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Annuity or Lump Sum - still confused
Old 02-04-2012, 10:22 AM   #1
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Annuity or Lump Sum - still confused

I am new to this forum, been reading a lot and still have questions about whether take a lump sum or annuity from my company.

The numbers. I am 56, wife 56 and I am about to retire. The company I work for (Megacorp) offers a “cash balance pension plan”. The cash balance is $676,111 which I can roll into an IRA. If I take an annuity starting April 2012, the single life annuity would be 3,684/month and 100% Joint and Survivor would be 3,380/month. No COLA. This seems like a decent payout, with single life annual payout at 6.54% of lump sum value.

What I’m confused about is how to weigh all the other factors. Here are some factors I can think of, but I am probably missing others.

Longevity. We are in good health and longevity runs in my family and in my wife’s family. This would favor annuity.

Annuity risk. Megacorp is in an industry rife with mergers and acquisitions. Megacorp may proper and acquire other companies, but an equally possible scenario is that things will go poorly and Megacorp and will have to merge or be acquired. What happens to the annuity if the company gets acquired? How do I determine the funding level and risk of losing all or part of the annuity?

Portfolio size. I have a decent portfolio including 401k, deferred comp and a taxable account. Adding the lump sum would create a portfolio large enough to retire on using a 3.5% SWR to meet required expenses. Does this scenario favor lump sum or annuity?

Taxes. If I start taking the annuity now then I have to pay taxes on that money now. I don’t need a pension now as I have other assets to live on. So that would seem to point to rolling over lump sum into IRA, correct?

Any advice or other factors I should consider?
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Old 02-04-2012, 10:34 AM   #2
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When DH faced this decision we chose the lump sum. One factor was that his pension if he chose that was large enough that if the Pension Guaranty Fund ever kicked in he would not get the full amount. Also while he could select an option for me to 100% of the benefit if he died the Pension Guaranty Fund only pays 50% to a surviving spouse.

We also liked the greater flexibility of the lump sum and felt that if wee chose that we could always buy an annuity later on if we wanted to.
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Old 02-04-2012, 10:45 AM   #3
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My former company offered the lump or a commercial annuity (think SPIA) through an external vendor that was not tied to the company. There was no defined benefit plan (e.g. pension).

After my own investigation, I found an SPIA that was better suited to our situation and desired options (no 50% reduction on death of either spouse, along with guaranteed minimum payout period) along with also paying a slightly better rate, than was being offered by my former employer, even with our desired "options".

I took the lump, purchased the SPIA with a portion and put the rest in my retirement cash bucket (for ongoing expenses).

Almost five years later, we have no regrets with our decision to "go it alone".

Just our personal situation on your immediate decision to be made. BTW, the SPIA works out well and we intend to purchase additional policies as we age...
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Old 02-04-2012, 10:48 AM   #4
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I faced the same decision about 8 months ago, though about 1/3rd the scale and an almost trivial amount of total assets. It appears you have all the bases well covered, all I can do is share the thoughts that led to my decision. I took the lump sum and rolled it into an IRA without hesitation.

1) The cash balance/lump sum should be the same as an annuity that provides the same income and provisions as your pension (more in 3 below). So I first got quotes on annuities and indeed found the cost to be almost exactly the same as my company lump sum. [If the lump sum in considerably less, I’d be asking my company some questions as to why first. If it's indeed significantly less, taking the monthly pension might be the better option.]

2) With interest rates currently so low, annuities are “expensive” right now, and lump sums should be relatively high as a result due to 1). When interest rates increase, and they certainly will IMO, an annuity providing the same income will be less expensive. So I was comfortable taking the lump sum now, with the expectation that I could buy an annuity (if necessary) to provide the same income for less later, and pocket the difference (and hopefully any investment return on the lump sum) in the meantime. This all assumes you have faith in future investment returns, I do.

3) I was also concerned about how my former Megacorp would fare in the decades ahead. But I asked and they don’t actually handle the funds when someone retires anyway. They simply buy an annuity on behalf of the retiree (sounds like your situation), so the only issue is the solvency of the annuity provider, the former Megacorp is out of the picture entirely.

By taking the lump sum now, I can always "buy a pension" later, so I haven't closed the door on that option - makes the even decision easier. If you take the pension now, there's no turning back, though it may be the right decision for some.

FWIW...
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Old 02-04-2012, 10:52 AM   #5
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IMO the key factor is your estimate of your longevity. Most such plans have very carefully done their math homework to balance the payoff options per actuarial tables. So, if you believe you will live longer than average, opt for the annuity, otherwise opt for the lump sum.
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Old 02-04-2012, 12:06 PM   #6
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On annuity risk, the key question is how the annuity works. It could be that the pension payments are just paid out of the pension fund assets, or that the pension fund buys an annuity from an insurance company that funds the payments but the annuity is owned by the pension plan or that the pension plan uses the lump sum to buy an annuity from an insurance company and washes its hands of the obligation to make pension payments. The last scenario is the best IMO, because the annuity is then only subject to credit risk of the insurer, who is regulated and is backstopped by state guaranty funds. For either of the first two scenarios you would have to look at the funding of the pension plan itself.

In terms of whether the 6.54% is reasonable, you could get quotes for SPIAs from a number of reputable insurers and compare the payments that the lump sum would provide with the annuity option. If the 6.54% is available from other insurers you could always take the lump sum and put it into an IRA and then used the proceeds to by a SPIA now or later and the annuity payments would be taxable when you receive them but the pension plan credit risk would be eliminated.
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Old 02-04-2012, 12:32 PM   #7
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Because of the high cost of an income stream today, I'd take the lump sum and roll it into an IRA. If an SPIA is more attractively priced in the future, I'd consider taking some of it and "buying a pension," so to speak. But I wouldn't take out an annuity any time soon; as long as the Fed's War on Savers continues, buying an annuity for income feels like a bad idea for now.

If I were going to put more money into an SPIA than a state guarantee fund would cover, I'd probably break it up into multiple annuities that are under that threshold.
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Old 02-04-2012, 12:57 PM   #8
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This is a personal preference position, cash is usually King, but I am assuming if you select the annuity option you also get the benefit of the Pension Benefit Guarantee and I feel this additional protection quite valuable insurance for a retiree. The funding level of the pension plan must be reported to you if you ask your plan administrator so you should check on that.

From the quotes I checked there is about a 10% premium on the annual payouts relative to the other plans, so the payout is quite good.
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Old 02-04-2012, 02:52 PM   #9
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FWIW a joint annuity from Buffett's company Berkshire Hathaway (one of the few insurance companies that I trust to be around for 40 years) was only $2538 for the same amount. So that is a large premium relative to the market. As others have said you should understand who is responsible for providing the annuity payments MegaCorp or an insurance company. If it is a insurance company make sure it is a highly rated one.
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Old 02-04-2012, 02:59 PM   #10
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Originally Posted by clifp View Post
FWIW a joint annuity from Buffett's company Berkshire Hathaway (one of the few insurance companies that I trust to be around for 40 years) was only $2538 for the same amount. So that is a large premium relative to the market. As others have said you should understand who is responsible for providing the annuity payments MegaCorp or an insurance company. If it is a insurance company make sure it is a highly rated one.
So with the quote from clifp, if it was me, I'd take the annuity and have my side savings as my non-annuity pile. I like the idea of an annuity for part guarenteed, and part not-annuity so I can pull out a pile if needed for say a new car, trip, whatever. I would probably go with the joint annuity.
Just my $0.02, since you asked.
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Old 02-04-2012, 03:54 PM   #11
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Thanks for all the great advice. I have to admit that I had been leaning to lump sum, but the $3380/month that Megacorp offers for a joint annuity compares pretty favorably to Berkshire at $2538. I also checked immediateannuity.com and they would offer $2974.

I also didn't realize that there are different ways that Megacorp might be handling this. I will check with the plan administrator to see if Megacorp is responsible for the annuity payments or if they transfer the responsibility to an insurance co.

Lots of variables to consider, but I probably can't go too wrong either way given that the experts here seem kind of split.
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Old 02-04-2012, 03:56 PM   #12
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Especially since their annuity payout is considerably higher than it would be in an SPIA at current market rates, it might be worth considering. Still, it would be nice if there were an option to partially annuitize it there and roll over a partial lump sum into an IRA.
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Old 02-04-2012, 04:21 PM   #13
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Originally Posted by clifp View Post
FWIW a joint annuity from Buffett's company Berkshire Hathaway (one of the few insurance companies that I trust to be around for 40 years) was only $2538 for the same amount. So that is a large premium relative to the market. As others have said you should understand who is responsible for providing the annuity payments MegaCorp or an insurance company. If it is a insurance company make sure it is a highly rated one.
Be aware that the SPIA offered from BRK does not accept qualified funds (e.g. tax-deferred) at this time, such as the OP is speaking about which are considered as such with a cash balance plan.

Here's the reference FAQ:
Frequently asked questions

Also, the OP quoted a payout percentage, which is hard to really put in context. Since our joint (life) SPIA is guaranteed for a minimum term, it was easy to compute an actual IRR return, without the impact of an implied larger rate since the insurance company is returning a part of your own money, which will tend to make it look like a better return than actual.

Using the IRR method (assuming a mininimum term), you can not only compute the actual return, but an "improved" return if you live longer than the contract term. In a life policy, the policy should (as our does) continue to pay out till we have both passed, with an actual overall higher total return, year by year.

BTW, the advantage of a guaranteed term is that the remaining SPIA "value" will go to your named beneficiary/estate assuming you (or in a joint policy, both of you) pass before the minimum payout period has been met.

Oh, on your question on taxes (on an SPIA). Yes, you pay taxes, but only on what you receive in total payments for the year. This can be taken care of simply by requesting the company to do a withholding on your payments or you can pay in some other manner. As for ourselves, we pay a bit more taxes on our monthly IRA withdrawls (for retirement income) and don't have the SPIA payments reduced. Works out the same, in either case.
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Old 02-04-2012, 04:32 PM   #14
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The retirement plan for the church my wife is now serving has a 403b with annuitization option upon retirement. For comparative purposes, I entered a $676K lump sum for two 56-year-olds in their annuity calculator.

They would pay $3,171 a month for 100% joint and survivor, and $3,691 for single life annuity, so again it looks like this payout is on the generous side for an annuity purchased today.
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"Hey, for every ten dollars, that's another hour that I have to be in the work place. That's an hour of my life. And my life is a very finite thing. I have only 'x' number of hours left before I'm dead. So how do I want to use these hours of my life? Do I want to use them just spending it on more crap and more stuff, or do I want to start getting a handle on it and using my life more intelligently?" -- Joe Dominguez (1938 - 1997)

RIP to Reemy, my avatar dog (2003 - 9/16/2017)
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Old 02-04-2012, 04:43 PM   #15
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They would pay $3,171 a month for 100% joint and survivor, and $3,691 for single life annuity, so again it looks like this payout is on the generous side for an annuity purchased today.
Don't forget that you are getting funded by the return of your own money, not necessarily due to any interest rate.

Many folks say/think that they will wait until they are older to purchase a vehicle such as an SPIA since they believe they get a higher interest rate. The rate has nothing to do with it since the bulk of the payments will be the return of your own money (preimum paid) over a shorter remaining lifespan.
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Old 02-04-2012, 04:48 PM   #16
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Don't forget that you are getting funded by the return of your own money, not necessarily due to any interest rate.

Many folks say/think that they will wait until they are older to purchase a vehicle such as an SPIA since they believe they get a higher interest rate. The rate has nothing to do with it since the bulk of the payments will be the return of your own money (preimum paid) over a shorter remaining lifespan.
Some of it, sure, But the younger you start, the more it is influenced by prevailing interest rates and the more the payments will be attributable to interest than to return of capital. If you start an annuity at 75, a lot more of the payout is return of capital than it would be if you start it at 55.

The Berkshire Hathaway calculator actually shows (for SPIA purchases with after-tax money) how much of each monthly payment is considered tax-free return of capital and how much is taxable income.
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"Hey, for every ten dollars, that's another hour that I have to be in the work place. That's an hour of my life. And my life is a very finite thing. I have only 'x' number of hours left before I'm dead. So how do I want to use these hours of my life? Do I want to use them just spending it on more crap and more stuff, or do I want to start getting a handle on it and using my life more intelligently?" -- Joe Dominguez (1938 - 1997)

RIP to Reemy, my avatar dog (2003 - 9/16/2017)
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Old 02-04-2012, 04:50 PM   #17
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I will check with the plan administrator to see if Megacorp is responsible for the annuity payments or if they transfer the responsibility to an insurance co.
Now you're talking!
Investigate all aspects thoroughly and be an informed decision maker.
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Old 02-04-2012, 04:55 PM   #18
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Some of it, sure, But the younger you start, the more it is influenced by prevailing interest rates and the more the payments will be attributable to interest than to return of capital.
Agreed.

Just for comparison purposes, the SPIA we purchased in mid-2007 has an IRR rate of 4.79% for a 28-year guaranteed period.

That's when interest rates were a bit higher than today and does not include any return of preimum in the monthly payments.

Just a real-life FYI...
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Old 02-04-2012, 09:20 PM   #19
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I had to make this same choice when I retired from my megacorp a year ago. If the Govt. (Dept. of Labor) hadn't changed the way companies were required to use to compute lump sum, I would have gone lump sum. I played it conservative, and went with the monthly payment/annuity. Not being married played into that decision, the existence of the PBGC was a factor (for how long, who knows), already having a large chunk of taxable 401k and IRA funds was a factor, my megacorp pension plan was at 1.04 for fuding (pretty solid for a plan that had been terminated/closed and replaced (withwhatever they call it - defined cash benefits? can't remember) plus being a little annoyed knowing my Lump Sum would have been almost $100k more under the old pre 2010 T-bill basis instead of corp bond rates basis was another factor. Only time will tell whether it was the right decsion.
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Old 02-04-2012, 09:35 PM   #20
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BTW _ I'm still confused, looks like most people took the lump sum. I kind of wished I had the 50/50 option (lump sum/monthly annuity) some mega corps offer or used to offer anyway.

I guess we are lucky just to have had the choice.
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