Lump sum of 500K or $3500 PM @ age 65

[MN_1021]

I am still trying to find a lump sum retirement number from my HR (without giving them any hints that I dream ER @ 55). Here is my story:

42 years old and plan to retire at 55. Questions (primarily for planning purpose):

When I retire at 55 and if my employer offers me a lumpsum of 500K (it will be approx. this amount) or a $3500 PM starting at 65 with COLA- which one should I take and why?

Thanks in advance!

 

[Tom52]

If it were me it would depend on what other retirement investments I would have in addition to the lump sum/pension offer. If I already had a lot of retirement investments I would probably take a lump sum and invest it.

There are certainly other considerations, a COLA is good but how solid is the pension, is it well funded? Are you married and is there a option for her if she outlives you? Do you have children that you want to leave an inheritance? Really need more details.

 

[nun]

I am still trying to find a lump sum retirement number from my HR (without giving them any hints that I dream ER @ 55). Here is my story:

42 years old and plan to retire at 55. Questions (primarily for planning purpose):

When I retire at 55 and if my employer offers me a lumpsum of 500K (it will be approx. this amount) or a $3500 PM starting at 65 with COLA- which one should I take and why?

Thanks in advance!

If we assume you live to 85 (average for someone age 65, a year less for a man and year longer for a woman) and that COLA is 2%. Then if you take the $500k at age 55, invest it and start taking $3500/month from it at age 65 you need to average an annual 3.3% return to equal the income from the pension. If you can give us the lump sum you'd expect at age 65 we could calculate the discount rate on the pension, but as it stands if you think you can get better than 3.3% and are ok without the longevity risk insurance aspect of the pension then take the lump sum. But you should have other funds to span the gap from age 55 to 65.

 

[nash031]

Lots of factors:

- Do you need the money at 55?
- How long do you expect to live/any immediate medical concerns?
- How would you invest the lump sum?
- What do the rest of your assets look like? Do you have significant monthly income elsewhere or are you relying solely on sale of invested assets to generate income? Social Security?

The longer you live, the more valuable the COLA pension. Obviously, if you have a family history of early demise for your gender, or you have an individual medical condition which might limit your life expectancy, the lump sum becomes more attractive.

Some quick, crude back of the napkin calculations show that someplace around 15 years (age 80) may be the crossover point where the pension becomes more valuable, but as nun pointed out, that depends largely on how the lump sum is invested and the assumptions you make regarding the pension itself. I like to model my (expected) pension as an equivalent annuity and compare value that way, but others like to make it a portion of their portfolio based on their preferred withdrawal rate and see what the equivalence would be.

As nun said, generally the pension provides longevity insurance. If you think you need it, that's the way to go. If not, you can possibly/probably(?) do better with the lump sum.

But it's really an impossible question to answer on limited information, and there's a different answer appropriate for each individual situation.

 

[DrRoy]

The pension payout rate is 8.4% of the lump sum. That is better than any annuity you could get and will last for life. Well worth considering.

 

[marko]

My main question is how solid the pension provider is.
A lot can happen to a pension plan over a 30-40 year period.

 

[nun]

The pension payout rate is 8.4% of the lump sum. That is better than any annuity you could get and will last for life. Well worth considering.

The payout is at age 55 and the pension starts at age 65 so you have to compound the payout to age 65 to do an honest comparison. If we use a number like 5% to compound $500k over 10 years we get $814k and the payout rate then would be around 4.7%......which is sensible.

 

[Finance Dave]

If we assume you live to 85 (average for someone age 65, a year less for a man and year longer for a woman) and that COLA is 2%. Then if you take the $500k at age 55, invest it and start taking $3500/month from it at age 65 you need to average an annual 3.3% return to equal the income from the pension. If you can give us the lump sum you'd expect at age 65 we could calculate the discount rate on the pension, but as it stands if you think you can get better than 3.3% and are ok without the longevity risk insurance aspect of the pension then take the lump sum. But you should have other funds to span the gap from age 55 to 65.

This is the way I'd look at it too...run two present value calculations. One will be the lump sum, the other will be a stream of $3,500 payments discounted at some rate...play with the rate or make an assumption.

One other consideration though...I think it's always good to have SOME money set aside that can NEVER run out...in case you live to 105. Maybe it's a small amount so you can at least eat and stay warm...but if you have no other funds that will serve this purpose...maybe this can be it.

 

[pb4uski]

Here is a way that I would look at it... if you live to certain ages then what is your "return" and do you expect that you can earn that return investing it yourself. In your case the returns are real returns since the pension benefits are COLA adjusted (assuming that COLA and inflation are about the same).

For the purpose I assumed the worst case... that if you die before you begin benefits that you get nothing (don't know if you are married or not or what the survivorship benefits are if you die before or after benefits begin).

So if the benefits were joint then I would wait and take the pension since I think it is likely that either DW or I will live to our early 90s and I don't think I could beat a 3-4% annual real return over 35 years but it might be a close call.

Age	Cash flow	IRR
55	(500,000)	-100.0%
56	-	-100.0%
57	-	-100.0%
58	-	-100.0%
59	-	-100.0%
60	-	-100.0%
61	-	-100.0%
62	-	-100.0%
63	-	-100.0%
64	-	-100.0%
65	-	-100.0%
66	42,000	-20.2%
67	42,000	-14.3%
68	42,000	-10.8%
69	42,000	-8.3%
70	42,000	-6.4%
71	42,000	-4.9%
72	42,000	-3.7%
73	42,000	-2.7%
74	42,000	-1.8%
75	42,000	-1.1%
76	42,000	-0.5%
77	42,000	0.0%
78	42,000	0.5%
79	42,000	0.9%
80	42,000	1.3%
81	42,000	1.6%
82	42,000	1.9%
83	42,000	2.2%
84	42,000	2.4%
85	42,000	2.6%
86	42,000	2.8%
87	42,000	3.0%
88	42,000	3.1%
89	42,000	3.3%
90	42,000	3.4%
91	42,000	3.5%
92	42,000	3.6%
93	42,000	3.7%
94	42,000	3.8%
95	42,000	3.9%
96	42,000	4.0%
97	42,000	4.1%
98	42,000	4.1%
99	42,000	4.2%
100	42,000	4.2%

 

[Big_Hitter]

When I retire at 55 and if my employer offers me a lumpsum of 500K (it will be approx. this amount) or a $3500 PM starting at 65 with COLA- which one should I take and why?

depends - what is the employer's lump sum calculation basis and what is the COLA basis?

plans subject to IRC 417e must take into account an estimate of the COLA when a lump sum is paid