Another pension lump sum scenario

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Lrn2nvst
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Another pension lump sum scenario

Post by Lrn2nvst » Thu Sep 25, 2014 12:15 am

Hello all,
Been lurking here for several months learning as much as I can, but have run into a deadline that I would like another opinion on. A former employer offered to buy out my meager pension and I want to make sure I'm not making a mistake.

I am 39, married with kids and plan to retire / semi-retire at 60. Financial plan is on track for this goal without this pension or SS, but extra money is never refused. I'm leaning toward the lump sum because family history hints of less-than-stunning life expectancy. Neither parent made it to 70. I plan to beat this, but I'm not expecting 80s.

Lump offer is just under $9500
Monthly at 65 is $286 without survivor benefits. It does offer them in exchange for a lower payment.
It is not inflation adjusted, so in 26 years it won't even pay for gas in my car.
There are multiple age options available, also for much lower payments.

My thoughts are to either:
1: Roll it into my work 401k (I think I can do that) and distribute it into my existing 3 funds (VBTIX, VINIX, VSISX)
2: Roll it into a new IRA at Vanguard and start with VTSMX, convert to admiral shares as soon as eligible, then begin diversifying later with growth.
3: follow my advisors advice and invest it through him in a yet to be determined fund. I like my advisor and I don't think he has ever steered me wrong, but the knowledge I have gained here over the last several months has shown me other options.

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LadyGeek
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Re: Another pension lump sum scenario

Post by LadyGeek » Thu Sep 25, 2014 3:40 pm

This thread is now in the Personal Finance (Not Investing) forum (lump sum vs. annuity decision).

Lrn2nvst - Welcome! This forum is better suited to answer your question.
Wiki To some, the glass is half full. To others, the glass is half empty. To an engineer, it's twice the size it needs to be.

JW-Retired
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Re: Another pension lump sum scenario

Post by JW-Retired » Thu Sep 25, 2014 8:13 pm

Lrn2nvst wrote:Hello all,
Been lurking here for several months learning as much as I can, but have run into a deadline that I would like another opinion on. A former employer offered to buy out my meager pension and I want to make sure I'm not making a mistake.

I am 39, married with kids and plan to retire / semi-retire at 60. Financial plan is on track for this goal without this pension or SS, but extra money is never refused. I'm leaning toward the lump sum because family history hints of less-than-stunning life expectancy. Neither parent made it to 70. I plan to beat this, but I'm not expecting 80s.

Lump offer is just under $9500
Monthly at 65 is $286 without survivor benefits. It does offer them in exchange for a lower payment.
Well just as a reference point, if you took that $9500 lump sum and bought an annuity today to start paying you in 25 years, it would pay $150/month.
https://www.immediateannuities.com/

If you took the $9500 and earned 6% tax deferred return on it, in 25 years it would be worth $40773. Drawing the classical 4%/yr from that would give you $136/month.

Seems like waiting for the $286/month is best. Paying for a full tank of gas is better than only half a tank.
JW
Retired at Last

Lrn2nvst
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Re: Another pension lump sum scenario

Post by Lrn2nvst » Thu Sep 25, 2014 11:15 pm

Thank you LadyGeek for moving to correct board.

JW, good point. Looking a little more, I see it would cost nearly $19,000 to buy an annuity that will pay $286/month. I also did some crude math that says I would need to earn almost 7% return on the $9500 to duplicate the pension payment in 25 years. Does this mean they are just throwing out a lowball offer to see if anyone will bite? Many of my coworkers at this company were not very good at personal finances.

Edit: just tried to refine my math a bit, if I assume life expectancy of 81, I would need an annual return of approx 5.79% to duplicate this pension.

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Bounca
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Re: Another pension lump sum scenario

Post by Bounca » Fri Sep 26, 2014 6:27 am

I agree, keep the pension. That is a very good monthly payout relative to the lump sum, granted there is no survivor ship.

A lot of pension lump sum threads these days. I'm in a similar boat. Just offered a lump of 27500 versus $545 monthly. 43, married with kids. Leaning towards keeping the pension.

cherijoh
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Re: Another pension lump sum scenario

Post by cherijoh » Fri Sep 26, 2014 6:42 am

Lrn2nvst wrote:Hello all,
Been lurking here for several months learning as much as I can, but have run into a deadline that I would like another opinion on. A former employer offered to buy out my meager pension and I want to make sure I'm not making a mistake.

I am 39, married with kids and plan to retire / semi-retire at 60. Financial plan is on track for this goal without this pension or SS, but extra money is never refused. I'm leaning toward the lump sum because family history hints of less-than-stunning life expectancy. Neither parent made it to 70. I plan to beat this, but I'm not expecting 80s.

Lump offer is just under $9500
Monthly at 65 is $286 without survivor benefits. It does offer them in exchange for a lower payment.
It is not inflation adjusted, so in 26 years it won't even pay for gas in my car.
There are multiple age options available, also for much lower payments.

My thoughts are to either:
1: Roll it into my work 401k (I think I can do that) and distribute it into my existing 3 funds (VBTIX, VINIX, VSISX)
2: Roll it into a new IRA at Vanguard and start with VTSMX, convert to admiral shares as soon as eligible, then begin diversifying later with growth.
3: follow my advisors advice and invest it through him in a yet to be determined fund. I like my advisor and I don't think he has ever steered me wrong, but the knowledge I have gained here over the last several months has shown me other options.
I would not take the lump sum unless you plan to roll it over into a tax-deferred account. You would have to pay taxes right off the top, then if you followed an advisor's advice have it further eaten up by fees.(You should consider untangling yourself from your advisor so don't give him any more money!)

As far as the lump sum into an IRA/401K vs. keep the existing plan, there are several risks you would need to assess in making your decision:
1) Longevity risk - since you don't expect to live longer than your actuarial life expectancy, this would favor taking the lump sum.
2) Inflation risk - as you pointed out, your pension benefit is fixed so its value will be eaten up by inflation. If inflation comes roaring back then you would likely do better by investing the lump sum.
3) Earnings Risk - if your investments didn't pan out you might fall short of duplicating the value of your current pension - it sounds like you have a sound plan, but a prolonged stock market retreat is always a possibility. On the other hand, you are taking nominal rates of return, so 7% is possible.
4) Company Specific risk - Twenty-six years is a long time, so I would check to make sure your pension is covered under PBGC http://www.pbgc.gov - since you are talking about such as small benefit, you don't need to worry about hitting the maximum coverage. But if your plan isn't covered at all, I would lean towards the lump sum.
Lrn2nvst wrote: JW, good point. Looking a little more, I see it would cost nearly $19,000 to buy an annuity that will pay $286/month. I also did some crude math that says I would need to earn almost 7% return on the $9500 to duplicate the pension payment in 25 years. Does this mean they are just throwing out a lowball offer to see if anyone will bite? Many of my coworkers at this company were not very good at personal finances.
The current interest rate environment means that annuities are really expensive now compared to their historical costs. So your company is probably assuming a more favorable return rate in calculating what value to offer as the lump sum. I think that everyone who has posted lately about a pension buyout offer has had the same issue. So I don't think that your company is being particularly miserly relative to other companies, but they aren't being generous either.

I would probably favor keeping the pension if you were closer to retirement based on the terms you were offered, but with a time frame of 26 years it is probably a crap shoot since you can't predict the future.

Lrn2nvst
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Re: Another pension lump sum scenario

Post by Lrn2nvst » Fri Sep 26, 2014 7:49 am

Thank you for the help. Crapshoot perfectly sums up how I feel about this.

Lump sum would absolutely be rolled into a deferred account.

I am worried about the risk of inflation before I retire. That and survivorship may end up pushing me to lump sum.

I am trying to find out more about the pension, i.e. covered by PBGC, etc.

I feel pretty confident I can beat the annuity in 26 years, but that's easy to say with the market in its current state.

ubermax
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Re: Another pension lump sum scenario

Post by ubermax » Fri Sep 26, 2014 8:21 am

OP , 7% to 5.79% , sample of 1 , where's the forfeiture pool ?

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Frugal Al
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Re: Another pension lump sum scenario

Post by Frugal Al » Fri Sep 26, 2014 9:25 am

cherijoh wrote:The current interest rate environment means that annuities are really expensive now compared to their historical costs. So your company is probably assuming a more favorable return rate in calculating what value to offer as the lump sum. I think that everyone who has posted lately about a pension buyout offer has had the same issue.
Companies with plans covered under ERISA are bound by regulation regarding the calculation of lump sums, so the companies don't get to choose the rates they use; however they can offer above the minimum (assuming adequate funding), and they can develop their own actuarial assumptions, if sufficient data exists. One thing that might be happening with what seems to be a rush of de-risking is that the look-back months commonly used are near the end of the calendar year. Offers made now might be marginally lower than in the near future (next year) due to the new look-back month rates rates that seem to be heading lower. The age of the prospective pensioner and the number of years at the longer rates vs the other rates really plays a significant role in the lump sum calculation.

While this case does indeed seem to be a crapshoot and the pension is not a bad deal, the fact that the OP might have longevity issues would lead me to lean towards the lump sum. Whether a lump sum will be offered next year is up to the plan sponsor. If they are serious about de-risking there are often other offers after a brief time.

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Re: Another pension lump sum scenario

Post by Valuethinker » Fri Sep 26, 2014 11:59 am

Given presumed longevity issues and the relatively small size of all this, I think Frugal Al is probably about right.

Roll it over into a tax deferred account. You should be able to get 5 to 7% return pa on it. If you put it in say 40% bonds (3% return) and 60% stocks (7% return) that would be 1.2 + 4.2 = 5.4% pa.

Lrn2nvst
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Re: Another pension lump sum scenario

Post by Lrn2nvst » Fri Sep 26, 2014 6:52 pm

What's a forfeiture pool? Is that the penalty for early withdrawal? If so, it's $120 at 55, $180 at 60 and $215 at 62.

The 7% figure (6.88% is more accurate, huge rounding error in first calculation) assumes perpetual withdrawal. Principle never touched.

The 5.79% represents drawing the account down to zero at 80 years 11 months.

It just occurred to me that I need to recalculate based on survivorship payouts. That will push necessary return down even further.

Thanks for all the help. I feel better knowing there wasn't an obvious "best" answer that I was missing. This is extra money for retirement either way I go. Just have to decide if mortality or market favors me more.

cherijoh
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Re: Another pension lump sum scenario

Post by cherijoh » Fri Sep 26, 2014 7:07 pm

Lrn2nvst wrote:Thank you for the help. Crapshoot perfectly sums up how I feel about this.

Lump sum would absolutely be rolled into a deferred account.

I am worried about the risk of inflation before I retire. That and survivorship may end up pushing me to lump sum.

I am trying to find out more about the pension, i.e. covered by PBGC, etc.

I feel pretty confident I can beat the annuity in 26 years, but that's easy to say with the market in its current state.
Check out the link in my earlier post. The PBGC website will tell you whether or not your company is insured.

Lrn2nvst
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Re: Another pension lump sum scenario

Post by Lrn2nvst » Fri Sep 26, 2014 7:28 pm

Thanks for the link, it is insured by PBGC. So the only real risk on the pension side is inflation and my mortality.

OutInThirteen
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Re: Another pension lump sum scenario

Post by OutInThirteen » Sat Sep 27, 2014 11:06 am

Lrn2nvst wrote:Thanks for the link, it is insured by PBGC. So the only real risk on the pension side is inflation and my mortality.
One caution - be sure to investigate whether or not the PBGC pension amount would be capped at less than your anticipated pension from your employer. The PBGC provides a maximum pension benefit (IIRC) based on your age at the time your plan is terminated. In my case, because of the fairly generous pension terms, my salary, and years of service, had my pension been terminated the PBGC would have only provided me with about half of my anticipated pension. An extreme example of this potential impact was United Airlines pilots, many of whom received about one-third of their pension.

ubermax
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Re: Another pension lump sum scenario

Post by ubermax » Mon Sep 29, 2014 12:13 pm

Lrn2nvst wrote:JW, good point. Looking a little more, I see it would cost nearly $19,000 to buy an annuity that will pay $286/month. I also did some crude math that says I would need to earn almost 7% return on the $9500 to duplicate the pension payment in 25 years. Does this mean they are just throwing out a lowball offer to see if anyone will bite? Many of my coworkers at this company were not very good at personal finances.
No lowball offer , looks like the 19K is based on naturally conservative deferred annuity rates , guesstimate around 3.4% for interest assumption and the 9.5K looks to be based on the July 2013 fed lump sum segment 3 rate of 5.44% , seems odd since a 6 month look-back isn't available - but that 2% differential over 26 years easily explains the difference .

I got 5.5% and 6.7% for the temporary and "perpetual" ( interesting twist on perpetuity ) annuities but close enough - for simplicity I used annual payments of (12)(286) beginning at 65.

Not sure what your thought pattern is where you say "recalculate based on survivorship payouts" ?? - the question , do I wait for the annuity or take the lump sum ? , the former requiring survivorship alone and the later survivorship and investment results; I also think the current yield curve model based on available marketplace bonds for pension funding and lump sum calculations is less volatile and more appropriate than a diversified portfolio - but your own conclusion that there isn't a "best" answer is correct - lump sums as well as annuities have their place depending on the personal situation.

I'd just roll that 9.5K somewhere and be done with it and report back when you decide whether mortality or the market favors you more .

O, yes the forfeiture pools , initially I didn't have a clue regards your 7% and 5.79 scenario with life expectancy thrown in and took a wild guess that you were thinking that your situation was similar to having a pure endowment contract with the survivorship bump that you derive due to the deaths, i.e. forfeitures - obviously you can see where the law of large numbers doesn't fit well with a sample size of one .

Lrn2nvst
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Re: Another pension lump sum scenario

Post by Lrn2nvst » Mon Oct 06, 2014 7:15 pm

Thanks again for all the help.

The "recalculate" statement was based on the incorrect idea that I would receive less if I took a survivorship option. I now see that 50% survivorship is included in the 65 payout.

Time is almost up to make a decision, and wife and I are leaning towards rolling into new Vanguard IRA. Put it all in VTSMX and convert to admiral shares when eligible. Put growth above 10k into VBFMX until AA ratio achieved, lather, rinse, repeat until retirement.

Ultimately this is less than 2% of my retirement plan so I'm trying not to over complicate it.

More important long term goal is to gain enough knowledge to pull away from broker. Maybe this will prove successful enough to make us pull the trigger.

P.S.
1: Found the interest rate they claim used for the calculation is 5.62%.
2: Realized my required return percentages are skewed high because I have been calculating interest annually instead of monthly.
3: Perpetual vs perpetuity. Sorry, did not know one was improper.

Valuethinker
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Re: Another pension lump sum scenario

Post by Valuethinker » Wed Oct 08, 2014 8:50 am

Lrn2nvst wrote: 3: Perpetual vs perpetuity. Sorry, did not know one was improper.
Perpetual is forever.

A perpetuity is a policy that pays forever (or until end of life). It's an insurance term. In perpetuity means to do something forever (legal term).

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Re: Another pension lump sum scenario

Post by Buffett_wannabe » Wed Oct 08, 2014 11:31 am

Lrn2nvst wrote:Lump offer is just under $9500
Monthly at 65 is $286 without survivor benefits. It does offer them in exchange for a lower payment.
It is not inflation adjusted, so in 26 years it won't even pay for gas in my car.
There are multiple age options available, also for much lower payments.
I'm tuning in late to this thread, so I hope I haven't missed your decision window. Have you reviewed the summary plan document for your former employer's pension? (they are obliged to provide you one and some have them online) If so, are there any options to delay past 65 in exchange for a higher payout?

I completely understand not wanting to complicate your retirement portfolio, but honestly there isn't much to a pension except setting aside the paperwork in your safe deposit box and marking a date on your calendar to apply for payments. A little bit of "longevity insurance" afforded by an annuity is better than none at all, even if it ends up paying to take the grandkids for ice cream once in a while. Perhaps taking the pension annuity would help you delay taking SS and rack up some extra delayed retirement credits. Think of it this way: you have to take on some risk in your own accounts to make a 7% return (a LOT of risk at today's interest rates). When a 7% risk free return is available on $9500 by doing nothing, what's not to like?

hth,
Craig B.

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Re: Another pension lump sum scenario

Post by Frugal Al » Wed Oct 08, 2014 1:35 pm

Buffett_wannabe wrote:A little bit of "longevity insurance" afforded by an annuity is better than none at all, even if it ends up paying to take the grandkids for ice cream once in a while.
Craig, you may have missed it, but the OP isn't necessarily concerned about longevity issues. Not everyone needs to maintain a pension. There are many valid reasons not to, especially pensions with moderate growth and long time horizons just until annuitization (perhaps 26 years in this case). Moreover, this is just a tiny part of the OP's retirement. The OP will likely be fine whichever choice he makes, but I know what I'd do in this case.

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Re: Another pension lump sum scenario

Post by Buffett_wannabe » Wed Oct 08, 2014 4:19 pm

Frugal Al wrote:Craig, you may have missed it, but the OP isn't necessarily concerned about longevity issues.
Indeed I did...sorry for the oversight. I would still look at the joint and survivor option if OP's spouse expects to live longer based on her family history. For example, put both ages into ImmediateAnnuities.com's calculator and evaluate the quoted prices as a proxy for the present value of those options. My own grandfather had a similar family history and died at 74, but grandma is still in good health at 91 and has done very well by survivor benefits.

As you and many others have said, there is no right or wrong answer, and in this case not a big chunk of OP's retirement riding on the outcome. But I do believe that for money not needed where someone might benefit from deferring payment, one should turn over every rock.

Cheers,
Craig B.

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Re: Another pension lump sum scenario

Post by Buffett_wannabe » Wed Oct 08, 2014 4:28 pm

OutInThirteen wrote:One caution - be sure to investigate whether or not the PBGC pension amount would be capped at less than your anticipated pension from your employer. The PBGC provides a maximum pension benefit (IIRC) based on your age at the time your plan is terminated. In my case, because of the fairly generous pension terms, my salary, and years of service, had my pension been terminated the PBGC would have only provided me with about half of my anticipated pension. An extreme example of this potential impact was United Airlines pilots, many of whom received about one-third of their pension.
True, but in this case it's a sure bet OP will never come anywhere near PBGC caps. Based on recent events with my own former employer's pension, I think the cap on your state's life insurance and annuity guaranty fund is a better proxy for the worst case limit on payouts. How solvent that fund is could be a concern as well.

Cheers,
Craig B.

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