Pension decision: Lump sum or annuity. Now or later?

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2016
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Pension decision: Lump sum or annuity. Now or later?

Post by 2016 » Sat Jul 30, 2016 7:09 am

Hello: So, I retired early from MegaCorp last month, and I had a traditional pension with them. They sent me a letter, offering me a lump sum pension cash-out or an offer to start monthly payments right away (I'm 46). If I don't take it now, I'll need to wait 9 years until I'm 55 to either take a lump sum, start monthly payment, or wait until I'm 65. At 65 then, the same two options: lump sum or annuity. What would you do if you were me? I don't need the money for day-to-day expenses but would simply be investing it. Here are the options:

Option 1: Cash-out now at 46. $142,000 lump sum
Option 2: Annuity of $415 a month starting right away

Option 3: Cash-out at 55. $239,000 lump sum
Option 4: Annuity of $954 a month starting in 9 years

Option 5: Cash-out at 65. $392,000 lump sum
Option 6: Annuity of $2,464 a month starting in 19 years

It looks like the lump sum increases about 6% every year. That's a guaranteed 6% which seems a bit hard to pass up (meaning, do NOT take a lump sum now). On the other hand, if I die before cashing it, my spouse only gets 50% of the value. I played around with some online calculators, and assumed inflation of 2.5%, returns if invested at 6%, and that I'll live to 85. With those parameters, taking a lump sum seems to make sense, instead of the annuities.

What would you do if you were me? I'm really at a loss, Thanks for any and all advice.

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Re: Pension decision: Lump sum or annuity. Now or later?

Post by ljb1234 » Sat Jul 30, 2016 7:29 am

It looks like the lump sum increases about 6% every year. That's a guaranteed 6% which seems a bit hard to pass up (meaning, do NOT take a lump sum now). On the other hand, if I die before cashing it, my spouse only gets 50% of the value. I played around with some online calculators, and assumed inflation of 2.5%, returns if invested at 6%, and that I'll live to 85. With those parameters, taking a lump sum seems to make sense, instead of the annuities.
I assume that your lump sum estimates are based on today's interest rates (ie. low). So if you wait, your lump sum will be recalculated in the future and it could go up or down. If interest rates go up, the lump sum will go down. If they go down, then it will go up. You have to make a guess what's going to happen. I would be surprised if your lump sum amounts in the future are guaranteed today, but I don't know your situation.

I had a similar decision to make about 3 years ago, but I was in my late 50's at the time. I was given a third option of a lump-sum plus annuity (the pension changed its calculation around mid-career for me). I took the lump sum plus annuity and I am happy with that decision. I like to spread risks if I can.

If you were already 65, then I would look at the annuity. Given you are 46, I would opt for the lump sum now. The annuity option now is not that good. Just my opinion.

It's difficult because you can't change your mind once you decide.

good luck!

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Re: Pension decision: Lump sum or annuity. Now or later?

Post by cherijoh » Sat Jul 30, 2016 7:53 am

2016 wrote:Hello: So, I retired early from MegaCorp last month, and I had a traditional pension with them. They sent me a letter, offering me a lump sum pension cash-out or an offer to start monthly payments right away (I'm 46). If I don't take it now, I'll need to wait 9 years until I'm 55 to either take a lump sum, start monthly payment, or wait until I'm 65. At 65 then, the same two options: lump sum or annuity. What would you do if you were me? I don't need the money for day-to-day expenses but would simply be investing it. Here are the options:

Option 1: Cash-out now at 46. $142,000 lump sum
Option 2: Annuity of $415 a month starting right away

Option 3: Cash-out at 55. $239,000 lump sum
Option 4: Annuity of $954 a month starting in 9 years

Option 5: Cash-out at 65. $392,000 lump sum
Option 6: Annuity of $2,464 a month starting in 19 years

It looks like the lump sum increases about 6% every year. That's a guaranteed 6% which seems a bit hard to pass up (meaning, do NOT take a lump sum now). On the other hand, if I die before cashing it, my spouse only gets 50% of the value. I played around with some online calculators, and assumed inflation of 2.5%, returns if invested at 6%, and that I'll live to 85. With those parameters, taking a lump sum seems to make sense, instead of the annuities.

What would you do if you were me? I'm really at a loss, Thanks for any and all advice.
Are you sure about the fact that your spouse would only get 50% of your pension if you die before collecting it? (I'm pretty the beneficiary rules can be different depending on if you die before or after starting to collect a pension). I think you may be confusing it with a 50% survivor benefit on a joint pension payout. I would verify your understanding with the HR/benefits people at your company.

If your spouse would not be penalized by 50% for your premature death, I see no reason to consider either option 1 or 2 unless you think you will need the money before 55. I also wonder it you are strictly limited to choosing 55 or 65 or if that was for illustration purposes only. I have a pension from a former employer that I can take anytime I want now since I am over 55. Due to a years-in-service rule, my pension amount will stop growing at age 60. If your pension allows you to choose an intermediate benefit start date, then you really only need to decide now whether or not to take the current buyout offer for an immediate pension benefit.

What you need to do are some internal rate of return calculations. You can do this in a spreadsheet like Excel. It may already have been incorporated in the calculators you looked at, but I'm always leery of online calculators since you don't always know all of the assumptions made for simplicity.

IMO, you also need to take into account the amount your spouse would get as a survivor benefit. You didn't mention your spouse's age or gender, but if you have a wife and she is your age or younger there is a significant actuarial probability that she could survive you by at least several years. This would steer you towards taking the monthly check over the lump sum.

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Re: Pension decision: Lump sum or annuity. Now or later?

Post by bertilak » Sat Jul 30, 2016 8:31 am

Since you don't need the money now, I'd lean towards letting things ride as the equity built up. That's both guaranteed and tax free 6%!

I think the answers to the following may have a bearing on the right decision...

Question: What income do you now have that pays your expenses? (i.e. Why don't you need the money now?)

Question: How big a nest egg do you have already?
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Re: Pension decision: Lump sum or annuity. Now or later?

Post by LadyGeek » Sat Jul 30, 2016 8:49 am

This thread is now in the Personal Finance (Not Investing) forum (retirement planning).

2016, Welcome! The wiki provides some guidance: Lump sum vs pension
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.

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Re: Pension decision: Lump sum or annuity. Now or later?

Post by ubermax » Sat Jul 30, 2016 10:11 am

cherijoh wrote:Are you sure about the fact that your spouse would only get 50% of your pension if you die before collecting it? (I'm pretty the beneficiary rules can be different depending on if you die before or after starting to collect a pension). I think you may be confusing it with a 50% survivor benefit on a joint pension payout. I would verify your understanding with the HR/benefits people at your company.
cherijoh wrote:If your pension allows you to choose an intermediate benefit start date, then you really only need to decide now whether or not to take the current buyout offer for an immediate pension benefit.
Good points , also you should ask HR what month is specified in the plan document for the determination of lump sums - that way we can do a quick check on the reasonableness of the values you provided ; that done , there are members of this forum that would be delighted to do an IRR analysis for you ; the only credible lump sum is the current one , future amounts are just estimates assuming current rates are used at those future times , i.e. not a guaranteed 6% increase ; while you're at it you could also ask HR if any of the early annuities are subsidized meaning having a value greater than actuarial equivalence , also double check age 46 , it seems low for a typical early retirement age but maybe not these days .

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Re: Pension decision: Lump sum or annuity. Now or later?

Post by LadyGeek » Sat Jul 30, 2016 11:42 am

ubermax wrote:the only credible lump sum is the current one , future amounts are just estimates assuming current rates are used at those future times , i.e. not a guaranteed 6% increase ;
Good point, as Jack Bogle says 3% is the rate going forward. He presented that info during the 2015 Bogleheads Conference.

It's captured in the wiki: Historical and expected returns (Expected future returns)
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Re: Pension decision: Lump sum or annuity. Now or later?

Post by Paul47 » Sat Jul 30, 2016 11:59 am

Some other questions I'd ask.
1. Can you roll your pension money into a tax deferred retirement such as an IRA?
2. Will your monthly payments stay the same forever once you start taking it? My wife has a pension annuity from a large hospital. We did not have an option other than the annuity (they were protecting her from spending it all at once). The pension amount hasn't changed so the value has decreased significantly over time. Her annuity has been sold several times and I've offered to take a cash amount or somehow buy it but it is such a good deal for the insurance companies that they don't want to part with it.

I'm a big believer in keeping control and managing my own assets. Even if you were guaranteed the 6% increase in the principal, will they change the rules in the future? Companies do that all the time. The 50% annuity for your wife if you die before starting to take yours might be true based upon the normal concept that a annuity usually pays about 50% to the survivor (or nothing). Check that carefully. If you call someone on the phone and they assure you she will get the full amount, it is indexed for inflation, etc, are you sure that person knows what they are talking about and it is legally binding? Probably not.

At 46, with your current financial needs being met (job?), you probably have many more years to earn and invest. I'd take the lump sum and invest it. I'd feel confident that you can make 6% on your money (equities).

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Re: Pension decision: Lump sum or annuity. Now or later?

Post by 2016 » Sat Jul 30, 2016 2:48 pm

cherijoh wrote:Are you sure about the fact that your spouse would only get 50% of your pension if you die before collecting it? ...I think you may be confusing it with a 50% survivor benefit on a joint pension payout. I would verify your understanding with the HR/benefits people at your company.
The language is surprisingly readable and non-lawyeresque. It reads: If you are married and die before pension benefit payments begin, the Pension Plan provides benefit protection for your spouse. Your spouse's benefit will be 50% of the benefit you would have received if you had chosen to begin benefit payments at age 55, and had elected a 50% joint and surviving spouse payment option
cherijoh wrote:I also wonder it you are strictly limited to choosing 55 or 65 or if that was for illustration purposes only. I have a pension from a former employer that I can take anytime I want now since I am over 55. Due to a years-in-service rule, my pension amount will stop growing at age 60. If your pension allows you to choose an intermediate benefit start date, then you really only need to decide now whether or not to take the current buyout offer for an immediate pension benefit.
Busted. I did gloss over some of the details to simplify the options. The options are really: take it now at 46 (lump or annuity). If I don't take it, the next earliest time I can start it is at age 55 (lump or annuity). But then I can choose to start it anywhere between 55-65. I can't extend it beyond 65. So, my options are really: 46, 55, 56, ...etc... 64, 65). So, my options are really boiled to: 1) Take lump sum now, 2) Start annuity now, 3) wait until age 55 (9 years) to decide at that point. Thanks for your input

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Re: Pension decision: Lump sum or annuity. Now or later?

Post by 2016 » Sat Jul 30, 2016 2:53 pm

bertilak wrote:Since you don't need the money now, I'd lean towards letting things ride as the equity built up. That's both guaranteed and tax free 6%!

I think the answers to the following may have a bearing on the right decision...

Question: What income do you now have that pays your expenses? (i.e. Why don't you need the money now?)

Question: How big a nest egg do you have already?
My spouse has income (and is roughly same age as myself). It covers our expenses and even leaves a bit left over to invest.

The nest egg is not that impressive (low 7 figures), but hopefully grows for another 10-15 years until she officially retires. Then, have a SWR of about 3.0 - 3.5%.

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Re: Pension decision: Lump sum or annuity. Now or later?

Post by 2016 » Sat Jul 30, 2016 3:03 pm

ubermax wrote:Good points , also you should ask HR what month is specified in the plan document for the determination of lump sums - that way we can do a quick check on the reasonableness of the values you provided ;
They assume a September 1 start date for annuities or for lump sum distribution. They have an online calculator using my real data, so I ran scenarios for all possible years:

Sep-1 of: Age Mothly Lump Sum
2016 46 415.84 142,351
2017 47
2018 48
2019 49
2020 50
2021 51
2022 52
2023 53
2024 54
2025 55 954.00 239,909
2026 56 1,052.00 253,058
2027 57 1,162.00 266,800
2028 58 1,286.00 281,175
2029 59 1,426.00 296,228
2030 60 1,584.00 314,238
2031 61 1,763.00 333,087
2032 62 1,966.00 352,294
2033 63 2,198.00 371,959
2034 64 2,464.00 392,109
ubermax wrote:that done , there are members of this forum that would be delighted to do an IRR analysis for you ; the only credible lump sum is the current one , future amounts are just estimates assuming current rates are used at those future times , i.e. not a guaranteed 6% increase ; while you're at it you could also ask HR if any of the early annuities are subsidized meaning having a value greater than actuarial equivalence , also double check age 46 , it seems low for a typical early retirement age but maybe not these days .
There's really not an "early retirement age" at my former company. Just when you could get a normal non-discounted pension at 65, and then penalties for quitting before that date. After 5 years of working, everyone was vested in the pension (new employees have no traditional pension like I have).

2016
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Re: Pension decision: Lump sum or annuity. Now or later?

Post by 2016 » Sat Jul 30, 2016 3:07 pm

ljb1234 wrote:If you were already 65, then I would look at the annuity. Given you are 46, I would opt for the lump sum now. The annuity option now is not that good. Just my opinion.

It's difficult because you can't change your mind once you decide.

good luck!
Thanks for your input. A hybrid option may have been a nice middle of the road, split the risk, option.

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Re: Pension decision: Lump sum or annuity. Now or later?

Post by 2016 » Sat Jul 30, 2016 3:09 pm

LadyGeek wrote:This thread is now in the Personal Finance (Not Investing) forum (retirement planning).

2016, Welcome! The wiki provides some guidance: Lump sum vs pension
Hey, thanks for the link. Good reading.

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Re: Pension decision: Lump sum or annuity. Now or later?

Post by 2016 » Sat Jul 30, 2016 3:55 pm

Paul47 wrote:Some other questions I'd ask.
1. Can you roll your pension money into a tax deferred retirement such as an IRA?
2. Will your monthly payments stay the same forever once you start taking it? My wife has a pension annuity from a large hospital. We did not have an option other than the annuity (they were protecting her from spending it all at once). The pension amount hasn't changed so the value has decreased significantly over time. Her annuity has been sold several times and I've offered to take a cash amount or somehow buy it but it is such a good deal for the insurance companies that they don't want to part with it.

I'm a big believer in keeping control and managing my own assets. Even if you were guaranteed the 6% increase in the principal, will they change the rules in the future? Companies do that all the time. The 50% annuity for your wife if you die before starting to take yours might be true based upon the normal concept that a annuity usually pays about 50% to the survivor (or nothing). Check that carefully. If you call someone on the phone and they assure you she will get the full amount, it is indexed for inflation, etc, are you sure that person knows what they are talking about and it is legally binding? Probably not.

At 46, with your current financial needs being met (job?), you probably have many more years to earn and invest. I'd take the lump sum and invest it. I'd feel confident that you can make 6% on your money (equities).
1. I assume I can roll it over to a traditional IRA and no tax consequences until withdrawals.
2. They do (stay the same). No indexing with inflation, etc.
3. As others have mentioned, these are the lump sums in the future, as of now. I do believe they'll change based on interest rates, etc.
Thanks for your thoughts, S

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Re: Pension decision: Lump sum or annuity. Now or later?

Post by technovelist » Sat Jul 30, 2016 5:02 pm

Have you considered waiting but buying term insurance to make up the difference if you die early? At your relatively young age, if you are in very good health, that should be extremely cheap, like $500/year for $250K face amount for 30 years. 20 year term is even cheaper, and that would cover you until 65.

(I assume you are in good health or you wouldn't even ask about the annuity but would take the lump sump without question.)
In theory, theory and practice are identical. In practice, they often differ.

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Re: Pension decision: Lump sum or annuity. Now or later?

Post by 2016 » Sun Jul 31, 2016 7:10 am

technovelist wrote:Have you considered waiting but buying term insurance to make up the difference if you die early? At your relatively young age, if you are in very good health, that should be extremely cheap, like $500/year for $250K face amount for 30 years. 20 year term is even cheaper, and that would cover you until 65.

(I assume you are in good health or you wouldn't even ask about the annuity but would take the lump sump without question.)
Interesting idea. I've been doing the opposite, actually. We when we had young children, I took out a 20-year level term policy for me ($1.5M), and another for my spouse ($750k). About a year ago, I reduced these to $750k for me, and $500k for my spouse, as the our kids are older and our need for 'replacement income' to support them is reduced. The original premiums for the full amount of the policies were only $1900/year for $2.25M in coverage, and now we're paying about half that.

Based on all of the discussion and suggestions, I'm leaning towards a lump sum payout immediately. Also have been googling around, and found this, which spoke to me: https://rodgers-associates.com/newslett ... m-payouts/

To me, additional reasons to take a lump sum right now are:
- Peace of mind. Get the money out, and stop worrying about interest rates increasing, pension fund underfunding, my dying (!) before cash-out
- WIth such low interest rates, why lock in a bad annuity rate forever, due to the quasi-temporary low-interest rate environment
- Assuming all options have a pretty equal Net Present Value (I believe gov't regulations mandate certain benchmarks and assumptions on future rates to calculate future lump sums and annuity amounts), just take the one most convenient for me and the most risk free
- Delay taxes for as as much as possible. Lump sum into an IRA delays taxes until at least 70. Annuities have taxes due from year 1 of the distributions
- If we hit a financial tsunami, having the pension in an IRA allows certain freedoms to cash it out without penalties in certain circumstances, instead of having it locked up until at least age 55

Thanks again for all the input, everyone.

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Re: Pension decision: Lump sum or annuity. Now or later?

Post by ljb1234 » Sun Jul 31, 2016 8:14 am

- Peace of mind. Get the money out, and stop worrying about interest rates increasing, pension fund underfunding, my dying (!) before cash-out
- WIth such low interest rates, why lock in a bad annuity rate forever, due to the quasi-temporary low-interest rate environment
I think you are making the best choice at this time.

You are actually locking in a good lump sum with the low interest rates.
Your annuity payment amount may or may not be tied to the current interest rates. It depends on the calculation method used.

Either way, the lump sum is a good value at this time.

regards,

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Re: Pension decision: Lump sum or annuity. Now or later?

Post by bberris » Sun Jul 31, 2016 8:21 am

I find the approach to this decision by calculating expected returns and interest rates to be pure guesswork.

Try pricing a comparable annuity using the lump sum payoff from one of the on line sites.

I'm sure you will find the lump sum option to be worse. The question is, do you want an annuity? If you are planning on buying one, you should almost certainly wait for your pension. Unless of course you know something about your life expectancy ...

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Re: Pension decision: Lump sum or annuity. Now or later?

Post by Watty » Sun Jul 31, 2016 9:23 am

A few things that may not have been mentioned.

1) If you do not take the lump sum now you may not be able to take it later. I have a small old pension and they blocked taking lump sums for about five years because the plan was underfunded. Eliminating the ability to take a lump sum seems to be a common change in pension plans.

2) If you take the lump sum now and invest it then you can buy an annuity when you are 65. If interest rates are higher then you could get a much larger annuity. You could also select an annuity with the terms that you want, or wait and buy one when you are 75 if it makes sense then.

3) The pension payment will be taxable income and if you are in the income range where each extra dollar of income causes more of your Social Security to be taxable then the tax rate could be surprisingly high. If you are widowed or divorced then you could be in the higher single tax brackets.

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

With the lump sum you might be able to manage your taxes better by doing Roth conversions before you start Social Security and RMD's from retirement accounts.

4) With this question I like to turn it around and ask "I have $142K in an IRA. Should I buy a deferred annuity that pays a non-inflation adjusted $2,494 starting in 19 years?" That is really the same question but it takes out the bias against making any changes to what you currently have. Few people actually buy differed annuities like that.

I would take the lump sum since you have so long until you retire.

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Re: Pension decision: Lump sum or annuity. Now or later?

Post by ubermax » Sun Jul 31, 2016 11:26 am

2016 wrote:They assume a September 1 start date for annuities or for lump sum distribution. They have an online calculator using my real data, so I ran scenarios for all possible years:
Administratively your former employer may have selected 9/1 as the annuity start date for all 2016 processing or possibly just for your situation ; all defined benefit plans in the private sector are required to use IRS mandated interest rates and a mortality table to determine lump sum amounts given an annuity , either immediate or deferred .

To prevent adverse selection regarding interest rates , plan sponsors are required to define a stability period ( a calendar month , calendar quarter, or calendar year) which contains the annuity start date and a look-back month ( any of the 5 months preceding the first month of the stability period) ; IRS publishes the required interest rates ( there are 3 and they're called segment rates) each month ; the particular start date, stability period , and look-back month define which rates are used ; a plan sponsor can also select a plan quarter or plan year and even choose to average interest rates over two or more look-back months.

You can see that in your case the set of interest rates to be used can be from any of 15 different months - that's why it would be helpful if you could contact HR at your former company and ask for the specific plan language that governs lump sum payouts or just simply ask them what month was used for the lump sum interest rates.

For example , using the June 2016 rates ( the latest ones available) and a monthly annuity amount of $416 starting at age 46 , I get a lump sum of roughly $96,600 which is $45,400 less than your amount of $142,000 ; granted the difference is in your favor but to my mind any discussion of which option is better should begin with a reasonability check of the data provided .

The lump sum calculation is a very straight forward present value application but you need to have both correct annuity values and the particular rate set .

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