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Lump Sum or Company Annuity
Old 03-23-2012, 12:27 AM   #1
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Lump Sum or Company Annuity

On the fence deciding to take a Lump Sum or a company Annuity (not COLA adjusted). An NPV discounted cash flow of the Annuity at 5.5% is a wash against the Lump Sum - to age 85.

Bottom Line - can one reasonably assume a 5.5% return on a Lump Sum over the next 30 years ?

Hate to take the Annuity, and die 10 years down the line.
Hate to take the non-COLA Annuity, live to be 95, and inflation eats it up.
Hate to take the Lum Sump, and realistically capture only a 3% ROR.

Any insight / considerations ?

-Mike G.
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Old 03-23-2012, 05:08 AM   #2
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If you die, what difference does it make? Do you have other retirement savings or is this most of your retirement income?

Here's a recent thread you may find helpful Annuity or Lump Sum - still confused
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Old 03-23-2012, 07:18 AM   #3
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When presented with the same "challenge" upon my retirement - five years ago, I looked at it in this manner:

First of all, I got the details on the "company pension" (actually an SPIA offered through a third party), and matched the monthly payout/terms against what I/we were looking for.

I used Immediate Annuities - Instant Annuity Quote Calculator. , along with quotes through both VG and FIDO.

What we were looking for was non-COLA based, joint life, with a minimum period payout which would insure payment continuing to our beneficiary/estate in case both of us would pass before our joint estimated lifespan.

I/we selected an SPIA that met our terms through FIDO. I'm not suggesting you do the same, but you need to specify what you want before just accepting what is offered to you.

In our case, we desired two "musts"; that is that we would not "lose" if we both passed shortly after getting the SPIA, and it would support a good deal of our basic retirement income needs up to the point of our receiving SS (DW at FRA age of 66, me at age 70).

We did not worry about inflation since we looked at it as "gap insurance" until we got to SS, which would actually replace the SPIA and be a superior annuity - one that would be COLA based and cover us for the rest of our lives. Payments from the SPIA would just be "icing on the cake" of SS. In addition, we were looking for the largest monthly payment available - of course reduced by the joint/survivor and guaranteed term which slightly reduced the maximum payment without options.

BTW, we only used 66% of my lump sum to purchase the SPIA, of which the premium represented 10% of our then combined retirement portfolio value. At the time of application, we had to "certify" that the annuity, plus all other annuity-type vehicles did not make up more than 50% of our combined retirement asset value. That's another point when talking about a COLA adjusted SPIA. In our case, the other 90% of our portfolio was used to ensure coverage of excessive inflation. We were lucky in that manner, since inflation has been low for the last five years since we've had the SPIA and we only have two more years before SS kicks in.

I certainly won't suggest what you should do but just offer the reasoning behind our decision.

Good luck....
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Old 03-23-2012, 12:30 PM   #4
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I retired 9 months ago and faced the same decision as you, rescueme and many others. Rescueme and I have (respectfully?) disagreed on this subject, but now I may see a big reason why (a SPIA was more attractive 5 years ago).

As you probably know, for a given monthly payout, the upfront costs of an annuity correlate with interest rates (actually determined by GATT/PPA rates). With interest rates currently at historic lows, this is a bad time to buy an annuity if you can avoid it (not everyone can defer though), and I'll illustrate next paragraph. However, what makes this a bad time to buy an annuity, should actually makes this an ideal time to take a lump sum.

I had earned a fixed monthly non-COLAd pension payout with my previous employer. Lump sum was always an alternative. At historic average interest rates, my lump sum payout would have been almost exactly 100 times my earned monthly payout (6.25% IIRC). When I retired Jun 2011, my lump sum was 170 times my earned monthly payout because interest rates were so low. Lump sums had never been higher in my experience. Since I can always buy an annuity on my own and the lump sum was a small part of our total portfolio (more later), it was a no-brainer IMO to take the lump sum. If/when I decide I want to buy an annuity when interest rates increase (and they will, though it will be several years it seems), I can get the same monthly payout for less, or a larger payout for the same lump sum. Using the numbers above, an annuity that would provide $X/month income would cost $170,000 today - in an average interest rate period I could get the same $X/month income at an annuity cost of $100,000.
If you're concerned about losing the lump sum, you can invest very conservatively while you wait. If interest rates don't change at all, an annuity becomes less expensive each year as well, because where you might have been buying X years of income this year, next year you'll be buying X-1 years of income so the upfront annuity cost decreases. And most important IMO, if markets provide decent real returns your lump sum can grow and you could then later buy an annuity for less and pocket a substantial investment gain as well. I can give you an 8-page article that explains this.
From The Bogleheads Guide to Investing (brackets my comments): "A final way to ensure income for life is to use part of your savings [your lump sum] to purchase an immediate annuity that guarantees a fixed monthly income. Although an annuity can be a good option for those ages 75 or older, it has its drawbacks, especially for younger retirees. First, the younger you are, the lower the payout is. Second, the monthly income rate is based on current interest rates [book was published in 2007, interest rates are even lower now], and in recent years, interest rates have been low, making the payouts relatively small [and conversely, lump sums relatively larger]. Third, most immediate annuities have no provision for inflation. With the possibility of retirement lasting 30 years or more, the purchasing power of an annuity will almost surely erode over time. You can purchase inflation-adjusted annuities, but the initial payments will be lower than those of a regular annuity. Finally, if you give the insurance company a hefty sum without choosing a term-certain payout option, and then die prematurely, it can be a very bad decision for your heirs."

This is very good advice from rescueme's post that everyone facing the pension vs lump sum question should check: "I used Immediate Annuities - Instant Annuity Quote Calculator. , along with quotes through both VG and FIDO." You should check to make sure the lump sum you've been quoted matches closely with the current cost of an equivalent annuity - if not, you need to find out why before you make your decision.

You haven't mentioned where your income will come from if you take the lump sum. Other sources? If your plan is to take the lump sum and hold it as cash/MMF and just spend it, you're probably better off with the company annuity unless you know for a fact that your lifespan will be very short.

You also haven't mentioned how significant the company annuity or lump sum are in your overall portfolio, that could make a big difference. If the lump sum is small relative to your portfolio, IMO it's a no-brainer to take the lump sum and purchase an annuity later when interest rates and annuity costs are more favorable. But if the lump sum is a large (or all) of your portfolio, it's not a no-brainer. If the company annuity would provide considerably more income than you need for projected spending (not common), you still probably want to take the lump sum but you might want to purchase an annuity to cover basic expenses with part of it and pocket the rest. But if the company annuity would be your primary income, you may not be able to safely defer the decision. The answer might change if that's the case, more like rescueme's POV.

Like rescueme "I certainly won't suggest what you should do but just offer the reasoning behind our decision.

Good luck..."
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Old 03-23-2012, 03:08 PM   #5
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Quote:
Originally Posted by mmgoebe View Post
On the fence deciding to take a Lump Sum or a company Annuity (not COLA adjusted). An NPV discounted cash flow of the Annuity at 5.5% is a wash against the Lump Sum - to age 85.

Bottom Line - can one reasonably assume a 5.5% return on a Lump Sum over the next 30 years ?

Hate to take the Annuity, and die 10 years down the line.
Hate to take the non-COLA Annuity, live to be 95, and inflation eats it up.
Hate to take the Lum Sump, and realistically capture only a 3% ROR.

Any insight / considerations ?

-Mike G.
Regarding a 3% ROR mentioned in your last sentence, if you took the lump sum and did a DIY pension, how would you invest the lump sum?

I think 5.5% is a reasonable return. It is what I have been using in my deterministic retirement planning for 60 fixed/40 equity portfolio (but is admittedly 200 bps lower than historical returns for such a portfolio).

If I were in your shoes, I would first compare the monthly payments with what they would be if you took a lump sum and purchased a SPIA through VG, FIDO or immediateannuities.com to see if the monthly payments are a "fair" deal. If the monthly pension payments exceed what you could get using the lump sum to buy a SPIA from a insurer then at least you will know that the "pricing" of your pension is reasonable.

You could also compare the payments for an inflation adjusted SPIA with guaranteed payments the non-COLA payments to get a sense of the trade-offs of adding a guarantee and a COLA.

As others have suggested the decision would somewhat depend on how big a deal this is in your overall finances. For me, the bigger this is as your overall retirement income, the more I would lean towards some annuitization option. OTOH, if you have other significant streams of income in place then you might be able to be comfortable with the lump sum.
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Old 03-24-2012, 09:46 AM   #6
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Originally Posted by Midpack View Post
Rescueme and I have (respectfully?) disagreed on this subject...
Hey, we all have reasons for making the decisions we did. Not all answers will apply to all people, at all times ...

I take no offense on a difference of opinion, as long as one does not specify that what they say is "the rule", regardless of personal situation....
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