Pension - Lump Sum Distribution ... or NOT

[Steelart99]

I've read the various topics about taking a Pension Lump Sum Distribution or not and I'm having a hard time finding an "easy" way to decide which way to go on this.

First off, we're not talking much on this particular pension. The facts, I'm 55 (Dec birthday) and the pension can start next month or anytime up to about 1/1/2024 (non-COLA). If I start the pension next month it is worth about $520/mo for life up to about $840/mo if I wait until 2024. The buyout is a lump sum of about $85K. I plan to work one more year ... hopefully no more than that at which time the pension would be $553/mo. At that time I'll be 57.

I tend to assume 3.5% inflation and 5% growth on any investment should I take the lump sum and put it into an investment or into my IRA. If I do the IRA, I can't touch it until I'm 59-1/2.

Any thoughts on how to put this mess into perspective?

 

[Car-Guy]

You might want to do some searches on this board regarding this topic. It's come up a number of times in the recent past and has had a lot of good discussions.

 

[MBAustin]

I recently had a lump-sum offer and agree with the OP that it's not easy to find the good threads on this topic - I kept getting the same threads multiple times in the search and it was a lot of work to get to some of the good ones.

What I concluded is that there is no one right answer. The factors that led me to decide to take the buyout were:
- My pension would be higher than the PBGC would guarantee and I'm not confident Megacorp will be around in 20 years.
- I was planning to start taking my pension next year (when it would no longer be reduced for early retirement, so I'd just be leaving money on the table if I didn't start then) but we really don't need the income at this point (and won't need it until I'm past 59-½) and it would just drive our taxes up. By putting it into an IRA I can continue to do Roth conversions at a reasonable tax rate from our other IRAs for several more years.
- I can manage the taxes by only taking out what we need (if any) between 59-½ and 70 when RMDs kick in, rather than being stuck with a fixed amount each year.

Obviously the OP's situation is very different.

 

[frayne]

I retired at 54 and took the lump sum as opposed to a pension for the sole reason I wanted control of the money. The amount was about $350K which I rolled into an traditional IRA along with my 401K. I set up a 72T distribution to eliminate the 10% early withdrawal penalty. That was over nine years ago and if I had it to do over again, I wouldn't change a thing. The bottom line still is, what fits your specific situation. I have compared notes with others that chose the pension and many regret the decision as they are pretty much locked into the pension agreement. I have been fortunate with my investments which with the exception of a couple of stocks are all low cost index funds.

 

[clifp]

The general approach to figuring out which is the better deal is to compare the monthly amount to how much an annuity would buy.

There aren't as many online source of annuity quotes as there use to be. To answer forum questions. I go here https://www.immediateannuities.com/, plug in in 85K and 55 years old the best I could see was a $394/month payment much less than the $520 company was offering.

However if it was my money, I'd try places like Vanguard, berkshirehathway.com known for their low cost perhaps you could do better there.

Since the crisis I've noticed that most companies and almost all public employees offer monthly pension significantly higher than you can buy from an insurance company. Obviously insurance companies are in the business to make a profit, but I also think insurance companies are smarter than government and most companies when it comes to figuring these things out.

As a retired 55 year old, I'd leap at the chance to get an almost guaranteed 7.3% for life, but there are good reasons to not take an annuity.

 

[Cobra9777]

I elected the annuity option on my DB pension. Here's a link to my latest explanation.

 

[clifp]

I elected the annuity option on my DB pension. Here's a link to my latest explanation.

I agree with your analysis completely. If investments (both stocks and bonds) perform as well as they have over the last 30 years, very few of us on the board will have much to worry about. (LYBM, good savers, above average incomes). The issue is what if it doesn't, in that case a pension even a modest $550-$840 one will be very nice to have.

 

[supernova72]

I read on one of these threads that one reason the company offer rarely equals which it would cost to buy a lifetime annuity is the whole lifespan element. Meaning---folks willing to "buy" an annuity are typically healthier than the average megacorp pension person.

So the megacorp is betting on the come that you won't outlive the income stream they would expect to pay over a lifetime. Kind of eery to think if it that way but it makes since.

Our company has also offered lump pkg to those eligible who have not started drawing. The discount offer is in the thread is referred to as a "haircut" Ha. All understandable however (thread attached below).

This thread may help you as well.

http://www.early-retirement.org/forums/f28/pension-payout-opinions-boeing-73788.html

 

[Steelart99]

Thanks to all who replied. I'm going to go chew on some of this ... I really can't imagine that this little amount would be worth anything as a flat non-COLA pension 20 years in the future. My general tendency is to grab the funds, invest in my IRA to avoid the taxes now and hope/plan to grow this into something usable. But that immediate tendency is what I want to avoid ... and thus why I started this thread.

 

[mtheulen]

I too will be looking at your issue in about 18 months.I have decided to take the monthly annuity for a couple of reasons.
1. This monthly income will be my base income come hell or high water.If the market is up on my ira, I can spend acoordingly. When a couple of down years hit, I can shut down the spending out of my IRA and live off the monthly check.
2. Because DW has no interest in managing money, she will have the survivorship clause and can live off this and have someone manage the rest.
This is another "one size does not fit all" issue

 

[Steelart99]

As a retired 55 year old, I'd leap at the chance to get an almost guaranteed 7.3% for life, but there are good reasons to not take an annuity.

I guess I don't understand this reference to a guaranteed 7.3% for life ... but then sometimes the obvious can escape me. Would you elaborate just a bit?

 

[Cat-tirement]

- I was planning to start taking my pension next year (when it would no longer be reduced for early retirement, so I'd just be leaving money on the table if I didn't start then) but we really don't need the income at this point (and won't need it until I'm past 59-½) and it would just drive our taxes up. By putting it into an IRA I can continue to do Roth conversions at a reasonable tax rate from our other IRAs for several more years.

So you are saying that payments from a pension count as income that would allow one to make IRA contributions when they otherwise could not? If so, I would presume that it could be to either traditional or Roth.

 

[Chuckanut]

I enjoy this pension lump sum discussions. They remind of the reverse thinking I went through when I bought more service years on my pension. I gave them a lump sum, and they gave me more $$'s each month. An interesting but different take in the same issue - pension versus personal money.

 

[Which Roger]

So you are saying that payments from a pension count as income that would allow one to make IRA contributions when they otherwise could not? If so, I would presume that it could be to either traditional or Roth.

I believe earned income is required to contribute to an IRA.

 

[MBAustin]

So you are saying that payments from a pension count as income that would allow one to make IRA contributions when they otherwise could not? If so, I would presume that it could be to either traditional or Roth.

No, they do not count as income for contributing to an IRA. But you can do a Roth conversion from an existing traditional IRA anytime (no age or income requirements or income limits AFIK).

Our income was too high to contribute to a Roth while we were working, so since ER I've been converting a modest amount from our existing traditional IRAs (mostly rollover from 401Ks) into Roths. You have to pay the taxes on it when you convert, but then it's like any other Roth - no taxes when you withdraw. [There are lots of threads about Roths out there if you want to search and learn more.]

If I took the pension, it would drive us into a higher tax break and make doing Roth conversions less attractive. By taking the lump sum and rolling it over into a traditional IRA, I can keep our taxable income lower for quite a few more years and thus get more money over into Roths which are not subject to RMDs.

Hope this makes sense, apologies for the confusion.

 

[rodi]

I guess I don't understand this reference to a guaranteed 7.3% for life ... but then sometimes the obvious can escape me. Would you elaborate just a bit?

Simple math.

520/month * 12 months = 6240/year.

vs 85k lump sum.

6240/85k = 7.3%.
Basically a CD that pays 7.3% for life - but you never get the principal. back. (Kind of a big gotcha - that principal thing.)

 

[clifp]

Simple math.

520/month * 12 months = 6240/year.

vs 85k lump sum.

6240/85k = 7.3%.
Basically a CD that pays 7.3% for life - but you never get the principal. back. (Kind of a big gotcha - that principal thing.)

Exactly right.I deliberately left out the word interest because that isn't an accurate description of what you are getting. I wish there was an agreed upon term.

A slightly more sophisticated analysis involves using a financial calculator or spreadsheet and solving for the interest rate for cashflow of N number of years with a $520 payment and $85,000 starting value.

The first approximately 14 years you are getting your principal back after that you are getting the equivalent of an interest rate. If you die at 70 (15 years) the rate is only 1.3% f you live until 85 the effective interest rate will be 6.3% if you make until 100 it is 7.0%

In today's interest rate environment all of those numbers look pretty attractive

 

[Steelart99]

Exactly right.I deliberately left out the word interest because that isn't an accurate description of what you are getting. I wish there was an agreed upon term.

A slightly more sophisticated analysis involves using a financial calculator or spreadsheet and solving for the interest rate for cashflow of N number of years with a $520 payment and $85,000 starting value.

The first approximately 14 years you are getting your principal back after that you are getting the equivalent of an interest rate. If you die at 70 (15 years) the rate is only 1.3% f you live until 85 the effective interest rate will be 6.3% if you make until 100 it is 7.0%

In today's interest rate environment all of those numbers look pretty attractive

Ahhhh ... I understand. Makes sense. Thanks guys.

 

[Cat-tirement]

If I took the pension, it would drive us into a higher tax break and make doing Roth conversions less attractive. By taking the lump sum and rolling it over into a traditional IRA, I can keep our taxable income lower for quite a few more years and thus get more money over into Roths which are not subject to RMDs.

Hope this makes sense, apologies for the confusion.

Thanks for that clarification. The confusion was my fault. I had misread your earlier post and was thinking that you did not take the buyout. Makes perfect sense now.

 

[jazz4cash]

Would it make sense to take the lump sum now and wait for rates to go up before purchasing an annuity, (e.g assumes cost of the annuity will fall when rates rise)?

 

[Aeowyn]

The reason it is hard to give a definitive answer is there is a lot of controversy about what return you can expect to get from your investments, what asset allocation should be, what withdrawal rate you should take from your nest egg and of course how long are you going to live.

One more thing to consider – are you married? If you are I assume the pension payments die with you. If you take the lump sum it would still be there for your spouse after you die so that needs to be factored in.

In the original post some assumptions were laid out. It was assumed that the invested portfolio would return 5%. There was also an assumption of 3.5% inflation, but this doesn’t factor in for comparison against the pension payout because the pension is not adjusted for inflation (unless the 5% return was net of inflation).

The other issue with a long term portfolio estimated return is that you don’t get that return each and every year. Some times you get less (or negative) and some years you do much better. But if we assume you get the same return every year, we could see how long the money lasts if we pull the same pension amount annually. So if you take the lump sum of $85K and a return of 5%, let it grow for a year and then start drawing $6,646 (12*553) annually, you will run out of money when you are 79. Will you still be alive?

If I misread your assumptions and you think you can get a 5% return above inflation of 3.5% (i.e. 8.5% return), then if you only take out the $6,646/year – you can live to 110 and you will have a nest egg from the lump sum left of $1.2 Million dollars.

By the way – I think a return of 8.5% long term is completely reasonable depending on how the money is invested. But it won’t be a calm ride (like the pension monthly is).

If it were me, I would take the lump sum because:

• I like having control over the money
• I don’t like the idea that the pension dies with me
• I like the flexibility of taking variable withdrawals (also am willing to adjust withdrawals to compensate for bad years in the market)
• I’m confident enough in historical market returns that I think they will enable me to take overall withdrawals from the portfolio that both exceed what the total pension payment is (no matter how long I live) and leave a nice nest egg for my heirs after I am gone.
• I’ve been through several dips in the market and know that I am comfortable with the volatility.
• I am willing to stay with a portfolio that is heavily weighted toward equities through retirement (planning to keep cash/bonds to < 20% that I am willing to spend completely down to zero during a market downturn)

 

[pb4uski]

Simple math.

520/month * 12 months = 6240/year.

vs 85k lump sum.

6240/85k = 7.3%.
Basically a CD that pays 7.3% for life - but you never get the principal. back. (Kind of a big gotcha - that principal thing.)

The 7.3% is a payout rate (benefits/premium) not an interest rate or rate of return. While you don't know when you will die, you can calculate the interest or rate of return assuming you live to various ages.

Monthly benefit	520
Lump sum	85,000
	IRR
65	-5.68%
70	1.31%
75	4.19%
80	5.60%
85	6.37%
90	6.81%
95	7.09%
100	7.26%
105	7.37%
110	7.44%