Help w/ odd Lump Sum vs Fixed Payment COLA'd Pension problem

[nsharp]

I am retiring soon and I am having trouble evaluating between the lump sum rollover and the fixed payment options of my pension.

Lump Sum:

As an example, the lump sum that would be taken is $30,000. I would like to assume that I could rollover that amount and realize an 8-10% annual rate of return from an investment portfolio.

Fixed Payment:

As an example, the alternative fixed payment allows $2400/yr for my life and $1800/yr (75%) for my spouse after my death. This option does have a COLA; however, the COLA doesn't kick in until after 5 years, at which point it's 3% annually.

Life Expectancy Assumptions: Let's assume that I live for 15 years after retirement, and that my wife will survive me by 20 years.


So, which is better? The one element I have the most trouble evaluating is
the 3% COLA after 5 years. I know this is of significant value, but I am
not sure what it drives the break even investment earnings point up to.

I would appreciate any ideas. Thanks for your consideration!

 

[haha]

I am retiring soon and I am having trouble evaluating between the lump sum rollover and the fixed payment options of my pension.

Lump Sum:

As an example, the lump sum that would be taken is $30,000. I would like to assume that I could rollover that amount and realize an 8-10% annual rate of return from an investment portfolio.

Fixed Payment:

As an example, the alternative fixed payment allows $2400/yr for my life and $1800/yr (75%) for my spouse after my death. This option does have a COLA; however, the COLA doesn't kick in until after 5 years, at which point it's 3% annually.

Life Expectancy Assumptions: Let's assume that I live for 15 years after retirement, and that my wife will survive me by 20 years.


So, which is better? The one element I have the most trouble evaluating is
the 3% COLA after 5 years. I know this is of significant value, but I am
not sure what it drives the break even investment earnings point up to.

I would appreciate any ideas. Thanks for your consideration!

This is complicated to do rigorously. A quick and dirty way to know about where you are would be to get an annuity quote for you only with no COLA. If it is anywhere close to $30,000 to provide the $2400 benefit, you know that the pension is a winner.

If it the annuity quote is meaningfully cheaper to produce that $2400 fixed benefit, then you have to do more work. But the 3% COLA, even delayed, and the 75% survivor benefit is actually worth a lot. My of the cuff guess is that this pension is a pretty good deal, provided you think the company will continue to pay it. Incidentally, your discount rate is too high. Probably you should limit yourself to 5% or so when you calculate how much you can withdraw with at least some inflation adjustment.

Ha

 

[W2R]

I am retiring soon and I am having trouble evaluating between the lump sum rollover and the fixed payment options of my pension.

Lump Sum:

As an example, the lump sum that would be taken is $30,000. I would like to assume that I could rollover that amount and realize an 8-10% annual rate of return from an investment portfolio.

Fixed Payment:

As an example, the alternative fixed payment allows $2400/yr for my life and $1800/yr (75%) for my spouse after my death. This option does have a COLA; however, the COLA doesn't kick in until after 5 years, at which point it's 3% annually.

Life Expectancy Assumptions: Let's assume that I live for 15 years after retirement, and that my wife will survive me by 20 years.


So, which is better? The one element I have the most trouble evaluating is
the 3% COLA after 5 years. I know this is of significant value, but I am
not sure what it drives the break even investment earnings point up to.

I would appreciate any ideas. Thanks for your consideration!

Well, you could get a rough estimate by dividing your computations into two parts.

(1) Consider the first five years, and what your lump sum payment would earn for you during that time, less the fixed payments and what they would earn for you for the various lengths of time you have them. From these computations, you can get a rough estimate an equivalent lump sum hypothetically given to you on year 5.

(2) Consider year 5 onwards, using the equivalent lump sum you computed above. Subtract 3% from your earnings on the lump sum.

This wouldn't give an exact, to-the-penny analysis but that is what I would do in your position as a first attack on the problem. But then I do love fiddling with numbers and making estimates. Probably Ha's idea is the best first approach!

 

[Moemg]

I would like to assume that I could rollover that amount and realize an 8-10% annual rate of return from an investment portfolio.

I don't think you can assume 8-10% anymore . 30,000 at 4% withdrawal is $1200 so you are already ahead . Plus the security of a pension no matter how small is nice to have .

 

[Independent]

I am retiring soon and I am having trouble evaluating between the lump sum rollover and the fixed payment options of my pension.

Lump Sum:

As an example, the lump sum that would be taken is $30,000. I would like to assume that I could rollover that amount and realize an 8-10% annual rate of return from an investment portfolio.

Fixed Payment:

As an example, the alternative fixed payment allows $2400/yr for my life and $1800/yr (75%) for my spouse after my death. This option does have a COLA; however, the COLA doesn't kick in until after 5 years, at which point it's 3% annually.

Life Expectancy Assumptions: Let's assume that I live for 15 years after retirement, and that my wife will survive me by 20 years.


So, which is better? The one element I have the most trouble evaluating is
the 3% COLA after 5 years. I know this is of significant value, but I am
not sure what it drives the break even investment earnings point up to.

I would appreciate any ideas. Thanks for your consideration!

If I'm reading this correctly, it seems that a simple Excel spreadsheet answers your question. Set up a column of benefits that looks like this: $2,400 per year for the first 5 years. Then increase by 3% each year for 10 years (going from $2,472 to $3,225). Then increase by 3% and decrease by 25% in the next year (to $2,492). Then increase by 3% annually. The last number is $4,369 in the 35th year.

Now treat those amounts as withdrawals from a fund that starts at $30,000 and earns 8% per year. With all those assumptions the fund has year-end balances of: First year, $29,906 ; 15th year, $21,700 ; 26th year, $1,534 ; 35th year, negative $46,700.

So the fund can't cover the fixed payment for the entire 35 years.

At 10% interest, the fund does much better, ending at a positive $79,774. By coincidence, the breakeven rate is very close to 9%.

Doing the math reminds you how sensitive the result is to the interest rate you choose. Like others above, I'd think that if you need a constant 9% to match the fixed payment, then you're better off with the fixed payment.

A couple notes on the method: 1) You didn't give actual ages. I don't know if there is a 50% chance of your wife living another 35 years, or a 2% chance. That could make a difference.
2) You didn't say how important this money is to you. If this is part of your "must have in order to buy groceries money", then the lifetime guarantee in the fixed payment becomes more important. The calc I did assumes this is "fun" money or estate, and all you care about is maximizing it.

A couple caveats on the math: 1) I assumed a single withdrawal each year at the middle of the year, 2) I assumed the 3% increases were compounded, they could be uniform amounts, and 3) I've been known to make stupid errors when doing simple math. Don't take my word for it, check the numbers.