Originally Posted by 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 ?
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.