Pension, take the lump sum or annual payments

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills
Post Reply
Topic Author
patrickza
Posts: 4
Joined: Thu Nov 19, 2015 6:13 am

Pension, take the lump sum or annual payments

Post by patrickza » Thu Nov 19, 2015 6:46 am

Greeting Bogleheads, I'm a new member here, I joined after finding all the advice I needed for investing my portfolio on this forum, thanks :)

Now I have a question that search couldn't answer. I have a pension through work. As I plan on FIREing myself at 40 in about 3 years to go on all sorts of weird and wonderful adventures, I get the choice of having my pension paid out then in a lump sum, or waiting till either 55 or 62 for annual payments.

So, at the moment I'm worth about $500k. I'll add about $50k to that each year for another 3 years. I also have a sideline income of about $600 a month, and monthly expenses of around $1100. My wife wants to carry on working as she loves her job. I also have a 9 year old from a previous relationship, and I cover most of his costs (included in the $1100).

So assuming the market grows at inflation + 5% for another three years, I would have about $740k invested in todays dollars (my current holdings are all in South Africa, but I plan to migrate everything to VWRD in future by then). If my expenses stay the same, and I expect they will, I would only using a 1.5% draw down rate, so there should be practically no way for the portfolio to fail. If the sideline income stays as is, then it'll work out to an even better 0.83% draw down. South Africa has no social security of any worth, so I'm completely on my own with that. Free medical is an option, but quality is questionable

Now on to the pension question. If I take the lump sum at age 40, it'll be worth $188k. I can take that amount then, or I can defer to 55 and get $12300 for the rest of my life. The other option is to defer till 62, when it will be worth $21200 for life. Both options will increase along with inflation, and AFAIK are defined benefit option. On a side note, my family generally live into their late 80s or even 90s, so it could be a long life.

I'm leaning towards the "leave it alone until I'm 62" option. My thinking is this: I won't need the money, and I quite like the idea of this money is my "even in a massive market crash, or a moment of madness, I won't end up living in a box" money.

On the other hand, if I had to take the lump sum and invest it, even with a low 5% per year growth over inflation, it would be worth $550k, meaning at the 4% rule it would pay $22000. At 7% it would be worth $833k and pay out $33300 per year at a 4% draw down.

So what would you do, and have I missed anything?

The Wizard
Posts: 13356
Joined: Tue Mar 23, 2010 1:45 pm
Location: Reading, MA

Re: Pension, take the lump sum or annual payments

Post by The Wizard » Thu Nov 19, 2015 8:39 am

I would retain it as a pension, though I'd want to run the numbers to verify the future values of those payout options are good.
Main reason is, no guarantee of 5% gain over inflation, so best not to have all eggs in one basket...
Attempted new signature...

User avatar
Frugal Al
Posts: 1717
Joined: Fri May 28, 2010 10:09 am

Re: Pension, take the lump sum or annual payments

Post by Frugal Al » Thu Nov 19, 2015 9:06 am

The growth on the pension isn't very impressive, but that's not the real issue with the plan. The real issue is you really can't afford to FIRE yourself yet. Age 40 is really early (OP is now age 37). What's the rush? You're accumulating well, and your expenses are low. As you point out, you have no social security and your health care expense going forward is unclear. Will your expenses always be this low? What if your wife can't work? I think I'd revisit this plan in 8 to 10 years. I agree with Wizard that your rate of return estimates are a bit rich. I'd be inclined to use 2% real for a conservative portfolio, and cross my fingers.

Topic Author
patrickza
Posts: 4
Joined: Thu Nov 19, 2015 6:13 am

Re: Pension, take the lump sum or annual payments

Post by patrickza » Thu Nov 19, 2015 9:20 am

Frugal Al wrote:The growth on the pension isn't very impressive, but that's not the real issue with the plan. The real issue is you really can't afford to FIRE yourself yet. Age 40 is really early (OP is now age 37). What's the rush? You're accumulating well, and your expenses are low. As you point out, you have no social security and your health care expense going forward is unclear. Will your expenses always be this low? What if your wife can't work? I think I'd revisit this plan in 8 to 10 years. I agree with Wizard that your rate of return estimates are a bit rich. I'd be inclined to use 2% real for a conservative portfolio, and cross my fingers.
There's a lot more I'd like to do with my life than spend it behind a desk accumulating far more wealth than I need. I'd like to cycle through Europe, hike the Appalachian trail, sail around the world, and have many other adventures maybe not possible as I get older.

Should the worst case exist, and my under 2% withdrawal fail, I could always get a job... I may even spend part of my "retirement" doing something I enjoy that pays money. I don't plan to, but it likely it may happen at some point in time.

clydewolf
Posts: 745
Joined: Tue Jul 21, 2015 12:51 pm

Re: Pension, take the lump sum or annual payments

Post by clydewolf » Thu Nov 19, 2015 3:48 pm

In your worst case, the economy goes to crap, Where do you ALWAYS get that job?

alex_686
Posts: 5097
Joined: Mon Feb 09, 2015 2:39 pm

Re: Pension, take the lump sum or annual payments

Post by alex_686 » Thu Nov 19, 2015 5:08 pm

First, do you know how to use an actuarial table and a discount rate to figure out what your pension payments will be worth in today dollars?

Second, my gut tells me that getting 5% + inflation is slightly less than a 50/50 chance of making that over the next 10 years. Coming from a background in the pension world, the 5% plus inflation seems high and aggressive. We assume that retired people have low human capital and fixed income needs and so have a low tolerance of risk - which is not exactly true in your case. I would start with the long term yield of 10 year BBB bonds (4.3%), subtract out expected inflation (10 year treasury 2.4% - 10 year TIPs .8%, or 1.6%) to get a safe rate of 2.7%.

Now, I am not suggesting that you invest in 10 year BBB bonds. Rather 10 year BBB bonds represents a nice basket of inflation, interest and credit risk (which can stand in for equity risk) - a quick and dirty way to figure out a discount rate for your future cash flow needs. A lower bound if you will. What would happen if market returns were subpar and you only got 2.7% real returns?

Like I said this might be a moot point - if you are willing to return to work then your human capital does not fall to zero. However, you human capital will be discounted. Time away makes skills and contracts go rusty. Fun or meaningfully jobs tend to pay less. It all comes down to time, money, and risk - and what trade off you are looking to make.

Post Reply