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Lump Sum or monthly
Old 06-01-2014, 04:08 PM   #1
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Lump Sum or monthly

Helping a friend who just retired get a few financials in order.

He is 45 has non cola pension that will pay 900 per month at age 65. Or take it at retirement and get approx 300 per

Q: He could take it monthly or a lump sum now of approx 63K usd and roll into an IRA and lump grows to 100k if he waits til 65.

That's approx 6% return if he takes the pension now vs lump sum now and his tax rate post retirement will be low - can't say same if he dumps the money onto an Ira as he has lots of tax deferred savings and likely draw that down later at a rate that may trigger higher than 15 pct taxation.

Is there a tool to plug in returns, taxes, etc to determine if a lump sum now or monthly payment now is better?

There is a 50 pct spousal survival been too if I understand him.

My conventional wisdom says take the lump sum now and roll it to an IRA - he could always buy an annuity with that cash if he wanted a steady guarantees til death income later - he can probably do better than the pension return.

What do you all think ?

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Old 06-01-2014, 05:54 PM   #2
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Often enough the lump sum is worth less than it would cost to purchase a similar annuity. They use a virtual interest rate to calculate a smaller lump sum. So you have to do the numbers. You can use a spreadsheet or maybe even a calculator to calculate the present value of the three options, using an assumed annuity duration and interest rate. Or you could see what interest rate would give you either of those cash flows given the lump sum as a start. If that interest rate looks bad to you, chose the lump sum. If it looks better than your portfolio (or fixed income portion of it) will be doing, then choose the monthly payout with the best rate. Of course, the flexibility of a lump sum or the guarantee of the monthly amount may be attractive enough to trump all the calculations.

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Old 06-01-2014, 05:59 PM   #3
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This might help: Bogleheads - 10 Reasons to take your pension annuity over a lump sum
Numbers is hard.

Retired in 2005 at age 58, no pension

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Old 06-01-2014, 06:32 PM   #4
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While the mathematics may point in one direction or the other, I'll offer another perspective:

What is the personality of the friend?

Is he the kind of person who might panic when the next crash hits the stock market?
Is he the kind of person who get too conservative and might end up investing in low interest CDs instead of stocks?
Is he the kind of person who will sleep well knowing that his annuity will keep rolling each month?
Does your friend care about leaving money to his kids, if he has them?

Also what about his wife? How is she on these questions.

Even if the lump sum makes the most sense from a strictly financial perspective, it still might not be the best choice for your friend. And vice versa.
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Old 06-01-2014, 07:25 PM   #5
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If you pay $63k and then receive 12*$300 a year later and each year for a total of 46 payments, that's an implied interest rate of 5.15%. if you waited 20 years before starting payments of 12*$900 for a total of 26 yearly payments, the implied interest rate is 4.75%. It is possible that your exact numbers might result in the same interest rate for both cases, depending on how the company is calculating the benefit.

That's not a bad interest rate, though your friend would have to live another 46 years to achieve that.
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Old 06-04-2014, 07:40 AM   #6
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Were I in the situation, I would roll the "cash" out to a real estate IRA type account.

A sample purchase bought by such an account in early 2013: 2 bedroom, 1 bath, 1 car garage, red brick, about 3 mile from the college. Bought for $77,500, rented for $805/month. After tax, insurance, etc. it’s dumping around $7000 (9%) a year tax-deferred into the account.

Since we don’t need the money yet, as it accumulates I keep putting it back into improvements in the house.

Had I been able to do the above when I was 45, by 65 I would expect it would have grown to a lot more than $900 per month…

Down side of real estate is bad or no tenant.

Up side is the "annuity" continues for a spouse and other heirs.
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Old 06-04-2014, 08:45 AM   #7
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From the boglehead article referenced above, here is the main reason I chose an annuity over a lump sum:

(8) Longevity Risk
Worried that you may outlive your assets? Not a problem with an annuity. It will pay every month till the day you die.

This is also the reason I will likely wait until age 70 to take SS. To me, it's not a question of which option will likely result in more $, but rather which option will minimize my chances of going broke before I expire.
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Old 07-05-2014, 02:43 PM   #8
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I got my er pension #'s in today- lump sum is 16% discounted from 10 year option that I am planning on taking (the 10 yr option is 2x the single life annuity amount). The 10 year will hold me until I reach 70, and then the rmd's will fill the income gap. If I take the lump sum, it will require almost 6% annual returns to sustain for 10 years.
Perhaps a better plan may be to have the monthly check deposited into an IRA. Because I plan to do a little bit of part time work, I may not need the money every month, and could let it stay invested.
Has anyone had experience with this option? If so, did it work?

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