Pension: Lump Sum or Monthly Payment ?

[Helena]

I may be retiring at age 55.

I can either take a lump sum
or immediately begin getting
a monthly (annuity) payment.

What are the pros and cons of each ?

 

[haha]

I may be retiring at age 55.

I can either take a lump sum
or immediately begin getting
a monthly (annuity) payment.

What are the pros and cons of each ?

I would first evaluate the staying power of the company or entity standing behind the pension. Federal government best, resource rich state second, etc. Last would be a corporation with a junk rating on its bonds. If the entity behind the pension stinks, take the money and run.

If you feel secure that the pension is safe, there are several things more to consider. Do you want a lump sum so you can buy something that you otherwise could not buy? Your own island, a cattle ranch or whatever. IMO this would usually be a mistake, but some people really want to do it.

Do you have some cash savings that you could tap for trips, etc. that might go beyond what you could finance out of the stream of annuity payments?

Do you need to or want to provide for someone else, even after your death? An annuity won't do this very well, if at all unless you can get a joint annuity with the other person. If it is children, the annuity won’t work at all.

If you find that you are qualitatively indifferent about having cash or an annuity, then it boils down to what is the nature of the annuity, and how generous are the actuarial assumptions behind it?

If it is full COLA, I would tend stop right there and take the annuity, since it really cannot be duplicated in the marketplace. Even the annuities sold by Vanguard are capped at 10% COLA.

Anyone who understands the time value of money and can use Excel can tell you if you are getting a fair shake.

One thing- during times like the present, with relatively low interest rates, cash-outs are more generous than they would likely be if interest rates were higher, because the discount rate used to arrive at PV for the stream of payments is relatively low.

I think there is no doubt that nominal interest rates are low today, at least by an historical comparison. Real interest rates, as reflected by the spread between TIPS and similar maturity treasuries are a more difficult thing to know. They may be pretty good right now. Since TIPS have been trading in the US, the implied real interest rates on them has been both higher and lower than at present.


I guess one more thing would be how much do you enjoy having control over and responsibility for your portfolio? An annuity gets you out from under much of that responsibility.

Ha

 

[AltaRed]

I agree staying power of the company behind the plan is probably the key factor. Look at what has happened to steel, airlines and soon....auto makers.

I had the choice of a DB pension payment (essentially a non-commercial annuity) or a lump sum when I retired in April 06. I eventually chose the 'annuity' after considerable financial analysis because:

1) the sleep-at-night factor allowed me to 'continue to get a paycheck' while still managing and potentially building our capital in our other investments,
2) while the math said I would be better off with lump sum from a Net Worth perspective throughout the rest of my life, Cash Flow over that same period was always superior with the annuity,
3) DW and I will have enough left from our investments to pass on a decent legacy to our children, i.e. we have no need to top it up with residual Net Worth from a lump sum, and
4) our nest egg is meant for DW and I to enjoy -- and we would rather help out our kids as we go while alive, than pass on a pot of cash when we are gone.

IOW, the reasons to choose one over the other can sometimes be more attributable to emotional and family factors than the hard math.

 

[Helena]

My company is a non-investor-owned mutual
insurance company. It is currently in excellent
financial condition... but one never knows what
the future might bring ?

I have another stream of income from a
part-time job and a company 401K that is
worth more than the pension.

If I rolled a pension lump sum into an IRA,
I couldn't touch it until 59 1/2 , right ?

 

[frayne]

FWIW, I worked for a very large oil company for over thirty years and ended up taking a pension lump sum vs. an annuity type pay out simply for the fact that I have control of the money by way of an IRA. And you can tap your IRA prior to 59.5 by using the 72T method.

Prior to making the decision I ask the company that was in charge of the administration of the pension program if the pension fund was fully funded or whether some of it was insured by way of PBGC. After hearing that a portion was indeed insured by the PBGC I decided on taking the money. Especially in light of the trend of companies trying to get out from under their future pension liabilities. Which company may be the next Enron, Delta, GM, Ford, etc., who knows ?

 

[donheff]

Prior to making the decision I ask the company that was in charge of the administration of the pension program if the pension fund was fully funded or whether some of it was insured by way of PBGC. After hearing that a portion was indeed insured by the PBGC I decided on taking the money.

Doesn't PBGC cover all of the defaulted pension up to a certain limit? Or do they only cover a portion? If they cover all and you are under the limit, it should be secure.

 

[frayne]

Doesn't PBGC cover all of the defaulted pension up to a certain limit?  Or do they only cover a portion?  If they cover all and you are under the limit, it should be secure.

I believe you are correct, but what if you are over the limit, and what applies now may not apply in the future. I guess the bottom line is that I felt more comfortable having the lump sum rolled over into an IRA so I could control how it was invested and knowing that I didn't have to rely on some 2nd or 3rd party making good on an annuity type long term commitment.

 

[ats5g]

Doesn't PBGC cover all of the defaulted pension up to a certain limit? Or do they only cover a portion? If they cover all and you are under the limit, it should be secure.

See What PBGC guarantees.

- Alec

 

[renferme]

One thing to consider: if you take the lump sum and then make withdrawals at the 4% SWR, the money withdrawn will be less than the pension.

 

[madeit!]

My money manager brother tells me that ninety percent of those that have the option take the lumpsum. Of those, fifty percent p***it away in less than a year and do not care about the tax consequences.
As far as the security of a pension annuity goes, you need to not only take into consideration the future prospects of the entity behind the pension (and it my not be your former company since many of them will purchase annuities on the open market for their retirees.), but you need to judge whether those prospects are any less doubtful than what ever investment i.e. mutual fund etc. that you drop the lump sum into.

 

[dlhanson]

I took the lump sum three years ago. I had the choice between $333K lumpsum or $1300 per month non-COLA'd annuity. I felt that I could take on added risk with the lumpsum in an IRA and achieve better returns than leaving it in the pension plan. I gave no thought to spending either the lump sum or 401K savings until I am 59-1/2, although I too know many who did.

 

[teejayevans]

wrong, google: 72t IRA
for a way to tap the IRA before your 59.5

If I rolled a pension lump sum into an IRA,
I couldn't touch it until 59 1/2 , right ?

 

[frayne]

My money manager brother tells me that ninety percent of those that have the option take the lumpsum.  Of those, fifty percent p***it away in less than a year and do not care about the tax consequences. 

A few comments; wonder where he gets his numbers from, is he chumming for some business perhaps, and I can't believe 50% of those who do take the LS piss it all away without regard to the tax implications. Just my opinion though.