Take the Lump Sum now? Or get annuity payments for life?

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teelainen
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Take the Lump Sum now? Or get annuity payments for life?

Post by teelainen »

Scenario:

67 year old male. He used to work for the state and now has a tiny pension available to him. His wife is 65 years old. Both are in good health. He has the option to pick one of the following choices for his pension:

Option 1) $18,000 lump sum payment now and no annuity payments.
Option 2) $155 monthly annuity payment for the rest of his life, and it will transfer to the surviving spouse for the rest of her life.
Option 3) $180 monthly annuity payment for the rest of his life, but it DOESN'T transfer to the surviving spouse.

Which option would you pick and why? Thanks.
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smarcus3
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Re: Take the Lump Sum now? Or get annuity payments for life?

Post by smarcus3 »

Which state is your pension coming from?

Inflation adjustment?

Assuming 20 more years left to take distributions (sorry for being morbid) the monthly payments are better. This assumes the lump sum earns 5% when you take the distribution and payments aren't adjusted for inflation. As long as the states pension is reasonably funded take the payments.
This is my personal opinion. I'm an engineer not a financial advisor.
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sergeant
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Re: Take the Lump Sum now? Or get annuity payments for life?

Post by sergeant »

Health status of the two? I would go with Option 2 but none of the 3 options would have any financial impact whatsoever for us. Does this small dollar amount mean anything to them?

I'm assuming a state pension has a COLA.
AA- 20+ Years of Expenses Fixed Income/The remainder in Equities.
farnsy
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Re: Take the Lump Sum now? Or get annuity payments for life?

Post by farnsy »

From the social security administration, life expectancy for a man who is 67 is 83.38 (16.38 years). Life expectancy for a woman who is 65 is 85.36 (20.36 years).

For option 3, to make the annuity worth $18,000 today, you would need to use a discount rate of around 9.8% annually. For option 2, you would need around 8.5% if my math is right. Both of those are high, so the annuity is a good idea. Since you say they are both healthy, they are likely to actually beat the averages above, so the annuity seems like a very good idea. Option 3 is best, based on these numbers. Basically they have made the option that most people will consider "riskiest" the most desirable, which is common practice.

Of course, this analysis assumes your state is going to pay out (it's not about to go bankrupt). Not sure which state you are in, but fear of this would be a potential reason to take the lump sum.
sixty40
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Re: Take the Lump Sum now? Or get annuity payments for life?

Post by sixty40 »

Based on a $18,000 payout, a $155/m payment comes out to $1860/yr which is more than a 10% payout rate.
An immediate annuity based on $18000 initial payment is $82/m or $1968/yr or about a 5.4% payout. (USAA annuity calculator)

Not having more information about your situation and based on your numbers only, I would definitely take the the annuity payment w/ or w/o surviving spouse. I would probably take the surviving spouse annuity since the difference seems minimal, and I assume the spouse would like it.
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Spinola
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Re: Take the Lump Sum now? Or get annuity payments for life?

Post by Spinola »

I would take the monthly payment options.. with survivor continuation. You would best the 18,000 lump sum at around 9.6 years, a little longer if you factor in inflation.. and with continuation for your spouse, would still be be ahead if she survives you..
NMBob
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Re: Take the Lump Sum now? Or get annuity payments for life?

Post by NMBob »

For the take the cash out option, You also have to ignore any return comparison and simply consider if the couple is capable of decently handling, and not losing , the option that hands them the cash. There is simply a certain percentage of people who should just virtually never be handed a pile of cash. 1 in 3 americans have 0 retirement savings, for many reasons, but some certainly will be mismanagement.
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#Cruncher
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Re: Take the Lump Sum now? Or get annuity payments for life?

Post by #Cruncher »

farnsy wrote: Sat Mar 16, 2019 12:26 amFrom the social security administration, life expectancy for a man who is 67 is 83.38 (16.38 years). Life expectancy for a woman who is 65 is 85.36 (20.36 years). For option 3 [Single $180/mo], to make the annuity worth $18,000 today, you would need to use a discount rate of around 9.8% annually. For option 2 [Joint $155/mo], you would need around 8.5% if my math is right.
You appear to be using the woman's life expectancy to value the 100% joint annuity, Farnsy. [1] This isn't correct. Even though the man's life expectancy is less than the woman's, there is still a possibility he will outlive her. Thus the expected years that at least one of them will live is higher than the woman's life expectancy alone. For the SSA 2015 Period Life Table (from which you got the man & woman's life expectancies) this is 23.48 years. [2] Using this instead of 20.36 in your calculation, raises the return to 9.1%, closer to the 9.4% return for the single life annuity. [3]

A more accurate way to estimate the returns is to base them on diminishing survival-weighted cash flows instead of constant ones that continue until the life expectancy and then abruptly stop. This method produces an 8.3% return for the single life annuity and 9.1% for the joint life annuity. [4] Both of these figures are suspiciously high. The annuity options I've seen on this forum typically have returns of about 4% versus taking the lump sum.

  1. 8.5% calculated with the Excel RATE function:
    Option 2 Joint: 8.5% = 12 * RATE(20.36 * 12, 155, -18000, 0, 0)
    Using the same method with the man's life expectancy I get 9.4% instead of 9.8% for the Single annuity:
    Option 3 Single: 9.4% = 12 * RATE(16.38 * 12, 180, -18000, 0, 0)
  2. This is displayed in cell I8 on the Alive sheet of my longevity estimator spreadsheet.
  3. Option 2 Joint: 9.1% = 12 * RATE(23.48 * 12, 155, -18000, 0, 0)
  4. Using cells N1:O4 on the Alive sheet of my longevity estimator spreadsheet.
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