Yet another pension vs lump sum Q, with a twist

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FireAway
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Yet another pension vs lump sum Q, with a twist

Post by FireAway » Thu Nov 14, 2019 4:35 pm

I know this concept in general has been discussed ad nauseam, but there's one aspect I haven't seen covered, and that is timing (I know, BHs don't like to talk about timing!)

I've retired (early), and there is a standing offer from Megacorp to take my (small) non-COLA pension as a lump sum.  The only number that Megacorp guarantees is the monthly, individual/no survivorship payment which would begin in the year I turn 65 (2027), which I'll just call $1000/mo.  That number was etched in stone the day I retired, and will never change.  Every other option I have - a lump sum today, a lump sum 5 or 8 years from now, a joint life annuity, etc. - is calculated from that $1000 using actuarial tables, estimates of future interest rates, etc.  The pension seems to be pretty well funded, and Megacorp has no immediate risks of going out of business.  The pension would probably be 10-15% of my retirement income.

I'd really like to take  lump sum at some point, for reasons many have pointed out - a run of inflation could render it nearly worthless, early death could make it completely worthless, Megacorp could have troubles, etc.  The issue is that the lump sum amount is not all that attractive, and it tends to fluctuate with interest rates.  For example, as the Fed was recently increasing the interest rate, the lump sum offer was decreasing.  (This makes sense - with a higher interest rate, the NPV of the $1000/mo is lower).  Now that rates are dropping, I have noticed an uptick in the lump sum.

If I compare the cost today to buy an individual annuity, to the lump sum offered by Megacorp,  MC is only offering ~75% of what the annuity is worth. 
If I look at the IRR, it looks as though leaving the lump sum on the table and taking the future pension works out to an rate of return of 4.6% (assuming I live to be 85),  which sounds better than I could do for a low-risk investment.

Any thoughts, or other ways I should be looking at this?  I've left the lump sum offer untouched for several years now, but now that interest rates are headed down it might be a good time to take it.  If we see a future inflationary period between now and when I die, two things are going to happen: (1) the real value of that $1000/mo is going to drop, faster than my other investments and (2) the amount that the company is willing to pay as a lump sum is going to drop, as well.

Thanks,

FireAway

123
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Re: Yet another pension vs lump sum Q, with a twist

Post by 123 » Thu Nov 14, 2019 4:48 pm

I was in a similar position with a pension and opted for the lump-sum after monitoring the changes in cash value (based on those interest rates established by the IRS). I was comfortable taking the lump sum because of the two issues you cited, mortality and inflation. The simple "break even" point on the monthly benefit was between 12 and 13 years (seemed even longer since I would have to wait out my first month of eligibility). I decided to eliminate the risk of mortality and inflation to the extent that I could be taking the lump sum (rollover into IRA). YMMV
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Watty
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Re: Yet another pension vs lump sum Q, with a twist

Post by Watty » Thu Nov 14, 2019 5:05 pm

FireAway wrote:
Thu Nov 14, 2019 4:35 pm
Any thoughts, or other ways I should be looking at this?
A couple couple of things to consider.

1) It would be good for you and your spouse to have a good physical to find out if your have any health issues that might impact your life expectancy.

2) Find out what happens to the money if you both die before starting the pension. In many cases your estate would not get anything .

3)The lump sum option may not always exist. I had a small cash balance pension from an old pension plan that was discontinued. There was about five years when I could not take the a lump sum because the pension funding numbers were below a certain percentage. When the percentage got better they started allowing the lump sum again.

4) You can get a suggested claiming strategy for Social Security here.

https://opensocialsecurity.com/

The lump sum might come in handy to fund your retirement until you start Social Security later to get a larger Social Security check. That is in essence buying an inflation adjusted government annuity that might be better than anything you could buy.

5) Turn the question around and ask, "I have $X in an IRA, should I buy a deferred annuity that starts in 2027 and will pay me a non-inflation adjusted $1,000 a month?" That is really the same question but it sounds less tempting to me than just keeping the pension option.

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FireAway
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Re: Yet another pension vs lump sum Q, with a twist

Post by FireAway » Thu Nov 14, 2019 7:45 pm

Watty wrote:
Thu Nov 14, 2019 5:05 pm

A couple couple of things to consider.
2) Find out what happens to the money if you both die before starting the pension. In many cases your estate would not get anything .
Yeah, there would be nothing. Of course I wouldn't need it then :), but it would be nice to leave it for my children.
Watty wrote:
Thu Nov 14, 2019 5:05 pm
The lump sum might come in handy to fund your retirement until you start Social Security later to get a larger Social Security check. That is in essence buying an inflation adjusted government annuity that might be better than anything you could buy.
I don't plan to draw SS until age 70, with or without the pension, so that's not an issue.
Watty wrote:
Thu Nov 14, 2019 5:05 pm
5) Turn the question around and ask, "I have $X in an IRA, should I buy a deferred annuity that starts in 2027 and will pay me a non-inflation adjusted $1,000 a month?" That is really the same question but it sounds less tempting to me than just keeping the pension option.
OK. To buy a $1000 deferred (single) annuity would cost $153K. But, the lump sum being offered is only 110K. Would I spend $153K to buy the annuity? Probably not, because I don't like the idea of non-COLA annuities; I'd rather hold onto and manage the money myself. But would I buy the $1000 annuity if it were available for $110K (which, really, is the option I have today)? Well, now it sounds more attractive. But I still have to depend on low expected inflation rates (and longevity) in order to make this advantageous. So I still don't know :?

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Stinky
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Re: Yet another pension vs lump sum Q, with a twist

Post by Stinky » Fri Nov 15, 2019 9:20 am

FireAway wrote:
Thu Nov 14, 2019 7:45 pm
Watty wrote:
Thu Nov 14, 2019 5:05 pm

A couple couple of things to consider.
2) Find out what happens to the money if you both die before starting the pension. In many cases your estate would not get anything .
Yeah, there would be nothing. Of course I wouldn't need it then :), but it would be nice to leave it for my children.
OP, you've answered your own question. While the risk of your death between now and 2027 is not very large, it is still a possibility.

Take the lump sum now. Invest it long-term as a part of your overall asset allocation.
It's a GREAT day to be alive - Travis Tritt

NoblesvilleIN
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Re: Yet another pension vs lump sum Q, with a twist

Post by NoblesvilleIN » Fri Nov 15, 2019 9:56 am

I have a small pension from a company (megacorp, pension seems well funded) that I left over 20 years ago. I plan to start taking the pension at 65, when it maxes out - in 3.5 years. Over the last 20+ years, I have received a few lump sum offers that didn't seem like such a good deal - similar to what you are seeing. I probably should have evaluated them by seeing what a deferred annuity at age 65 for the lump sum would have paid me. Instead, I multiplied the lump sum by .04 (4% SWR) and looked at that amount. It was nowhere near what I would have received from keeping the pension.

You might consider taking the lump sum, increasing it by a relatively low annual growth rate - say 3% to 2027 and then seeing what a 4% SWR would give you.

Another thing to consider is that you don't have to manage a pension, that is the company's problem. It gives you another source of income at 65 that is guaranteed (as much as any pension is) regardless of what the stock market is doing. This might let you sleep better if your investments are down early in your retirement.

Topic Author
FireAway
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Re: Yet another pension vs lump sum Q, with a twist

Post by FireAway » Fri Nov 15, 2019 11:05 am

NoblesvilleIN wrote:
Fri Nov 15, 2019 9:56 am
You might consider taking the lump sum, increasing it by a relatively low annual growth rate - say 3% to 2027 and then seeing what a 4% SWR would give you.
Well, see, there's the rub, the 'twist' referred to in the subject: I've done the rate of return calculations, and IF I believe that inflation will maintain its current, low rate well into the future, then it absolutely makes more sense, dollar-wise, to take the pension. However, if we get into inflationary times again, then my money will do better being managed by me. But by that time, it will be too late to take the lump sum, because the lump sum payout value will have dropped to 'price in' the higher interest rates. I either need to trust that low inflation rates are here to stay (and opt for the pension), or take the lump sum BEFORE there's a hint of runaway inflation in the air.

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