities purchased on the open market are expensive because only health people buy them. Pension plans however have both healthy and sick employees and the lump sum (or price of the annuity) is priced accordingly.

Like I said earlier, every plan sponsor is different, so the following items may or may not impact your situation.

(5) Early Retirement Subsidies
Many plan sponsors offer early retirement subsidies. What I mean by this is that they don't reduce the benefit by as much as an actuary would for early commencement. Usually, if you take the benefit early, the benefit should be reduced. For example, if you take the benefit 10 years early then you might expect about 10 more years worth of payments. To keep the expected value equivalent, the benefit should be reduced by about half to account for the value of these added payments. Many companies offer more generous (as in smaller) reductions. BUT... depending on the way the plan document is written, the lump sum doesn't need to include the value of these subsidies. So your annuity might have a big subsidy, but the lump sum might not.

(6) Prefunded Benefit
Many private sector pensions pre-funded. Most are at least 80% funded. This percentage will depend on the assumptions but I don't want this post to become sidetracked by nitpicking assumptions. Suffice it to say that there is probably a large amount of money set aside in a trust should the plan sponsor declare bankruptcy. This gives your benefit you some protection from creditors.

(7) PBGC Insurance
Most benefits are insured by the PBGC. This means that your benefit is covered even if your company goes bankrupt and the assets aren't sufficient to purchase an annuity for you. The PBGC might not insure everything (they're not in the business of insuring short term subsidies or really really big benefits) but they'll pay about 5,000 per month to someone age 65. That's nothing to scoff at and should cover most rank and file employees.

And finally, some reasons that an annuity may be helpful even if it isn't provided by a pension plan.

(8) Longevity Risk
Worried that you may outlive your assets? Not a problem with an annuity. It will pay every month till the day you die.

(9) Investment Risk
Worried about the performance of your assets? Let someone else do it for you! The pension plan can take on all of this risk for you.

(10) Peace of Mind
Annuities make planning simple. No need to worry about what SWR to use because you know exactly how much you'll be receiving.

Hopefully this helps explain why an annuity may be a better deal than a lump sum. I look forward to commentary from the community.

-g$$

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Re: 10 Reasons to take your pension annuity over a lump sum

Post by TT » Sat Jan 04, 2014 5:04 am

Calculating options of an annuity vs lump sum pension without cola resulted in I could elect the lump sum and generate 5.57% return which would enable me to have the same monthly income and the total principal amount. Considering I did not need the monthly draw to live I elected to take the lump sum and invest in an IRA and not pay any taxes at this time. Also, SS and another PBGC pension that I am not drawing on are both annuities. Ever circumstance needs to be calculated and considered on an individual basis.

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Re: 10 Reasons to take your pension annuity over a lump sum

Post by dickenjb » Sat Jan 04, 2014 7:27 am

TT wrote:Calculating options of an annuity vs lump sum pension without cola resulted in I could elect the lump sum and generate 5.57% return which would enable me to have the same monthly income and the total principal amount. Considering I did not need the monthly draw to live I elected to take the lump sum and invest in an IRA and not pay any taxes at this time. Also, SS and another PBGC pension that I am not drawing on are both annuities. Ever circumstance needs to be calculated and considered on an individual basis.
Please tell us where you found the risk free 5.57% return investment? I would like to buy some for my IRA.

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Re: 10 Reasons to take your pension annuity over a lump sum

Post by TT » Sat Jan 04, 2014 8:10 am

dickenjb wrote:
TT wrote:Calculating options of an annuity vs lump sum pension without cola resulted in I could elect the lump sum and generate 5.57% return which would enable me to have the same monthly income and the total principal amount. Considering I did not need the monthly draw to live I elected to take the lump sum and invest in an IRA and not pay any taxes at this time. Also, SS and another PBGC pension that I am not drawing on are both annuities. Ever circumstance needs to be calculated and considered on an individual basis.
Please tell us where you found the risk free 5.57% return investment? I would like to buy some for my IRA.

"risk free"- You are presuming that Pension plans / annuities are risk free ?

"...the reality of a fixed-payout annuity is a steady loss of purchasing power. If you invest the money on your own, you have a good, but by no means assured, chance of investing it so that it will keep up with inflation.

Anticipated income. Generally, annuity payouts give you less income than you could make if you were investing the money on your own. Reason: The payout schedules tend to be figured very conservatively to minimize the annuity company's future financial risks. In plain English, this means that the company is betting you’ll live to 200. Find out the exact monthly or quarterly stipend you'd receive from an annuity and compare this figure to your anticipated rate of return if you were investing the money on your own.

Mortality risk. Traditionally, annuity payments stop when you die. So, if you die prematurely, your estate is considerably poorer than it would have been if you'd taken a lump sum. Note, though, that many annuity plans - both the corporate type and the kind you buy on your own – offer some sort of provision for this event, although at a price. Typically, it's a continuation of some lesser stream of payments for the benefit of a surviving spouse, or the option of receiving a lump-sum payout of a portion of the money that was originally put into the annuity.."

"Nearly 80% of the private pension plans covered by the Pension Benefit Guaranty Corp., or PBGC, are underfunded, to the tune of $740 billion. The news is even worse among the nation's largest companies. Only 18 defined benefit pension plans offered by companies in Standard & Poor's 500 benchmark are fully funded.
More than 1,400 companies shut down their pension plans in fiscal year 2011, compared with 1,200 in 2009, according to the PBGC. An additional 152 plans failed, meaning they were terminated without enough money to pay promised benefits and were taken over by the PBGC. The PBGC itself, which is funded by employer-paid insurance premiums, is running a $26 billion deficit.
Public pension funds are underfunded by at least $1 trillion, according to a report by the State Budget Crisis Task Force. To close the gap, 35 states have reduced pension benefits for their employees, and half have increased worker contributions to their plans, according to a report released in March by the U.S. Government Accountability Office. Three states -- Georgia, Michigan and Utah -- have implemented hybrid plans that include defined contribution plans, similar to 401k's, that shift some investment risk to workers."

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Re: 10 Reasons to take your pension annuity over a lump sum

Post by cherijoh » Sat Jan 04, 2014 9:44 am

Good Summary! Here are some additional considerations/comments:

5) Early Retirement Subsidies - Many companies offer a formula that is favorable to a long-term employees, so the length of employment could impact whether a pension is a better deal than a lump sum. My former employer has a rule of 85 - if your age + years of service is 85 or more you can get your pension with NO reduction in benefits at 55 (assuming you are still employed there at that time). With 15 or more years of service, it is 80% of full benefit at 55 ramping up to a full pension at 60. With fewer than 15 years, you take a 40% haircut at 55 and get full benefits at 65. A lump sum wasn't an option when I left the company in 2004, but this subsidy has no actuarial basis so I doubt it would be included in a lump sum if one were available. So early retirees with long term tenure may be in a sweet spot when it comes to pension vs. lump sum. Check out your company's formula.

6) Prefunded benefit - if your pension plan falls under the assumptions made by the OP, your company is legally required to provide an annual notice that shows what percentage of benefits are funded. So check it out before deciding whether a bird in the hand is the better option.

7) PBGC Insurance - this is set up to be a safety net so you are more likely to be made whole by the insurance the smaller your pension benefit. If you check out their website, you can easily determine the amount of risk you would assume if you company declares bankruptcy. Those taking early retirement take additional risk IF their company goes belly-up before they turn 65.

If I were given a choice of a pension or lump sum, I would go with the pension. I have other investable assets that can cover the declining real value of the pension. I value it's diversification benefit.

I think Bogleheads are in the position to do better than the average Joe with a lump sum because they are much more savvy about investing and are much less likely to be dependent on just SS and the pension. IMO, a non-Boglehead would likely overweight market risk and underweight inflation risk so that they would NOT do better than the implied return of the annuity over the long term. I suspect there are a lot of people nearing retirement out there who have a big chunk of their 401k invested in the stable value fund because it is "safe"! Do you really see folks like that becoming MORE aggressive in retirement and going 50/50 or 40/60 stocks and bonds and staying the course? Not me! Also, those arguing for a lump sum seem to be putting the same value on the risk of leaving money on the table as running of money before you (and your spouse) die. I just don't get it.

Also worth mentioning is the possibility that someone taking a lump sum will fall victim to an unscrupulous financial advisor/stock broker just waiting to get their hands on a tidy lump sum. :moneybag It is amazing the number of free dinner seminars to which I get an invitation now that I am approaching early retirement age. :annoyed

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Re: 10 Reasons to take your pension annuity over a lump sum

Post by g$$ » Sat Jan 04, 2014 12:03 pm

TT wrote:Ever circumstance needs to be calculated and considered on an individual basis.
I agree.
TT wrote:"risk free"- You are presuming that Pension plans / annuities are risk free ?
No, but they considerably reduce your market risk and longevity risk.

TT wrote:"...the reality of a fixed-payout annuity is a steady loss of purchasing power. If you invest the money on your own, you have a good, but by no means assured, chance of investing it so that it will keep up with inflation.
Sure, most don't increase with inflation. However, most retirees will have Social Security which is indexed to CPI. These two annuities provide a very good base for retirement income. Other savings, like a 401(k), can be used to supplement more flexible spending.
TT wrote:The payout schedules tend to be figured very conservatively to minimize the annuity company's future financial risks. In plain English, this means that the company is betting you’ll live to 200.
This is not true. The mortality tables used to calculate a lump sum are mandated by the IRS, as described above.
TT wrote:Mortality risk. Traditionally, annuity payments stop when you die. So, if you die prematurely, your estate is considerably poorer than it would have been if you'd taken a lump sum."
OK, but do you really care when you wont be around anymore? You could also argue that by taking the lump sum you can't spend as much while you are living. With a lump sum you need to develop a safe withdrawal rate (SWR) that will protect you from outliving your assets. If you spend enough to live to the average life expectancy, then you would be broke the day after you lived past that time frame. An annuity allows to you spend the same amount but without any risk of outliving your money. That risk has been diversified along with everyone else in the annuity pool. Some will outlive it and some wont.
TT wrote: "Nearly 80% of the private pension plans covered by the Pension Benefit Guaranty Corp., or PBGC, are underfunded, to the tune of $740 billion. The news is even worse among the nation's largest companies. Only 18 defined benefit pension plans offered by companies in Standard & Poor's 500 benchmark are fully funded.
More than 1,400 companies shut down their pension plans in fiscal year 2011, compared with 1,200 in 2009, according to the PBGC. An additional 152 plans failed, meaning they were terminated without enough money to pay promised benefits and were taken over by the PBGC. The PBGC itself, which is funded by employer-paid insurance premiums, is running a $26 billion deficit.
Public pension funds are underfunded by at least $1 trillion, according to a report by the State Budget Crisis Task Force. To close the gap, 35 states have reduced pension benefits for their employees, and half have increased worker contributions to their plans, according to a report released in March by the U.S. Government Accountability Office. Three states -- Georgia, Michigan and Utah -- have implemented hybrid plans that include defined contribution plans, similar to 401k's, that shift some investment risk to workers."
740 billion means nothing without knowing what piece that is out of the total pension pie. This measure is also highly dependent on assumptions and timing. I see you choose 2009, right after the market downturn in 2008. Interest rates have obviously been low during this time which further inflates this number.

Shutting down a plan isn't a big deal because upon termination they simply buy an annuity from a life insurer to replace yours. The only thing changing from a retirees perspective is the name on the envelope with their monthly check. Let them pay for all those extra expenses and more conservative assumptions!

In the unlikely event that the PBGC needs to take it over they can even place a lien on the plan sponsor and absorb the company's assets to pay the annuity.

Public pension plans were not part of this discussion.
Last edited by g$$ on Sat Jan 04, 2014 12:13 pm, edited 1 time in total.

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Re: 10 Reasons to take your pension annuity over a lump sum

Post by g$$ » Sat Jan 04, 2014 12:10 pm

cherijoh wrote: Also worth mentioning is the possibility that someone taking a lump sum will fall victim to an unscrupulous financial advisor/stock broker just waiting to get their hands on a tidy lump sum. :moneybag It is amazing the number of free dinner seminars to which I get an invitation now that I am approaching early retirement age. :annoyed
This is an excellent point.
cherijoh wrote:I think Bogleheads are in the position to do better than the average Joe with a lump sum because they are much more savvy about investing and are much less likely to be dependent on just SS and the pension. IMO, a non-Boglehead would likely overweight market risk and underweight inflation risk so that they would NOT do better than the implied return of the annuity over the long term. I suspect there are a lot of people nearing retirement out there who have a big chunk of their 401k invested in the stable value fund because it is "safe"! Do you really see folks like that becoming MORE aggressive in retirement and going 50/50 or 40/60 stocks and bonds and staying the course? Not me!
Exactly. Bogleheads may be in a better position with the lump sum than others. For the average Joe though, I find it a bit reckless to jump straight to the lump sum recommendation.
cherijoh wrote:Also, those arguing for a lump sum seem to be putting the same value on the risk of leaving money on the table as running of money before you (and your spouse) die. I just don't get it.
I agree again. Running out of money before I die seems worse than leaving behind a smaller inheritance.

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Re: 10 Reasons to take your pension annuity over a lump sum

Post by White Coat Investor » Sat Jan 04, 2014 12:22 pm

I'm surprised how few lottery winners choose the annuitized option.
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Re: 10 Reasons to take your pension annuity over a lump sum

Post by teacher » Sat Jan 04, 2014 1:06 pm

cherijo wrote:
I suspect there are a lot of people nearing retirement out there who have a big chunk of their 401k invested in the stable value fund because it is "safe"! Do you really see folks like that becoming MORE aggressive in retirement and going 50/50 or 40/60 stocks and bonds and staying the course?
That would be me. We took the lump sum pension a couple weeks ago and plan to invest it in Stable Value. We did it for two reasons, inflation risk and desire to pass on residual to heirs. On another thread, hudson mentioned the "pile theory". That sort of fits this plan in that this sum, which is about a fifth of our portfolio plus cash, will be "safely" parked. We don't expect great returns. We just hope for nominal growth to ameliorate inflation and anything remaining to go to our heirs. The rest of the portfolio will provide the bells and whistles. With that said, our intent is to consider this sum as part of our Asset Allocation.

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Re: 10 Reasons to take your pension annuity over a lump sum

Post by Bradley » Sat Jan 04, 2014 2:59 pm

teacher wrote: We took the lump sum pension a couple weeks ago and plan to invest it in Stable Value. We did it for two reasons, inflation risk and desire to pass on residual to heirs.
There are many reason to take a lump sum. The desire to pass on residual to heirs was among the most important to me. I took both a defined benefit and defined contribution as a lump sum back in 2010 and never gave any serious consideration to the annuity option.
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Re: 10 Reasons to take your pension annuity over a lump sum

Post by bsteiner » Mon Mar 17, 2014 3:52 pm

cherijoh wrote:...It is amazing the number of free dinner seminars to which I get an invitation now that I am approaching early retirement age.
If you go to the free dinner seminar, and you're the one who buys the annuity, the living trust, the timeshare, or the bridge, not only did you pay for your free dinner, but you just paid for the free dinners for everyone else in the room.

Another benefit of the lump sum is the potential additional value of a Roth conversion (in those cases where it's beneficial).

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Re: 10 Reasons to take your pension annuity over a lump sum

Post by vested1 » Mon Mar 17, 2014 5:24 pm

As the OP pointed out, it depends on the circumstances. I retired early at 57 and continued to work at another job, allowing my lump sum to grow substantially in a rolled over IRA. At the time I retired the interest rate used to determine the lump sum was more favorable because it was based on US treasuries. A year or so after I retired the corporation was allowed to convert the basis to corporate bonds, thus reducing the lump sum dramatically for future retirees.

Often the pension is a better option, especially if you are planning on really retiring and not continuing to work. There are some plans that allow you to delay taking your annuity payment if you don't need it immediately, which allows the monthly amount to grow until you decide to initiate payments.

Advocates of taking the annuity always point out that you can't purchase an SPIA with the lump sum payment and expect to receive the same amount of monthly income, which is an almost universal truth. That doesn't mean it's always the best decision. If I converted my IRA to an SPIA now, after its 5 years of growth I would get a larger monthly amount than I would have received if I took the annuity, which would not have been adjusted for COLA. Of course I would never convert that percentage of my retirement savings to a SPIA, just like I would never put all my eggs in one basket.

Additionally, by continuing to work and receiving the annuity I would have been pushed into a higher tax bracket.

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Re: 10 Reasons to take your pension annuity over a lump sum

Post by vested1 » Mon Mar 17, 2014 5:41 pm

vested1 wrote:Of course I would never convert that percentage of my retirement savings to a SPIA, just like I would never put all my eggs in one basket.
I'll break the cardinal rule and quote myself. This more than anything else compelled me to take the lump sum. The finality of an annuity can be daunting.

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Re: 10 Reasons to take your pension annuity over a lump sum

Post by mickeyd » Mon Mar 17, 2014 5:51 pm

I toyed with the idea of taking one of my pensions in cash and investing it myself but did not act on that idea. I'm now very glad that I have one more monthly income stream arriving at my checking account on the first of each month. Handing my IRA/Roth/taxable stash is enough for me and the pensions insure that if I make a stupid mistake with the IRA there is a steady stream coming in soon.
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Re: 10 Reasons to take your pension annuity over a lump sum

Post by tractorguy » Mon Mar 17, 2014 8:51 pm

Reason 11: In at least one state (Illinois), payments from a qualified pension are exempt from state income tax with no limits. I haven't looked in other states but I think some may have a similar provisions with limits.

I took the pension and haven't looked back. I've got significant other taxable and tax sheltered investments as well but it is real nice to have a "paycheck" as a foundation for managing my investments. Its also really nice to know that my spouse will continue to get the paycheck if I pre-decease her. I'm interested in managing our investments but every time I tell her what I'm doing I can see her eyes start glazing up. Of course I look the same way when she starts talking about some of her interests.
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Re: 10 Reasons to take your pension annuity over a lump sum

Post by Watty » Mon Mar 17, 2014 9:27 pm

Be sure to also consider taking the lump sum and using it to live on while you delay starting social security to get a larger social security check. This is in effect buying an inflation adjusted annuity that may have a larger payout and tax additional tax advantages.

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Re: 10 Reasons to take your pension annuity over a lump sum

Post by teacher » Mon Mar 17, 2014 11:47 pm

vested wrote:
Additionally, by continuing to work and receiving the annuity I would have been pushed into a higher tax bracket.
DH recently took the lump sum, and we may have a lower effective tax rate which would help with ROTH conversions, but at 70 1/2, we expect the lump sum will raise the RMD withdrawal amount, and subsequently, will increase our tax liability.

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Re: 10 Reasons to take your pension annuity over a lump sum

Post by g$$ » Tue Mar 18, 2014 12:07 am

tractorguy wrote:Reason 11: In at least one state (Illinois), payments from a qualified pension are exempt from state income tax with no limits. I haven't looked in other states but I think some may have a similar provisions with limits.

I took the pension and haven't looked back. I've got significant other taxable and tax sheltered investments as well but it is real nice to have a "paycheck" as a foundation for managing my investments. Its also really nice to know that my spouse will continue to get the paycheck if I pre-decease her. I'm interested in managing our investments but every time I tell her what I'm doing I can see her eyes start glazing up. Of course I look the same way when she starts talking about some of her interests.
teacher wrote:
vested wrote:
Additionally, by continuing to work and receiving the annuity I would have been pushed into a higher tax bracket.
DH recently took the lump sum, and we may have a lower effective tax rate which would help with ROTH conversions, but at 70 1/2, we expect the lump sum will raise the RMD withdrawal amount, and subsequently, will increase our tax liability.
Bradley wrote:
teacher wrote: We took the lump sum pension a couple weeks ago and plan to invest it in Stable Value. We did it for two reasons, inflation risk and desire to pass on residual to heirs.
There are many reason to take a lump sum. The desire to pass on residual to heirs was among the most important to me. I took both a defined benefit and defined contribution as a lump sum back in 2010 and never gave any serious consideration to the annuity option.
These are some really good points that help to drive home the point about every situation being different. I specifically avoided tax considerations in my list above because of the uncertainty. Tax implications will favor the annuity in some instances but will favor the lump sum in others. It always depends on the circumstances.

-g$$

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Re: 10 Reasons to take your pension annuity over a lump sum

Post by The Wizard » Tue Mar 18, 2014 12:33 am

EmergDoc wrote:I'm surprised how few lottery winners choose the annuitized option.
Well, ED, lottery winners are generally stupid folks (no offense, lottery winners), so that would stand to reason.
But in reality, I suspect the lottery payout over 25 years or whatever is independent of age, so it's not really in the same ballpark as an SPIA actuarially...
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Re: 10 Reasons to take your pension annuity over a lump sum

Post by The Wizard » Tue Mar 18, 2014 12:37 am

What's fun is to annuitize sufficient funds to have monthly income in retirement to cover all your expenses, but then ALSO retain an unannuitized portfolio of significant size as well. That's what I did, though I realize it's not feasible for everyone...
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Re: 10 Reasons to take your pension annuity over a lump sum

Post by Sheepdog » Tue Mar 18, 2014 1:43 am

I took my pension as a lump sum because
1. I didn't trust my employer funding the pension properly.
2. I had had a heart attack 2 months before retiring, so I did not expect to live too long. At the time, I did not believe the joint and survivor annuity choices were satisfactory. 100% to my wife reduced the monthly payout too much, I felt. 50% gave a reasonable payout while I lived, but too low for my spouse after I died. Managing the lump sum was my choice because I did not like those choices.

Looking back, it has now been 15 years and counting, the rollover IRA has worked fine. I am receiving income and have more in that account than at the beginning, but it has taken management. If I had not lived long, my wife would have had much difficulty in managing the overall investments. The annuity would have been her safety net. I wouldn't have had to worry about the crashes like 2008-09 and maintain income. It didn't hurt taking the lump sum, but the 100% to the survivor annuity would have been more effective. I would take it now.

Out of curiosity, I checked to see what an immediate annuity would pay today If I were to buy one with the present balance in that rollover IRA. The present balance is about 10% more than it was in 1998 after 11 years of taking out more than RMDs. At age 80 and spouse 74, a current 100% to the survivor annuity, would pay only about $140 more a month than at my 65 years of age quote. That shows the effect of today's low interest rate environment compared to the 5.99% rate in 1998.
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Re: 10 Reasons to take your pension annuity over a lump sum

Post by Dandy » Tue Mar 18, 2014 1:31 pm

I agree that for most taking a pension is a better idea. I considered these points when making my decision
1. the ability to leave some of your pension to your spouse.

2. to diversify the money management of my/our retirement - having SS and a pension means my spouse and I are not responsible for the investment decisions for all of our income. I think I manage money well now - at some point it may be beyond my capabilities - and I might not be fully aware of that. My spouse is not interested or qualified to manage our investments and the less she is subject to mismanagement by her, well meaning relatives and maybe not so well meaning advisors the better.

3.Puts less demands on funding your retirement needs by your investment withdrawals. Less reliance on investments allows much more freedom to be aggressive with your retirement investments or decide to be conservative. You are not under as much pressure for your portfolio to fund your needs.

Lump sum amounts tend to dazzle and make people lose focus. Not many people get a chance to get a check for several hundred thousand and probably overestimate their ability to make as much as their pension for a long retirement.

Taking a pension isn't risk free - the company can default, you could die early and your spouse/estate could have had more assets. Life decisions tend to be a bit of a gamble.

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Re: 10 Reasons to take your pension annuity over a lump sum

Post by ofcmetz » Tue Mar 18, 2014 5:07 pm

Interesting discussion, thanks for starting it OP. In my case there is only the option of the pension, so no decision to be made. I'd imagine that many would jump at the lump sum just like a lottery winner jumping at the lump sum, but I have nothing to base this on. Would be interesting to see the actually numbers as it relates to the behavioral finance questions this brings up.

Ideally, most can be in Wizards shoes, with a pension and a nest egg on the side. I'd never want to have all my eggs just in the pension basket.
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Re: 10 Reasons to take your pension annuity over a lump sum

Post by Ledgesitter » Tue Mar 18, 2014 6:45 pm

In about 6-8 years (hopefully) I will have the option to choose between traditional pension or lump sum. As of now I hope to take the lump sum. I will be approximately 52-53 years old at the time. I agree that each scenario is different for every one, in my case I have a few different scenarios going on (taxable accounts, part-time work, spousal income, etc) that will allow me to not touch the lump sum for several years. There are many factors each person has to consider but I would have to venture to say that not "needing" the immediate access that the annuity provides is a major factor for those that often prefer and choose the lump. There are no guarantees on returns but longer timeframe before the "need" to access the money and wise AA (done by me or my heirs--another plus of lump!) are attractive factors when opting for the lump.

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Re: 10 Reasons to take your pension annuity over a lump sum

Post by g$$ » Tue Mar 18, 2014 9:16 pm

The Wizard wrote:What's fun is to annuitize sufficient funds to have monthly income in retirement to cover all your expenses, but then ALSO retain an unannuitized portfolio of significant size as well. That's what I did, though I realize it's not feasible for everyone...

That's my plan too. If it works out i'll post about it (30 years from now!).

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Re: 10 Reasons to take your pension annuity over a lump sum

Post by tfb » Tue Mar 18, 2014 9:19 pm

g$$ wrote:A common request on this board is for advice when faced between an annuity and a lump sum in a pension plan. Below I provide some context around why I think an annuity is usually the right choice.
Well-reasoned. Thank you. (1) through (5) show why you usually can't beat a company pension by using the lump sum to buy an annuity outside.
Harry Sit, taking a break from the forums.

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Re: 10 Reasons to take your pension annuity over a lump sum

Post by investor » Tue Mar 18, 2014 9:28 pm

had the choice in 1996. Rates were around 7% at that time for the figuring of lump sum amounts. I took the pension, age 55. supplementing with savings till age 62 where I took the social security. Mean time my 401(k) and separate IRA grew and started collecting comma's. .Have no regrets. The burden of funding the pension was not on me but on my ex employer. I spent four years deciding between lump sum or pension.

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Re: 10 Reasons to take your pension annuity over a lump sum

Post by DonCamillo » Tue Mar 18, 2014 9:39 pm

I took the pension and started another job. Used the pension to pay my living expenses while putting my salary into a deferred savings plan. Did well because an early retirement bonus meant I retired at 55 with payments as if I were 65. The deferred savings benefitted from lucky timing, as instead of investing a lump sum in 2000, I was investing my salary through the 2000 to 2002 and 2008 to 2009 market turmoil.
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Re: 10 Reasons to take your pension annuity over a lump sum

Post by House Blend » Wed Mar 19, 2014 10:31 am

One thing I'm curious about is whether any of this interacts with the Windfall Elimination Provision that can reduce your SS benefits.

Suppose you are covered by a pension and don't pay into SS while doing so (e.g., school teachers in certain states). But you also had a second career before or after where you did pay into SS.

If you take the lump sum option in lieu of the state pension, is there still a reduction in your SS benefits? Or maybe the workers in these scenarios are generally not offered a lump sum option?

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Re: 10 Reasons to take your pension annuity over a lump sum

Post by ofcmetz » Sat Mar 22, 2014 8:03 am

House Blend wrote:One thing I'm curious about is whether any of this interacts with the Windfall Elimination Provision that can reduce your SS benefits.

Suppose you are covered by a pension and don't pay into SS while doing so (e.g., school teachers in certain states). But you also had a second career before or after where you did pay into SS.

If you take the lump sum option in lieu of the state pension, is there still a reduction in your SS benefits? Or maybe the workers in these scenarios are generally not offered a lump sum option?

I worked only 3 years in a job covered by SS before starting my state job. I don't pay SS and will be covered by the Windfall Elimination Provision. We don't get a lump sum option. I'd be very surprised if any of the pensions for jobs that don't pay SS are allowed to give their recipients lump sum payment options. Most government pensions give the option to have only ones contributions refunded with no interest or with maybe with minimal interest. The pension funds usually retain the employer contributions and most of the investment returns which really benefits the long time employees.
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Re: 10 Reasons to take your pension annuity over a lump sum

Post by Sheepdog » Sat Mar 22, 2014 11:07 am

History of my 1998 pension lump sum
I made a comment above about taking my pension as a lump sum in 1998 instead of an annuity. Last night, fighting a little insomnia, I checked the history of that lump sum. How has it performed and how well has it provided income?

This is the synopsis of that exercise.
10/29/1998 Lump sum of $222,283 was invested conservatively in a Vanguard Rollover IRA.
11/1/2002 First distribution ($11,000)
The accumulative RMDs to date of this account totals $130,493; however, I took out more than the RMDS. (about $18,000 was not used for expenses but was rolled over to an existing Roth IRA)
3/21/2014 Rollover IRA distributions to date -$203,187
3/21/2014 Rollover IRA balance $243,244.

If I had instead taken the annuity (100% to surviving beneficiary, I would have received to date ($1479.39 per month) $255,934.
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Re: 10 Reasons to take your pension annuity over a lump sum

Post by Nukeboilermaker » Sat Mar 22, 2014 11:55 am

I recently took a promotion from union to a company position and in doing so went from a pension plan to a cash balance plan. Like many union pensions it was a pretty good deal, however after I was hired, the union and company changed the retirement plan where the people hired after my class fell into a cash balance plan. This resulted in me being the youngest person in the pension plan, not a place I cared to be with the average age of coworkers being in their late 40s. That fact made it even less of an issue for me to leave the better pension plan to improve a career and have more control on my retirement portfolio, not to mention more flexibility with a career and in turn having greater income capital.

Edit: sheepdog what was your starting balance prior to the cash balance rollover?

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Re: 10 Reasons to take your pension annuity over a lump sum

Post by dharrythomas » Sat Mar 22, 2014 12:03 pm

My prime consideration is to ensure a steady income stream for the spouse. I signed up for my Army Reserve pension at immediate annuity upon my death max rate and intend to do the same for my next pension at decision time. That plus social security should give her enough income to live on even after I'm gone. We've also got funds in traditional accounts invested in target date funds where the RMDs will provide a nice cushion (still adding since matching funds all go into traditional). Roth accounts should be bigger than the traditional by the time I retire and can be used to try to build a legacy. There also may be a small taxable account with a small investment, money from cashing out a cash value life insurance policy we no longer need, and maybe an inheritance (though I hope my mother lives a healthy productive life as long as Taylor--which means I haven't built inheritance into our retirement plan).

Bottom line, even though we've been BLESSED with ENOUGH, having a safe income stream for the spouse is more important to me than the chance to have additional money. My first concern is securing the base.

Good luck whatever you decide.

Harry

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Re: 10 Reasons to take your pension annuity over a lump sum

Post by Sheepdog » Sat Mar 22, 2014 12:08 pm

Nukeboilermaker wrote:

sheepdog what was your starting balance prior to the cash balance rollover?
That is the same lump sum rollover amount, $222,283, shown above.

You should realize that that amount was calculated at an interest rate of 5.99% which was considerably higher than today's. Today, the lump sum amount would be much higher.
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Re: 10 Reasons to take your pension annuity over a lump sum

Post by g$$ » Sat Mar 22, 2014 6:48 pm

tfb wrote:
g$$ wrote:A common request on this board is for advice when faced between an annuity and a lump sum in a pension plan. Below I provide some context around why I think an annuity is usually the right choice.
Well-reasoned. Thank you. (1) through (5) show why you usually can't beat a company pension by using the lump sum to buy an annuity outside.
Glad you found the list useful. I've certainly found your website helpful in the past.

Also, I Just realized there are actually two "(5)"s in the original post :oops: . So I guess there are really 11 reasons up there. Oops.

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Re: 10 Reasons to take your pension annuity over a lump sum

Post by VictoriaF » Mon Jun 29, 2015 6:07 am

g$$ wrote:Shutting down a plan isn't a big deal because upon termination they simply buy an annuity from a life insurer to replace yours. The only thing changing from a retirees perspective is the name on the envelope with their monthly check. Let them pay for all those extra expenses and more conservative assumptions!
Fantastic thread, g$$, Thank you very much!

I came here from Lucent offering pension buyout to retirees: what to do?, where your scenario is now playing out. Our group has tens of thousands of annuitants who have been receiving Alcatel-Lucent pension for many years. Thus, we are facing not the initial decision for lump sum vs. annuity, but a secondary decision to exchange an existing annuity for a lump sum or to move from an employer funded pension plan to an insurance company's SPIA-like annuity.

The Alcatel-Lucent offer is not likely to be rare, and thus second-tier decision making is applicable even to those who are facing the initial decision.

I am very interested in your analysis. Thank you,

Victoria
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Re: 10 Reasons to take your pension annuity over a lump sum

Post by VictoriaF » Mon Jun 29, 2015 6:15 am

tractorguy wrote:Reason 11: In at least one state (Illinois), payments from a qualified pension are exempt from state income tax with no limits. I haven't looked in other states but I think some may have a similar provisions with limits.
If a qualified pension is transferred to an insurance company, is it still a "qualified pension"?
If it is not, does it mean that an existing annuitant will start paying higher state tax?

Victoria
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Re: 10 Reasons to take your pension annuity over a lump sum

Post by heyyou » Mon Jun 29, 2015 11:21 am

On the lump or annuity choice, has anyone looked at delaying the start of an SPIA by purchasing a deferred income annuity (DIA)? Per Wade Pfau, that boosts the annuity payout better than DIY of waiting to buy an SPIA while hoping for good market returns.

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Re: 10 Reasons to take your pension annuity over a lump sum

Post by 53timr » Mon Jun 29, 2015 1:29 pm

g$$ wrote: There are a few forces working in your favor that would cause the annuity to be a better deal. First, a few assumptions:
(+) This assumes your pension is a qualified plan provided by a single employer in the private sector. Not a public/government plan.
Since you specifically stated "Not a public/government plan" in your assumptions, I wonder how your 11 points would change if it were a public/government plan.

I would hazard a guess that more government employees have a defined benefit plan as compared to the private sector. I would also imagine that whether or not the plan is fully funded plays into the equation. My government plan was funded at about 140% but dropped to about 85% during the Great Recession. Last year the plan once again reached 100% funding.
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Re: 10 Reasons to take your pension annuity over a lump sum

Post by dc81584 » Mon Jun 29, 2015 3:51 pm

I'd go for the annuity.

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Re: 10 Reasons to take your pension annuity over a lump sum

Post by itstoomuch » Tue Jun 30, 2015 12:32 am

@gss, good post.
We bought deferred income VA and deferred FIA, in a series of purchases beginning in 2008 and ending in 2012. Purchases funded by IRAs and 401ks. The expected guaranteed Income from the annuities, today, far exceeds the minimum income guarantees at purchase. They are indeed valuable insurance in a down market and very useful in Income planning 10 years out. YMMV.
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Re: 10 Reasons to take your pension annuity over a lump sum

Post by itstoomuch » Tue Jun 30, 2015 12:40 am

And we had to search for a salesman for our annuities. We didn't get to buy anyone's meal(s). :(
Saw dozens of presentations.
Rev012718; 4 Incm stream buckets: SS+pension; dfr'd GLWB VA & FI anntys, by time & $$ laddered; Discretionary; Rentals. LTCi. Own, not asset. Tax TBT%. Early SS. FundRatio (FR) >1.1 67/70yo

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Re: 10 Reasons to take your pension annuity over a lump sum

Post by island » Tue Jun 30, 2015 1:15 am

Great thread and discussion. Thanks.

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Re: 10 Reasons to take your pension annuity over a lump sum

Post by HIinvestor » Tue Jun 30, 2015 2:53 am

We had a choice about what % survivor benefit for H to give me with his fed govt pension. We chose the max @ 55%, since I'm 15 years younger and longevity seems to run in my family. I have very little retirement savings of my ien, as I have mostly worked PT while raising our kids and running our household. Our annuity gets COLa increases.

We had the option of getting an an annuity for an amount we contributed in after tax $$ (up to 10% of H's govt lifetime earnings) into a 403k, but elected to roll it over to a Roth IRA instead.

We also have to take RMDs, since H is > 70. We have no regrets and sleep very well at night.

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Re: 10 Reasons to take your pension annuity over a lump sum

Post by Valuethinker » Tue Jun 30, 2015 3:17 am

The key things with a DB pension are:

- longevity insurance - you (and your survivor, I would almost always encourage a retiree to choose a spousal survivor benefit) can't outlive their money

- portfolio diversification - a fixed (or even better a COLA) income stream is highly diversifying against a bond/ equity portfolio. I have not seen anyone run the numbers, but intuitively that is true

Shortened life expectancy and various other factors argue against the DB pension. The paperwork (if the employer is taken over, etc.) can be a real hassle

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Re: 10 Reasons to take your pension annuity over a lump sum

Post by g$$ » Tue Jun 30, 2015 10:34 pm

VictoriaF wrote:
tractorguy wrote:Reason 11: In at least one state (Illinois), payments from a qualified pension are exempt from state income tax with no limits. I haven't looked in other states but I think some may have a similar provisions with limits.
If a qualified pension is transferred to an insurance company, is it still a "qualified pension"?
If it is not, does it mean that an existing annuitant will start paying higher state tax?

Victoria
If the plan is terminated and benefits are transferred to an insurance company it is no longer a "qualified pension". That said, it still operates in a very similar manner:
The benefit is still prefunded. It's just that the benefit is now funded by the insurance company's reserves rather than the plan sponsor's trust fund. In fact, the pension will probably have a better funded ratio at the insurance company than it would in the plan sponsor's trust. The plan sponsor will need to cover any shortfall before transferring the liabilities and assets to the insurance company.
The benefit is still guaranteed. It's just that the benefit is now guaranteed by State guarantee funds instead of the PBGC. The limits vary by state but should be available on the Google machine somewhere. There are some tradeoffs here. State guarantees are usually lower than the PBGC. One could argue that these funds are much more secure than the PBGC's trust though. They're probably less likely to be needed as well since the insurance company is less likely to default than the plan sponsor (higher credit ratings).
Tax treatment is the same. At least i think it is... I would expect the annuity to be considered taxable income regardless of the source (pension trust fund or insurance company). I'll try to confirm this and get back to you.

One more note...
The plan sponsor can't just go out and purchase annuities from the cheapest bidder. They need to select the insurance company with the best interests of the plan sponsor in mind.
The DOL says that this is a fiduciary act and has outlined a very detailed process for selecting the insurance company as an annuity provider. These rules are outlined in Interpretive Bulletin 95-1. Here are the things an employer needs to consider:
(1) The quality and diversification of the annuity provider's investment portfolio;
(2) The size of the insurer relative to the proposed contract;
(3) The level of the insurer's capital and surplus;
(4) The lines of business of the annuity provider and other indications of an insurer's exposure to liability;
(5) The structure of the annuity contract and guarantees supporting the annuities, such as the use of separate accounts;
(6) The availability of additional protection through state guaranty associations and the extent of their guarantees.

Best of luck,

-g$$

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Re: 10 Reasons to take your pension annuity over a lump sum

Post by g$$ » Tue Jun 30, 2015 10:42 pm

53timr wrote:
g$$ wrote: There are a few forces working in your favor that would cause the annuity to be a better deal. First, a few assumptions:
(+) This assumes your pension is a qualified plan provided by a single employer in the private sector. Not a public/government plan.
Since you specifically stated "Not a public/government plan" in your assumptions, I wonder how your 11 points would change if it were a public/government plan.

I would hazard a guess that more government employees have a defined benefit plan as compared to the private sector. I would also imagine that whether or not the plan is fully funded plays into the equation. My government plan was funded at about 140% but dropped to about 85% during the Great Recession. Last year the plan once again reached 100% funding.
It probably depends a lot on the specific plan and the rules of that state/county/whatever. My experience is almost exclusively in the private sector so I won't bother to guess. I specifically call out these types of plans though (in the private sector) because they fall under a fairly strict set of rules. The benefits are reasonably secure and not likely disappear into thin air.

-g$$

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Re: 10 Reasons to take your pension annuity over a lump sum

Post by g$$ » Tue Jun 30, 2015 10:46 pm

Valuethinker wrote:The key things with a DB pension are:

- longevity insurance - you (and your survivor, I would almost always encourage a retiree to choose a spousal survivor benefit) can't outlive their money

- portfolio diversification - a fixed (or even better a COLA) income stream is highly diversifying against a bond/ equity portfolio. I have not seen anyone run the numbers, but intuitively that is true

Shortened life expectancy and various other factors argue against the DB pension. The paperwork (if the employer is taken over, etc.) can be a real hassle
I agree completely. Longevity insurance is tough to find but a pension provides this at no added cost. The diversification is nice too. Obviously if you have a short life expectancy then the pension will look like a raw deal.

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Re: 10 Reasons to take your pension annuity over a lump sum

Post by abuss368 » Wed Jul 01, 2015 12:18 am

Thanks!
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Re: 10 Reasons to take your pension annuity over a lump sum

Post by abuss368 » Wed Jul 01, 2015 12:18 am

Cash flows...
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