How do I decide this pension option?

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whyme
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How do I decide this pension option?

Post by whyme »

I am a teacher in California. In addition to a pension, at retirement I will have a small "defined benefit supplement" account. Assuming that I retire at 65, that account will contain about $19,035 pre-tax dollars. I would appreciate advice on how to evaluate the options below.

I could:

1. Roll the money into a traditional IRA. (This would be mixed with my other assets, about 70/30 stock/bond, low cost index funds.)

2. Take a "period-certain annuity." My understanding is this would be a fixed amount, with no COLA or other increase.

Here are the options and the monthly payouts:

3 years: $586/mo
5 years: $375/mo
10 years: $219/mo

and one period-uncertain option: $136/month for life.

The amount isn't life changing, but I'd like to understand how to best evaluate the value of this sum given the various methods of deploying it. Thanks in advance for any insights.
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dmcmahon
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Re: How do I decide this pension option?

Post by dmcmahon »

If you’re familiar with the concept of Net Present Value, you might evaluate the period-certain options with this:

https://financialmentor.com/calculator/ ... calculator

I get an implied interest rate of 7% for the period-certain annuities. You’d have to use annuity tables to evaluate the life annuity. Please double-check me, I’m not 100% certain of those figures, my trusty HP-12C is not handy. 7% is not a bad rate of return these days - if you took the $19k you’d have trouble beating it without taking more risk than you likely have with the payor of the annuity. JMHO.
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whyme
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Re: How do I decide this pension option?

Post by whyme »

Thanks! So, to use that NPV calculator, do I enter an assumed inflation rate in the "interest" slot?
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dmcmahon
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Re: How do I decide this pension option?

Post by dmcmahon »

whyme wrote: Wed Dec 04, 2019 9:59 pm Thanks! So, to use that NPV calculator, do I enter an assumed inflation rate in the "interest" slot?
A better calculator would give you the IRR (internal rate of return) from the inputs of the monthly payment and the $19k initial sum. With that calculator you have to guess at the IRR and see if the NPV is close to $19k. Try using 7% and you’ll see what I mean.

What it’s telling me (which could be wrong) is that if I had $19k cash, and someone offered me any of those period-certain payment options in exchange for my $19k, the rate of interest Implied by the stream of payments is 7%. If you could earn 7% on a bond of equivalent risk, you’d be somewhat indifferent as to either choice. This neglects tax effects, if any. I assume taking the $19k in a single year might involve a higher tax rate up front, but the payments could come to you at a lower rate, or at least at the same tax rate.
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big bang
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Re: How do I decide this pension option?

Post by big bang »

My suggestion will be to roll it to an IRA. This way you do not pay taxes immediately, it stays invested till the time that you need the money. When the time comes you can decide how much to withdraw.
(1) save a lot, (2) select an asset allocation containing both stock and bond asset classes, (3) buy low cost, widely diversified funds, (4) allocate funds tax-efficiently, and (5) stay the course.
anonenigma
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Re: How do I decide this pension option?

Post by anonenigma »

I chose the same option for the DBS as for the base pension: life plus 75% survivor. The money arrives monthly without having to think about it.
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Watty
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Re: How do I decide this pension option?

Post by Watty »

whyme wrote: Wed Dec 04, 2019 8:55 pm I would appreciate advice on how to evaluate the options below.
One of the first things I would do would be to check to see how much of an annuity you could buy with the $19K. You can check that here.

https://www.immediateannuities.com/

The 19K may be too small to get a quote but you can just multiply that by 10 and use $190,350. You would then divide the monthly number by 10.

What you are looking for is that sometimes government pensions can be a lot higher than an annuity that you could buy yourself which could make them too good a choice to not take.

I also like to turn this question around and ask, "I have $19,035 in an IRA, should I buy an annuity that has one of those options?"

The annuity options may sound less appealing when you look like it that way.

Buying carefully selected Single Premium Immediate Annuity(SPIA) can be a valid part of a retirement plan so there is nothing inherently wrong with them but when does make sense you then have to ask yourself when to buy it. Some people buy them when they are in their late 70 since there will be less time for inflation to be a problem and the payment is higher because you will be collecting it for fewer years.

One option would be to take the lump sum then invest it for 10+ years and then buy an annuity when you are in your 70s when the lump sum has grown. In ten years interest rates could be higher which would also make the monthly payment higher.
Valuethinker
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Re: How do I decide this pension option?

Post by Valuethinker »

whyme wrote: Wed Dec 04, 2019 8:55 pm I am a teacher in California. In addition to a pension, at retirement I will have a small "defined benefit supplement" account. Assuming that I retire at 65, that account will contain about $19,035 pre-tax dollars. I would appreciate advice on how to evaluate the options below.

I could:

1. Roll the money into a traditional IRA. (This would be mixed with my other assets, about 70/30 stock/bond, low cost index funds.)

2. Take a "period-certain annuity." My understanding is this would be a fixed amount, with no COLA or other increase.

Here are the options and the monthly payouts:

3 years: $586/mo
5 years: $375/mo
10 years: $219/mo

and one period-uncertain option: $136/month for life.

The amount isn't life changing, but I'd like to understand how to best evaluate the value of this sum given the various methods of deploying it. Thanks in advance for any insights.
I am trying to understand the benefit.

For period certain annuity is that:

- the number of years for which you get the benefit? Zero after that? That's how the pattern of payments reads

- you get the benefit until you die, but if you die before the end of the period your estate is guaranteed that many years - ie if I die 18 months in, on the 10 year option my estate would get a further 8.5 years of payments?


The whole point of annuities is that they provide longevity insurance - you cannot outlive them. The former interpretation (the first one) means no longevity insurance. Unless the projected return is terribly attractive, I'd rather have the lump sum to invest.
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Stinky
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Re: How do I decide this pension option?

Post by Stinky »

dmcmahon wrote: Wed Dec 04, 2019 10:17 pm
whyme wrote: Wed Dec 04, 2019 9:59 pm Thanks! So, to use that NPV calculator, do I enter an assumed inflation rate in the "interest" slot?
A better calculator would give you the IRR (internal rate of return) from the inputs of the monthly payment and the $19k initial sum. With that calculator you have to guess at the IRR and see if the NPV is close to $19k. Try using 7% and you’ll see what I mean.

What it’s telling me (which could be wrong) is that if I had $19k cash, and someone offered me any of those period-certain payment options in exchange for my $19k, the rate of interest Implied by the stream of payments is 7%. If you could earn 7% on a bond of equivalent risk, you’d be somewhat indifferent as to either choice. This neglects tax effects, if any. I assume taking the $19k in a single year might involve a higher tax rate up front, but the payments could come to you at a lower rate, or at least at the same tax rate.
I agree with the 7% rate on the period certain options. That's certainly an attractive rate of interest.

If it were me, I would probably take a period certain option, and then invest the monthly payments according to my asset allocation. You can decide how long you want to stretch the payments out. You will pay taxes as you get the funds.

But I wouldn't disagree if you wanted to roll into your IRA.
It's a GREAT day to be alive - Travis Tritt
Topic Author
whyme
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Re: How do I decide this pension option?

Post by whyme »

Valuethinker wrote: Thu Dec 05, 2019 6:49 am
I am trying to understand the benefit.

For period certain annuity is that:

- the number of years for which you get the benefit? Zero after that?
That's how I understand it, yes. Basically, it's a choice between payout at once via lump sum, payout monthly over a fixed period of years or a small monthly lifetime annuity payment.

I'm not sure what happens if I die before the fixed payout period ends, I suppose I should look into that if I want to cover all of the bases.
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Stinky
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Re: How do I decide this pension option?

Post by Stinky »

whyme wrote: Thu Dec 05, 2019 1:37 pm
I'm not sure what happens if I die before the fixed payout period ends, I suppose I should look into that if I want to cover all of the bases.
If you name a beneficiary, it would go to them. If no beneficiary, then to your estate.

After your death, the insurer might offer a commuted present value of future payments. But I wouldn't count on it.
It's a GREAT day to be alive - Travis Tritt
anonenigma
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Re: How do I decide this pension option?

Post by anonenigma »

Ten-year payout will total $26,280. At $136 per month for the lifetime annuity, it will take 194 months (16 years) to equal that. The question, then, is how long you expect to live. If you live into your 80s, the lifetime annuity is the better deal. At 65, average life expectancy for an American man is 19 years. For a woman, it's 22 years.

I decided to bet on longevity and also protect my wife with a survivor benefit.

You don't mention your age, but interest is applied to the DBS annually during your working years. It will also grow as you perform extra activities. You may be looking at more significant numbers if retirement is 20 years in the future.
EZ James
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Re: How do I decide this pension option?

Post by EZ James »

I get an implied interest rate of 7% for the period-certain annuities. You’d have to use annuity tables to evaluate the life annuity. Please double-check me, I’m not 100% certain of those figures, my trusty HP-12C is not handy. 7% is not a bad rate of return these days - if you took the $19k you’d have trouble beating it without taking more risk than you likely have with the payor of the annuity. JMHO.
Top
Punching the numbers into an HP12C clone, this is what I get:

At $586/m x12 = $7032/yr (taken at beginning of year) , for 3 yrs and PV = $-19035
the interest rate would be 11.25 %/yr if compounded yearly. If taken at the end of year, 5.32%/yr.

Changing to 10 yrs at $219/m x12 = $2628/yr the rate would be 8.01% taken at beginning, 6.32% at end.

This could be incorrect. Changing the compounding period would change the numbers and I am not sure how to interpret the numbers for comparison to a purchased annuity.
texasdiver
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Re: How do I decide this pension option?

Post by texasdiver »

Are you married and do you have heirs that you care about and want to leave a legacy?

My understanding is that CA teacher's pensions are relatively generous compared to those in other states. But they do end upon your death and that of your spouse if you adopt the dual survivor benefit option.

On the other hand, IRAs, 401k accounts and so forth can be passed down to your heirs.

If your retirement savings is heavily tilted towards pension and you want to leave any sort of legacy that would argue towards the lump sum.
If the bulk of your retirement savings is in personal retirement accounts and you want more security that would argue towards the pension.

Put another way, what you do really need more of at this point? more pension or more individual savings? That could influence which way you go, assuming the decision is reasonably equivalent in actuarial terms.
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Stinky
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Re: How do I decide this pension option?

Post by Stinky »

EZ James wrote: Thu Dec 05, 2019 3:23 pm
I get an implied interest rate of 7% for the period-certain annuities. You’d have to use annuity tables to evaluate the life annuity. Please double-check me, I’m not 100% certain of those figures, my trusty HP-12C is not handy. 7% is not a bad rate of return these days - if you took the $19k you’d have trouble beating it without taking more risk than you likely have with the payor of the annuity. JMHO.
Top
Punching the numbers into an HP12C clone, this is what I get:

At $586/m x12 = $7032/yr (taken at beginning of year) , for 3 yrs and PV = $-19035
the interest rate would be 11.25 %/yr if compounded yearly. If taken at the end of year, 5.32%/yr.

Changing to 10 yrs at $219/m x12 = $2628/yr the rate would be 8.01% taken at beginning, 6.32% at end.

This could be incorrect. Changing the compounding period would change the numbers and I am not sure how to interpret the numbers for comparison to a purchased annuity.
Payments would be received monthly, not at the beginning or end of the year.

Using your trusty calculator, you could put in $586 for 36 periods, and you'll find that the discount rate to get to a $19k current value is close to 7% / 12.
It's a GREAT day to be alive - Travis Tritt
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dmcmahon
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Re: How do I decide this pension option?

Post by dmcmahon »

EZ James wrote: Thu Dec 05, 2019 3:23 pm
I get an implied interest rate of 7% for the period-certain annuities. You’d have to use annuity tables to evaluate the life annuity. Please double-check me, I’m not 100% certain of those figures, my trusty HP-12C is not handy. 7% is not a bad rate of return these days - if you took the $19k you’d have trouble beating it without taking more risk than you likely have with the payor of the annuity. JMHO.
Top
Punching the numbers into an HP12C clone, this is what I get:

At $586/m x12 = $7032/yr (taken at beginning of year) , for 3 yrs and PV = $-19035
the interest rate would be 11.25 %/yr if compounded yearly. If taken at the end of year, 5.32%/yr.

Changing to 10 yrs at $219/m x12 = $2628/yr the rate would be 8.01% taken at beginning, 6.32% at end.

This could be incorrect. Changing the compounding period would change the numbers and I am not sure how to interpret the numbers for comparison to a purchased annuity.
You have to use monthly compounding since that's what the payments are. Stinky seems to confirm my 7% number. 7% is pretty darned good - if it were me I'd take the 5-year or 10-year payout, assuming the payor is one you have confidence in for those time periods.
Topic Author
whyme
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Re: How do I decide this pension option?

Post by whyme »

Thanks to everyone for the replies. I will likely take one of the fixed-term options, since it seems like a reasonable offer: this will be particularly tempting if I do retire around 65, as it could fill in a stream of income between then and my (very tiny, windfall eliminated) Social Security payment beginning at 70.

In response to some of your questions, should anyone like to take this discussion further:

* I am near retirement age, my best guess is that I'll retire in two or three years. (As a tenured faculty member, I'm in the fortunate position of choosing when to retire.)
* Single, no kids, leaving money behind is desirable but not essential.
* I expect a pension that will replace 40 - 45% of my current salary (purchasing power will erode over time, but there is a mechanism to supplement payments if the PP drops below 85% of the original PP). The Social Security I'll claim at 70 will provide something like 5 -10% of current salary.
* I have invested assets (most in tax-deferred accounts) that I will use to supplement the above. Right now, I think my investments could produce 30-35% of salary replacement.
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