Early Retirement - Lump Sum vs. Annuity

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Bonch
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Early Retirement - Lump Sum vs. Annuity

Post by Bonch » Mon Dec 11, 2017 6:51 pm

I am considering retiring at 55 after 32 years of service. I just received a lump sum payment offer in lieu of my pension benefit. I am not sure which option would be the best to consider.

My age: 55
Wife's age: 58
Current 401K: $1,041,000
Other investments: $100,000
No debt at all
Monthly expenses around $4,000

Lump Sum Retirement Offer: $1,030,000

Pension Benefits Options (No COLA)
Single Life Annuity - $4,921
25% Joint and Survivor Annuity - $4,749
33 1/3% Joint and Survivor Annuity - $4,691
50% Joint and Survivor Annuity - $4,576
60% Joint and Survivor Annuity - $4,507
66 2/3% Joint and Survivor Annuity - $4,462
75% Joint and Survivor Annuity - $4,404
90% Joint and Survivor Annuity - $4,301
100% Joint and Survivor Annuity - $4,232

I expect my wife will outlive me potentially by many years. I am in fair health while she is in good health.

Which is the better option, lump sum or annuity?

Should I consider any of the survivor annuity options or bank of the 401K and savings supporting my wife should I die early?

Any advice will be greatly appreciated.
Last edited by Bonch on Mon Dec 11, 2017 7:04 pm, edited 1 time in total.

Thesaints
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Re: Early Retirement - Lump Sum vs. Annuity

Post by Thesaints » Mon Dec 11, 2017 6:56 pm

First concern, I’d say, is solvency of pension payer. Following that, estimate the DCF rate applied to convert between pension and lump sum.

rkhusky
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Re: Early Retirement - Lump Sum vs. Annuity

Post by rkhusky » Mon Dec 11, 2017 6:59 pm

See what this site gives you: https://www.immediateannuities.com/

Silk McCue
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Re: Early Retirement - Lump Sum vs. Annuity

Post by Silk McCue » Mon Dec 11, 2017 7:01 pm

You made no mention of a COLA. Is there one and if so what is it.

Bonch
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Re: Early Retirement - Lump Sum vs. Annuity

Post by Bonch » Mon Dec 11, 2017 7:04 pm

There is no cost of living adjustment (COLA) for the annuities. I edited my original post to include this. Company is very solvent and should stay in business for the foreseeable future.

delamer
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Re: Early Retirement - Lump Sum vs. Annuity

Post by delamer » Mon Dec 11, 2017 7:10 pm

In general, the pension with a survivor annuity is the better option. One exception would be if you have doubts as to the financial stability of the pension fund.

With a "safe" withdrawal rate of around 3% to 4% on the lump sum, the pension will give you a better return. Plus you will still have your 401(k) money available to act as a COLA for the pension, as needed. If you and/or your wife are uninterested in managing investments, the pension also means you won't need to worry as much about generating income from them.

Thesaints
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Re: Early Retirement - Lump Sum vs. Annuity

Post by Thesaints » Mon Dec 11, 2017 7:32 pm

I guess we are all guilty of not seeing the elephant in the room: the 1 million payout will be taxed in the year you receive it.

Another consideration is that a stable income source may allow to increase withdrawal rate from the rest of the capital.
Of course, if the equivalent capital for the pension is too low that’s not what you probably want.

The useful annuity calculator tells you that your offer is in line with what you can get on the annuities market, but not the discount rate implied in the conversion.

diy60
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Re: Early Retirement - Lump Sum vs. Annuity

Post by diy60 » Mon Dec 11, 2017 7:34 pm

I recently retired from a MegaCorp that had similar options, and few extra options thrown in for good measure as well. The MegaCorp pension trust administrator provided a "relative value" analysis for all of the various options compared to that of the single life annuity option. All options were within an extremely tight band of +/- 0.5%, with the 100% survivor option being the highest. You should inquire if there is a similar type analysis available to you. Personally, I did not even consider anything other than 100% survivor annuity.

delamer
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Re: Early Retirement - Lump Sum vs. Annuity

Post by delamer » Mon Dec 11, 2017 7:41 pm

Thesaints wrote:
Mon Dec 11, 2017 7:32 pm
I guess we are all guilty of not seeing the elephant in the room: the 1 million payout will be taxed in the year you receive it.

Another consideration is that a stable income source may allow to increase withdrawal rate from the rest of the capital.
Of course, if the equivalent capital for the pension is too low that’s not what you probably want.

The useful annuity calculator tells you that your offer is in line with what you can get on the annuities market, but not the discount rate implied in the conversion.
Based on past posts on this topic, you are wrong about the taxes. The lump sum can be rolled over into a traditional IRA. Otherwise, no one would ever take (or recommend taking) the lump sum.

Unless you are talking about rolling over into a Roth.

https://www.kiplinger.com/article/retir ... n-ira.html

Horsefly
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Re: Early Retirement - Lump Sum vs. Annuity

Post by Horsefly » Mon Dec 11, 2017 7:52 pm

I retired about 4.5 years ago, with much the same situation and choices as the OP: Age 55 (DW also 55), with just under 33 years at the same company. Had the option of taking a lump sum of similar size or all of the same non-COLA annuity choices the OP has. I decided to take the lump sum for a couple of reasons.
  • First, we had a fairly sizable post-tax nest egg, so we knew we wouldn't need the lump sum or 401K until well past our 59.5 ages. That allowed me to roll both the lump sums and 401K's into IRAs which I've invested fairly aggressively. Obviously those have done well in the past 4.5 years, and have dwarfed probable value of the annuity over time.
  • Second, we have a couple of kids that we would like to leave something to. The annuities would take care of us, but when the second of us dies there would be much less left to pass on to our daughters. Of course, we intend to spend as much of it as we can, but just in case. :D
You didn't mention kids, so I'm not sure this second point applies at all to you.

Keep in mind that if you take the lump sum you'll need to roll it into an IRA to avoid paying taxes on the whole payment, but then you can't access most of it (without penalty) until you are 59.5. With only $100K outside of your retirement accounts, I'm not sure you will have enough to stretch until you get to 59.5. That may argue for the annuity in your case.

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Re: Early Retirement - Lump Sum vs. Annuity

Post by MrPotatoHead » Mon Dec 11, 2017 7:53 pm

Oft the pensions I have seen also offer a partial option which is to say you can take a partial lump sum and annuitize the remainder. Is that an option for you?

Even if not, though the annuity looks tempting it is not inflation adjusted. Your nut amounts to 48K a year. If you take the lump sum, that is less than a 2.5% a year withdraw rate on a 2,070,000 portfolio. At 55 you only need to keep up that withdraw rate until you can draw social security. 55 if awful young. You could be looking at a life span of 50 more years (given medical and simple technological advancements, the latter should not be underestimated). In the end I think the annuity is subject to too much inflation risk over your lifespan. My guess is once you get to SS you will have most of your nut serviced by SS. So, I am not seeing a great deal of value in the annuity.

You did not mention if leaving a legacy was important to you; I assumed perhaps it was, which contributed to my commentary.

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Taylor Larimore
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Re: Early Retirement - Lump Sum vs. Annuity

Post by Taylor Larimore » Mon Dec 11, 2017 8:16 pm

Bonch:

I went to Immediate Annuities.com and put in the information you provided (using the state of Florida).

https://www.immediateannuities.com/info ... tep-1.html

The best they can do is give you $4,232/month for a 100% joint and survivor annuity compared with your company pension of $4,064. The company life-time pension is significantly superior to what's available commercially. Consider it carefully.

I have two life-time annuities purchased in our early 80s. It is great comfort receiving income each month and knowing I will never run out of money.

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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CWRadio
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Re: Early Retirement - Lump Sum vs. Annuity

Post by CWRadio » Mon Dec 11, 2017 8:34 pm

How come MegaCorp can offer a better SPIA then companies like via immediateannuity.com, Vanguard, Fidelity etc? Thanks Paul

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Taylor Larimore
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Re: Early Retirement - Lump Sum vs. Annuity

Post by Taylor Larimore » Mon Dec 11, 2017 8:53 pm

CWRadio wrote:
Mon Dec 11, 2017 8:34 pm
How come MegaCorp can offer a better SPIA then companies like via immediateannuity.com, Vanguard, Fidelity etc? Thanks Paul
Paul:

My guess is that MegaCorp is using an old mortality table. Why, I'm not sure.

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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alec
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Re: Early Retirement - Lump Sum vs. Annuity

Post by alec » Mon Dec 11, 2017 8:54 pm

Horsefly wrote:
Mon Dec 11, 2017 7:52 pm
I retired about 4.5 years ago, with much the same situation and choices as the OP: Age 55 (DW also 55), with just under 33 years at the same company. Had the option of taking a lump sum of similar size or all of the same non-COLA annuity choices the OP has. I decided to take the lump sum for a couple of reasons.
  • First, we had a fairly sizable post-tax nest egg, so we knew we wouldn't need the lump sum or 401K until well past our 59.5 ages. That allowed me to roll both the lump sums and 401K's into IRAs which I've invested fairly aggressively. Obviously those have done well in the past 4.5 years, and have dwarfed probable value of the annuity over time.
  • Second, we have a couple of kids that we would like to leave something to. The annuities would take care of us, but when the second of us dies there would be much less left to pass on to our daughters. Of course, we intend to spend as much of it as we can, but just in case. :D
You didn't mention kids, so I'm not sure this second point applies at all to you.

Keep in mind that if you take the lump sum you'll need to roll it into an IRA to avoid paying taxes on the whole payment, but then you can't access most of it (without penalty) until you are 59.5. With only $100K outside of your retirement accounts, I'm not sure you will have enough to stretch until you get to 59.5. That may argue for the annuity in your case.
Don't forget about the 401(k), which may let the OP withdraw from it starting at age 55 without penalty. My 401(k) does.
"It is difficult to get a man to understand something, when his salary depends upon his not understanding it!" - Upton Sinclair

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Taylor Larimore
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Re: Early Retirement - Lump Sum vs. Annuity

Post by Taylor Larimore » Mon Dec 11, 2017 9:00 pm

Bonch:

One thing you almost certainly don't want to do is take the money in cash or put it into a taxable account. You will pay income tax on the withdrawal at your maximum tax rate. :(

Best wishes.
Taylor
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FiveK
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Re: Early Retirement - Lump Sum vs. Annuity

Post by FiveK » Mon Dec 11, 2017 9:11 pm

Bonch wrote:
Mon Dec 11, 2017 6:51 pm
Lump Sum Retirement Offer: $1,030,000

Pension Benefits Options (No COLA)
Single Life Annuity - $4,921
100% Joint and Survivor Annuity - $4,232
Charts below show the pure math results. The first for $4921/mo annuity, the second for $4232/mo annuity.

On top of those one can overlay one's thoughts about life expectancy, investment returns including inflation, pension stability, estate desires, other income (e.g., the 401k, SS), etc.

Image

Image

See rows 94-114 on the 'Misc. calcs' tab of the personal finance toolbox spreadsheet if you'd like to run other cases.

Dottie57
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Re: Early Retirement - Lump Sum vs. Annuity

Post by Dottie57 » Mon Dec 11, 2017 9:45 pm

rkhusky wrote:
Mon Dec 11, 2017 6:59 pm
See what this site gives you: https://www.immediateannuities.com/

$4224 for joint annuity at the amount of pension. Pretty comparable to 100% joint pension.

GuyInFL
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Re: Early Retirement - Lump Sum vs. Annuity

Post by GuyInFL » Mon Dec 11, 2017 10:01 pm

Don't forget about the 401(k), which may let the OP withdraw from it starting at age 55 without penalty. My 401(k) does.
You can also do 72t withdrawals from an IRA at any age

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Re: Early Retirement - Lump Sum vs. Annuity

Post by #Cruncher » Tue Dec 12, 2017 1:13 am

Taylor Larimore wrote:
Mon Dec 11, 2017 8:16 pm
I went to Immediate Annuities.com and put in the information you provided (using the state of Florida).The best they can do is give you $4,232/month for a 100% joint and survivor annuity compared with your company pension of $4,064. The company life-time pension is significantly superior to what's available commercially. Consider it carefully.
[I get $4,186 at Immediate Annuities.com, not $4,232. The 100% joint pension is $4,232, not $4,064.]

The company pension is only slightly better than a commercial annuity. Both of them provide a low return. For example, if you and your wife have life expectancies commensurate with the SSA 1960 Cohort Life Table, all the pension options provide only a 3.0% or 3.1% return on the $1,030,000 lump sum as calculated with my longevity estimator.

Code: Select all

                 --- Mo Pmt While Alive ---   Pretax
                 Only You  Only Wife   Both   Return
                 --------  ---------  -----   ------
 Single Life       4,921         0    4,921    3.0%
 25%     Joint     4,749     1,187    4,749    3.0%
 33 1/3% Joint     4,691     1,567    4,691    3.0%
 50%     Joint     4,576     2,288    4,576    3.1%
 60%     Joint     4,507     2,704    4,507    3.1%
 66 2/3% Joint     4,462     2,975    4,462    3.1%
 75%     Joint     4,404     3,303    4,404    3.1%
 90%     Joint     4,301     3,871    4,301    3.1%
100%     Joint     4,232     4,232    4,232    3.1%
I would recommend taking the pension only if -- with $1,030,000 already sitting in your hand -- you would go out and buy a commercial annuity. Otherwise I recommend taking the lump sum and rolling it into a traditional IRA. Pretax you would likely earn a better return. After tax the comparison is even more favorable to the IRA because you would not have to pay taxes until you began withdrawing from it.

Bonch
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Re: Early Retirement - Lump Sum vs. Annuity

Post by Bonch » Tue Dec 12, 2017 1:39 am

#Cruncher wrote:
Tue Dec 12, 2017 1:13 am
Taylor Larimore wrote:
Mon Dec 11, 2017 8:16 pm
I went to Immediate Annuities.com and put in the information you provided (using the state of Florida).The best they can do is give you $4,232/month for a 100% joint and survivor annuity compared with your company pension of $4,064. The company life-time pension is significantly superior to what's available commercially. Consider it carefully.
[I get $4,186 at Immediate Annuities.com, not $4,232. The 100% joint pension is $4,232, not $4,064.]

The company pension is only slightly better than a commercial annuity. Both of them provide a low return. For example, if you and your wife have life expectancies commensurate with the SSA 1960 Cohort Life Table, all the pension options provide only a 3.0% or 3.1% return on the $1,030,000 lump sum as calculated with my longevity estimator.

Code: Select all

                 --- Mo Pmt While Alive ---   Pretax
                 Only You  Only Wife   Both   Return
                 --------  ---------  -----   ------
 Single Life       4,921         0    4,921    3.0%
 25%     Joint     4,749     1,187    4,749    3.0%
 33 1/3% Joint     4,691     1,567    4,691    3.0%
 50%     Joint     4,576     2,288    4,576    3.1%
 60%     Joint     4,507     2,704    4,507    3.1%
 66 2/3% Joint     4,462     2,975    4,462    3.1%
 75%     Joint     4,404     3,303    4,404    3.1%
 90%     Joint     4,301     3,871    4,301    3.1%
100%     Joint     4,232     4,232    4,232    3.1%
I would recommend taking the pension only if -- with $1,030,000 already sitting in your hand -- you would go out and buy a commercial annuity. Otherwise I recommend taking the lump sum and rolling it into a traditional IRA. Pretax you would likely earn a better return. After tax the comparison is even more favorable to the IRA because you would not have to pay taxes until you began withdrawing from it.
Wouldn't US Treasury bonds exceed the 3.1% margin by a percent or two in the long haul. That is where I was thinking that the lump sum invested in an IRA till 59-1/2 or later and pulling out monthly withdrawals at that point would significantly improve the available monthly cash flow available from the simple annuity. However, I wanted to check with those much more versed in these options. I am assuming over the long haul making 6-7% on your money isn't that large of a stretch.

As i have it know, I can withdraw a fixed amount say $5,000 from my 401K (under the 55 rule) till 59-1/2 and the $4,200 from pension or take a $9-10,000 withdrawal monthly from the 401K withdrawal and put the the lump sum into simple IRA till 59-1/2 when I would rollover the 401K into the IRA plan account.

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Re: Early Retirement - Lump Sum vs. Annuity

Post by Thesaints » Tue Dec 12, 2017 1:52 am

Bonch wrote:
Tue Dec 12, 2017 1:39 am
Wouldn't US Treasury bonds exceed the 3.1% margin by a percent or two in the long haul.
The 30-years bond yield is 2.84%.
I am assuming over the long haul making 6-7% on your money isn't that large of a stretch.
Perhaps not on average, but your situation is different since you would be withdrawing.
Volatility is your enemy in that case ands there is no way you could do 6% average return without substantial volatility.
Of course, if you had the option not to withdraw, then things would change. That's why having part of the retirement secured by fixed sources allows to be more aggressive on allocation and withdrawal rate on the rest of the capital.

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Re: Early Retirement - Lump Sum vs. Annuity

Post by Lancelot » Tue Dec 12, 2017 2:58 am

delamer wrote:
Mon Dec 11, 2017 7:41 pm
Thesaints wrote:
Mon Dec 11, 2017 7:32 pm
I guess we are all guilty of not seeing the elephant in the room: the 1 million payout will be taxed in the year you receive it.

Another consideration is that a stable income source may allow to increase withdrawal rate from the rest of the capital.
Of course, if the equivalent capital for the pension is too low that’s not what you probably want.

The useful annuity calculator tells you that your offer is in line with what you can get on the annuities market, but not the discount rate implied in the conversion.
Based on past posts on this topic, you are wrong about the taxes. The lump sum can be rolled over into a traditional IRA. Otherwise, no one would ever take (or recommend taking) the lump sum.

Unless you are talking about rolling over into a Roth.

https://www.kiplinger.com/article/retir ... n-ira.html
Yes, rolling over to a Traditional IRA would not trigger taxes. I did that with my lump sum, rolled over to Vanguard.

Congratulations to the OP; you've done well. Enjoy your retirement!
No Where for Very Long...

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Re: Early Retirement - Lump Sum vs. Annuity

Post by snackdog » Tue Dec 12, 2017 6:01 am

The annuity payout is low because current interest rates are so low. The time to buy an annuity is later in life (say age 70), when you need it, when the payout is higher (because you actuarily closer to kicking the bucket), and when interest rates may be higher. The lump sum is high for the same reason - interest rates are low. So, best to take the lump sum. Your chances of improving on the returns over the very low returns estimated for the lump sum calc are very, very high if you invest it in the 3-fund manner over a few decades. The lump sum also gives you much greater flexibility - you can invest it for 15 years then use it to buy an annuity when you are 70, if an annuity makes sense for you.

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Re: Early Retirement - Lump Sum vs. Annuity

Post by Bacchus01 » Tue Dec 12, 2017 6:41 am

You guys are awesome. The math work is fast and detailed.

Based on that I’d take the lump, role to an IRA with the idea that it isn’t touched until can do Roth conversions to fill tax brackets. Otherwise RMD. Gives you a longer time horizon that you can be more aggressive and have a good chance of beating the underlying rate assumption.

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Re: Early Retirement - Lump Sum vs. Annuity

Post by John Z » Tue Dec 12, 2017 8:46 am

Also consider taxes, controlling them. With the pension annuity you'll have $50-$60K rolling in every year that is taxable with no way to stop it. With taking the lump sum you'll know what your tax universe is and have some room and options to maximize your income and minimize taxes.

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Re: Early Retirement - Lump Sum vs. Annuity

Post by CyclingDuo » Tue Dec 12, 2017 8:50 am

Bonch wrote:
Mon Dec 11, 2017 6:51 pm
I am considering retiring at 55 after 32 years of service. I just received a lump sum payment offer in lieu of my pension benefit. I am not sure which option would be the best to consider.

My age: 55
Wife's age: 58
Current 401K: $1,041,000
Other investments: $100,000
No debt at all
Monthly expenses around $4,000

Lump Sum Retirement Offer: $1,030,000

Pension Benefits Options (No COLA)
Single Life Annuity - $4,921
25% Joint and Survivor Annuity - $4,749
33 1/3% Joint and Survivor Annuity - $4,691
50% Joint and Survivor Annuity - $4,576
60% Joint and Survivor Annuity - $4,507
66 2/3% Joint and Survivor Annuity - $4,462
75% Joint and Survivor Annuity - $4,404
90% Joint and Survivor Annuity - $4,301
100% Joint and Survivor Annuity - $4,232

I expect my wife will outlive me potentially by many years. I am in fair health while she is in good health.

Which is the better option, lump sum or annuity?

Should I consider any of the survivor annuity options or bank of the 401K and savings supporting my wife should I die early?

Any advice will be greatly appreciated.
Your worst enemy will be inflation. So the annuity without COLA, down the road, is the potential red flag depending on how your 401k investments do, when you take SS and how much it will be, as well as your long term goals/needs with regard to healthcare, passing money on to heirs, expenses.

You could take the annuity, and with the excess you don't spend each month - invest it to build an inflation cushion on your own. If you take the joint survivor option at 100%, this would leave little - to no - leftover to fund that based on your current estimate of $4K per month in expenses, and after taxes of the annuity income. You could also take the single Life Annuity from your company, and then purchase term life insurance to cover your spouse in case of your passing and loss of the annuity. Not sure, after taxes and premiums, if that would leave much, if anything to work with for additional investments. But worth calculating all the possibilities.

You could take the lump sum and purchase a SPIA with COLA. You could purchase an annuity with a given time frame (say 15 or 20 years) that has higher payouts, and invest the difference in the amount you don't use for your expenses which would bridge the gap between now and taking full Social Security, as well as allow your 401K investments to continue to compound. Again, you would need to calculate your taxes to see how viable this option would be for several durations - 15 years, 20 years, or lifetime.

You could take the lump sum, roll it over into an IRA. Set up a dividend paying portfolio that produces $60,000 - 62,000 per year currently. What you don't need to withdraw to cover your expenses, reinvest the dividends in more shares to allow the growth and income act as your COLA and fight inflation which your pension would not. This also removes the need to worry about your wife via choosing which percentage of the joint survivor annuity as the dividend portfolio would pass to her 100% as it continues to produce dividend income. It also would allow you to control your taxes until 70 1/2 and the required RMD's as you would only withdraw what you need to for expenses allowing your dividend portfolio to grow over the next 15 years.

You have options.
"Everywhere is within walking distance if you have the time." ~ Steven Wright

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Re: Early Retirement - Lump Sum vs. Annuity

Post by bsteiner » Tue Dec 12, 2017 8:54 am

The payout on the annuity is about 5%. If you take the lump sum, there's a good chance you can earn 5% a year. If you earn 5% a year, and you withdraw 5% a year, you'll have the same payments and you'll still have your $1 million at the end.

The lump sum, if rolled over, also provides some tax benefits, since the required distributions are smaller in the early years.

But if you take the lump sum, there's a chance you won't earn 5% a year. There's a chance that the money will run out. The annuity will provide certainty.

Comparing the annuity to the cost of a commercial annuity makes sense if you would otherwise buy an annuity. But it doesn't make sense if you wouldn't otherwise buy an annuity. In exchange for certainty, there's a cost to the annuity, since the insurance company has to cover its expenses and make a profit.

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Watty
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Re: Early Retirement - Lump Sum vs. Annuity

Post by Watty » Tue Dec 12, 2017 9:16 am

Something to look into is that sometimes taking a lump sum also means that you don't get things like retiree health benefits.
Bonch wrote:
Mon Dec 11, 2017 6:51 pm
Monthly expenses around $4,000
One thing that is missing from your post is what your Social Security benefit amount will be. There will be all sorts of permutations on when each of you starts it and how much the survivor will get when one of you dies but I would think that it would cover a large part of your expenses once you start Social Security.

You will also have to start taking RMDs from the 401k or IRA.

There will be a gap until you start both of those but after that I don't see any big need for the income from the annuity.

There is an old saying, "Buying an elephant for a dime is only a good deal if you need an elephant and have a dime."

Even if the annuity was a mathematically good deal it makes little sense to buy an annuity now when you will eventually be paying taxes on the annuity income and then just investing it in a taxable account.

One other thing I did not see mentioned is that if you take the lump sum then you may be able to do more Roth conversions before you start Social Security which could help eventually have less of your Social Security taxed which can be at a surprisingly high tax rate in some situations.

https://www.bogleheads.org/wiki/Taxatio ... y_benefits

Under the current tax laws laws when one of you dies the survivor would be filing single tax returns and get into the 25% tax bracket pretty quickly so doing more Roth conversions now in the 15% tax bracket would be to your advantage.

Annuities can have good role in retirement planning but if an annuity is right for you then there is the question of when to buy it. People sometimes buy a series of annuities as they age to help the keep up with inflation so buying several at the ages of 70, 75, and 80 would be another option to keep in mind if they make sense then. 55 is very young to buy an annuity.

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Re: Early Retirement - Lump Sum vs. Annuity

Post by Lancelot » Tue Dec 12, 2017 7:14 pm

Bacchus01 wrote:
Tue Dec 12, 2017 6:41 am
Based on that I’d take the lump, role to an IRA with the idea that it isn’t touched until can do Roth conversions to fill tax brackets. Otherwise RMD. Gives you a longer time horizon that you can be more aggressive and have a good chance of beating the underlying rate assumption.
Pretty much what I did; started taking withdrawls at age 59.5, up to the limit of the 15% tax bracket. If I were to do it over again, I would have started withdrawls earlier with the 72-T provision, again up the the 15% bracket.
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Re: Early Retirement - Lump Sum vs. Annuity

Post by WoodSpinner » Wed Dec 13, 2017 1:54 pm

OP,

I suggest you spend some time reviewing this article by Michael Kitces before finalizing your decision.

From my experience, this is one of the most difficult decisions you will face since its so dependent on your specific situation, the Lump Sum proposed and the Pension calculation used by the company.

For my situation (retiring in Dec2017, me 58, DW 57) the following factors were key to my decision to take the Pension rather than a Lump Sum:

1. The security of our Retirement funding is more important to us at this point than passing on more money to our heirs.
2. Megacorp Pension calculation is not tied to Interest Rates -- it is based on Salary, Age, SocSec Offset, and Years of Service.
3. The Pension is higher than any Annuity I can purchase with the Lump Sum on the open market (www.immediateannuities.com) and has an IRR of about 4.1%.
4. MegaCorp has strong financials and a long track record of being well managed with well funded Pensions (80-90% over the years)
5. I do not have a large After-Tax portfolio -- the Pension will significantly reduce my withdrawal rate from pre-tax sources and allow me to fund both living expenses and Roth Conversions using mostly after-tax dollars.

If I only knew how long we were going to live, what returns the market would deliver, and how healthy we will be it would be a really easy decision.

It's been a really challenging decision to make. Emotionally taking the Lump Sum seems so much more attractive but logically I think the Pension is a better choice in my case. Of couse this doesn't stop me from waking up in the middle of the night and replaying the arguments pro/con in my head.

Has this thread helped you to make a decision?

Good luck!

8-)

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Re: Early Retirement - Lump Sum vs. Annuity

Post by ceeshrek » Wed Dec 13, 2017 5:29 pm

I keep hearing of the 6% rule of thumb.

If the "rate of return" = 12 x (annuity payments)/lump-sum > 6% then take the payments; else take the lump-sum.

Does this hold any water?

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Re: Early Retirement - Lump Sum vs. Annuity

Post by FiveK » Wed Dec 13, 2017 5:49 pm

WoodSpinner wrote:
Wed Dec 13, 2017 1:54 pm
I suggest you spend some time reviewing this article by Michael Kitces before finalizing your decision.
+1

The two Excel charts shown previously match that article for a single survivor pension. Takes a little more (guess)work to evaluate when there are joint survivor choices.

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Re: Early Retirement - Lump Sum vs. Annuity

Post by WoodSpinner » Wed Dec 13, 2017 6:53 pm

ceeshrek wrote:
Wed Dec 13, 2017 5:29 pm
I keep hearing of the 6% rule of thumb.

If the "rate of return" = 12 x (annuity payments)/lump-sum > 6% then take the payments; else take the lump-sum.

Does this hold any water?
I haven’t seen this rule of thumb before. Do you have a source or a reference explaining it?

Interesting that I get about 7% with my numbers ... Not 100% sure if that means anything yet.

:?

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Re: Early Retirement - Lump Sum vs. Annuity

Post by #Cruncher » Wed Dec 13, 2017 9:04 pm

ceeshrek wrote:
Wed Dec 13, 2017 5:29 pm
I keep hearing of the 6% rule of thumb. If the "rate of return" = 12 x (annuity payments)/lump-sum > 6% then take the payments; else take the lump-sum. Does this hold any water?
This should be called "payout ratio", not "rate of return". And it can't be properly used to evaluate an annuity in the absence of the time the annuity is expected to run. For example, the following table [*] shows the actual "rate of return" for five payout ratios 4% to 8% that run between 10 and 50 years.

Code: Select all

Years    4.0%     5.0%     6.0%     7.0%     8.0% <-- payout
-----    ----     ----     ----     ----     ----
   10  (16.0%)  (12.4%)   (9.4%)   (6.7%)   (4.3%)
   15   (6.3%)   (3.6%)   (1.4%)    0.7%     2.5% 
   20   (2.1%)    0.0%     1.9%     3.6%     5.1% 
   25   (0.0%)    1.9%     3.5%     5.0%     6.4% 
   30    1.3%     2.9%     4.4%     5.7%     7.0% 
   35    2.0%     3.6%     4.9%     6.2%     7.4% 
   40    2.6%     4.0%     5.3%     6.5%     7.6% 
   45    2.9%     4.3%     5.5%     6.6%     7.8% 
   50    3.2%     4.5%     5.6%     6.8%     7.8%
For example a 6% payout would provide a good 5.3% return for a young person who expects to live 40 years. But for an old person who only expects to live 15 years, it would provide a terrible -1.4% return. (Since 15 X 6% is less than 1, it wouldn't even pay back the investment.)

* Table calculated using the Excel RATE function. For example:

Code: Select all

-1.4% = 12 * RATE(12 * 15, 6% / 12, -1, 0, 0)
 5.3% = 12 * RATE(12 * 40, 6% / 12, -1, 0, 0)

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Re: Early Retirement - Lump Sum vs. Annuity

Post by FiveK » Wed Dec 13, 2017 9:13 pm

ceeshrek wrote:
Wed Dec 13, 2017 5:29 pm
I keep hearing of the 6% rule of thumb.

If the "rate of return" = 12 x (annuity payments)/lump-sum > 6% then take the payments; else take the lump-sum.

Does this hold any water?
Probably, for whatever specific assumptions were used. In general? That's a tougher call.

In the chart below, the orange curve is the 6% "rate of return" as defined above. Depending on what one assumes for longevity and actual return, one can justify either the annuity or the lump sum. Curves for 5% and 7% "rates of return" are also shown. E.g., if one assumed 4% actual return and ~28 year longevity, the rule of thumb would be consistent.

Image

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Re: Early Retirement - Lump Sum vs. Annuity

Post by technovelist » Wed Dec 13, 2017 9:17 pm

CyclingDuo wrote:
Tue Dec 12, 2017 8:50 am
You could also take the single Life Annuity from your company, and then purchase term life insurance to cover your spouse in case of your passing and loss of the annuity. Not sure, after taxes and premiums, if that would leave much, if anything to work with for additional investments. But worth calculating all the possibilities.
It is worth calculating but I would be very surprised if life insurance would be "profitable" in such a case. It's almost always better to take a joint&100% survivor annuity than to buy life insurance to cover the risk of death of the single annuitant, if you have that option.

Although the tax consequences would probably be better with the life insurance payout, since those are generally not taxable.

This is complicated stuff, as if that weren't obvious already. :D
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Re: Early Retirement - Lump Sum vs. Annuity

Post by ceeshrek » Thu Dec 14, 2017 9:18 am

Fair point that payout ratio must be measured against duration. Typically, one must make an irrevocable decision at the time of separating from MegaCorp (say, age 65). Assuming a 90 year lifespan (not too optimistic), the rate of return for the 6% payout ratio is 3.5% (table below) -- better than current AAA rated muni bonds and close to the 4% withdrawal rule.

How to assign a value to the guarantee of the income stream from Megcorp compared the volatility of the stock market? Does the guarantee make the 6% rate look any better?

[...]
Years 4.0% 5.0% 6.0% 7.0% 8.0% <-- payout
----- ---- ---- ---- ---- ----
10 (16.0%) (12.4%) (9.4%) (6.7%) (4.3%)
15 (6.3%) (3.6%) (1.4%) 0.7% 2.5%
20 (2.1%) 0.0% 1.9% 3.6% 5.1%
25 (0.0%) 1.9% 3.5% 5.0% 6.4%
30 1.3% 2.9% 4.4% 5.7% 7.0%
35 2.0% 3.6% 4.9% 6.2% 7.4%
40 2.6% 4.0% 5.3% 6.5% 7.6%
45 2.9% 4.3% 5.5% 6.6% 7.8%
50 3.2% 4.5% 5.6% 6.8% 7.8%[/code]For example a 6% payout would provide a good 5.3% return for a young person who expects to live 40 years. But for an old person who only expects to live 15 years, it would provide a terrible -1.4% return. (Since 15 X 6% is less than 1, it wouldn't even pay back the investment.)

[...]

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Re: Early Retirement - Lump Sum vs. Annuity

Post by mnnice » Thu Dec 14, 2017 9:56 am

Is this a straightforward one or the other?

I think in your shoes I would want about 50% annuity vs. 50% lump sum.

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Re: Early Retirement - Lump Sum vs. Annuity

Post by technovelist » Thu Dec 14, 2017 11:53 am

Another possibility is to try to estimate your lifespan more accurately.

One way to do this is to apply for individually underwritten term life insurance.

The rating you get when you do that is probably the best possible existing information for estimating your life expectancy.
In theory, theory and practice are identical. In practice, they often differ.

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Mortality Tables ?

Post by Taylor Larimore » Thu Dec 14, 2017 12:05 pm

Bogleheads:

It is important to understand that mortality tables have little to do with retirement planning. Why? Because nearly all of us must plan to live to age 90 and longer (I'm 93).

Best wishes.
Taylor
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Re: Mortality Tables ?

Post by technovelist » Thu Dec 14, 2017 12:12 pm

Taylor Larimore wrote:
Thu Dec 14, 2017 12:05 pm
Bogleheads:

It is important to understand that mortality tables have little to do with retirement planning. Why? Because nearly all of us must plan to live to age 90 and longer (I'm 93).

Best wishes.
Taylor
Sure. But knowing your estimated lifespan is important if you trying to figure out the relative value of a lump sum and an annuity.

My 90th percentile lifespan estimate is 99 based on my life insurance rating.

And my mother is already 91 and still doing well (as are several others in my family), so I'm planning for 99.
In theory, theory and practice are identical. In practice, they often differ.

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