Pension Plan Sum verses Annuity

[AlanS]

I am working on an early retirement plan and am considering how to take the pension my company offers, either lump sum or annuity. I have recently discovered this site and the wisdom of the 4% withdrawal rate. If I take the annuity, say at a 50% survivor rate, the annuity would be equivalent to 7% of the lump sum. So it seems like this might be the way to go and use the 4% rule for the money in my 401k and IRAs. Any thoughts on this would be greatly appreciated. The pension plan lump sum would be about double what the other sources add up to.

Thanks,
Alan

 

[earlyout]

Alans, Lump sum or annuity,

Really need more info to answer question (e.g. age of you and spouse, how solid is company is annuity thru insurance etc, is there any future income adjustment in annuity?).

However, a quick look at immediateannuity.com shows for a 100% suvivorship the rate is about 6.1% (depending on age). You may want to go that site and run a few scenarios based upon your ages and the lump sum amount.

If you can get as good as the company's annuity elsewhere then that may be what you want to do. Also are there tax consequences with the lump sum or is it perhaps tax sheltered until in your hands? Do you want 50% or 100% survivorship? How does 100% suvivorship affect your monthly annuity amount from your company?

Pensions are really a form of an annuity. Your company pays you monthly in lieu of a lump sum amount. Some may have future inflation adjustments. How solid is your company? Could they go bust a leave you holding the bag? It was reported somewhere that with the current low interest rate, that lumps sums should be greater than the were just a few years ago.

Some things to think about,

Happy ER

earlyout

 

[earlyout]

Here is one comparison, these are all "equal" in cost to the company:
Form of Annuity Monthly Benefit Surviving Spouse's

Joint and 50% $1,225.68 $612.84
Joint and 66 2/3% 1,176.65 784.43
Joint and 100% 1,066.34 1,066.34

Lump Sum Payment $210,082.79

In 1999 the rate to calculate the amount of lump sum you should receive was 6.3%, today it is 5.4%. the lower interest rate means a larger lump sum.
Also, if you take lump sum you should be willing and capable of handling and investing the lump sum amount.
If not, then definitely take the annuity. There can be very valid reasons to go either way, no "right" or "wrong" answer, you need to understand and feel comfortable with decision.

Best wishes

Earlyout

 

[sgeeeee]

I just went through this decision process myself. I retired at age 49 this past April. My company offered an annuity style pension benefit starting at age 65, or a benefit worth 50% of the age 65 annuity starting at age 55. (You could also start the benefit payment at any other time between age 55 and 65 based on a linear prorating). Alternatively, I could take a lump sum. If the lump sum is rolled into an appropriate tax deferred account, there are no tax consequenses to the payout.

I ran the numbers through a lot of annuity calculators and built a number of spreadsheet programs to look at all of the possibilities. In my case, it was pretty clear that if I took an annuity style benefit, I would probably be better off taking it starting at age 55 rather than wait till age 65 for the full pension. But the lump sum vs annuity payout was less clear -- too many risk variables to be definative.

However, I don't have a lot of faith in my old company and I was able to find out that their pension fund is currently underfunded significantly. I decided that I would rather take the money and manage my own risk than let them mismanage it. I ended up shopping around and rolling my lump sum payment into another tax sheltered account. If I need to, I could take SEPP withdrawals from it starting as soon as I desire. Otherwise, I can continue to manage the money along with the rest of my portfolio.

 

[Michael]

I would like to point out something if you opt for the monthly pension:

If your defined benefit is not inflation adjusted, you cannot safely take 4% out of your other funds to live on at the start of your retirement. As inflation gradually erodes your defined benefit pension, you will need ever greater withdrawals from your savings to compensate. I recommend living almost exclusively on your defined benefit pension at the start, and gradually supplementing it with slowly increasing withdrawals from your savings to compensate for inflation. If you will get Social Security soon, this may not be as necessary. If you are very young, taking 4% from your savings to supplement your pension at the start will leave you with less and less purchasing power to live on as the years pass.

Also, do you have medical insurance?

 

[Alan]

Thanks very much for the advice and suggestions. To answer some of the points that were raised, I am 56 and my wife is 55. If I take the lump sum I can roll it over into an IRA. My companys pension fund is fully funded, at least currently. There is no inflation adjustment on the annuity and I can continue medical coverage when I retire.

Thanks again,
Alan

 

[earlyout]

Alan ,

Based on your ages, an annuity that pays $1,000/ month with 100% survivorship to the spouse is valued at approximately $190,000. This should help in assessing your company's annuity vs lump sum payout.

best regards

earlyout

 

[AlanS]

Thanks earlyout. That is about the same ratio as my companys offer.

I had another question of clarification on the withdrawal rate calculated by the online calculator. Is it correct that the rate should be adjusted for inflation? So if my 95 percent safe initial rate is $3000, after 10 years of 2% inflation, it would be about $3600?

Thank you,
Alan

 

[Richard]

What I'm planning to do to inflation adjust my pension is to use 40% the first year (saving 60%), 43% the second year ... up to 160% the 41st year. Not sure what I'll do if I live more than 41 years - reverse mortgage on my house? Earnings on the money saved would go to boost the 3% pool (given that I may live 50 years and am more into bonds than recommended, I'm using 3% rather than 4%).

 

[John Galt]

About reverse mortgages. This is part of my back up plan. Say that all of my investments go in the tank.
I can still survive on SS and a reverse mortgage, unless
inflation goes completely nuts. Then all bets are off.

John Galt

 

[Jarhead*]

Hi John Galt:

I have investigated reverse mortgages, and the problem is unless you are over 70, the amount you can qualify for is really small. Even at age 70, its not much.
Of course it depends on the evaluation of the property.
We happen to really love our location, and property even though it is way more than the 2 of us need at this point. The fact that you can currently exclude up to $500,000 in capital gains, effectively tax free, it would probably make more sense to eventually sell, and move to a less expensive property.
The current tax code very much encourages real estate, and it is no wonder to me, given the low interest rate environment and supply and demand that real estate has done so well in the last few years.
In your previous posts, you apparantly have made a sizable bet on real estate, and in my humble opinion I think you will be fine, as folks continue to pour into our country, and demand should continue to be strong.
If I was younger and had more energy, I wouldnt worry at all about the long term outlook on real estate.
Regards, Jarhead

 

[John Galt]

Hello Jarhead! Real estate has been good to me over
the years. I like it. I understand it. It's a "no brainer"
if you can afford to wait, or if you want to spend lots
of time researching "deals".

John Galt

 

[renferme]

Some folks, like me, will have no choice about pension or lump sum. In my case, I have to take the pension and hope the company has a good future ( no guarantee there).
But, if you take the lump sum and take 4% a year from it, the amount will be far less than the pension. And, it will take about 15 years of pension payments to equal the lump sum. So if you take the lump sum, you had better do a really good job of investing it.
So, I plan to take the early pension, supplement it with my personal savings, and in a few years begin to receive social security.

 

[JWR1945]

It is important to clarify what the 4% number refers to. Withdrawals are 4% plus adjustments that match inflation. The dollar amounts increase (excluding deflationary periods).

Have fun.

John R.

 

[JWR1945]

I need to add a further clarification.

Most studies base withdrawal on either the initial portfolio balance or the portfolio's current balance.

FIRECalc provides answers based upon the initial balance. It suggests withdrawing 4% of the initial balance and then increasing your withdrawals to match inflation. There are qualifiers such as how long you want your portfolio to last. Roughly speaking, decreasing your withdrawal rate by 0.2% should extend your portfolio's lifetime by a decade or decreasing it by 0.3% should extend it by two decades.

The qualifier about whether the future is worse than the past is far from trivial. For a variety of reasons, you should expect a portfolio consisting of an S&P 500 index fund and commercial paper not to do as well. The most obvious reason is that valuations are still outside of the historical range (i.e., prices are higher according to several measures than those of the historical record that are available to FIRECalc).

With careful asset allocation and diversification, you can still expect the 4% number to work.

The other number most frequently mentioned in studies is to take 5% of your portfolio's current balance. If your investments do poorly, your income will not keep up with inflation. But, your portfolio will never run out of money.

The oldest, most traditional approach that I am familiar with (for stocks) is to live off of the dividends. Dividends have generally grown slightly faster than inflation as measured over the really long-term (of fifty years or longer). Keep in mind that things can go wrong. Remember the bond investors who lived through the Great Depression and what inflation did to their holdings.

Have fun.

John R.

 

[wzd]

But, if you take the lump sum and take 4% a year from it, the amount will be far less than the pension.

Like you, I had no effective choice. The lump sum choice was not a competitive one. It seems that they have some options in calculating the lump sum, and in my case the lump sum was about 6x the annual payment, which far less than half the amount from annuity calculators. The reason they could offer the lowball cash out had to do with the annuity being enhanced by an early retirement offer vs. the lump sum being calculated based on a deferred, beginning at age 65, pension.

However, in response to the quote above, I think that is not quite a fair comparison. The 4% is an initial amount and is inflation adjusted, so the initial amount will be less than the pension. For example, using the 100% survivor annuity above, the lump sum is $210,082.79. With 3.50% inflation, and a 4%SWR:

year annuity SWR inflation(CPI style)

1 $1,066.34 $700.28 100
2 $1,066.34 $724.79 103.5
13 $1,066.34 $1,058.17 151.1
20 $1,066.34 $1,346.28 192.3
21 $1,066.34 $1,393.40 199.0
30 $1,066.34 $1,899.06 271.2

The crossover in actual dollars is in year 13. At year 21, the pension is now worth 1/2 the initial value. At year 30, the monthly pension is worth $393.21. So, the annuity provides a steady monthly stream, declining in value. The lumpsum/SWR provides a probable monthly stream, starting at a lower value, and matching the annuity in year 13.

It's a tradeoff, and depends on individual situations and preferences. And inflation could be worse or better, who knows, so some of it is a wild guess.

Wayne

 

[renferme]

Wayne,
What if, in your example, you took the 1066.43 per month, but only used 700.20 in the first year, then increased for inflation each year after ? Then invested the unused portion (1066.43 - 700.20 in the 1st yr ). After year 13, you could begin to take out of your investments enough to keep up with the SWR.
Would that tacic work ?
Ray

 

[Brat]

Link thanks to Fund Alarm:

Retirement Distributions: Creating a Limitless Income Stream for an "Unknowable Longevity"

http://www.fpanet.org/journal/articles/2004_Issues/jfp0204-art1.cfm?renderforprint=1

 

[ats5g]

Brat,

Along those same lines, Milevsky and Chen wrote an interesting article, Merging Asset Allocation and Longevity Insurance: An Optimal Perspective on Payout Annuities.

- Alec

 

[wzd]

yes, some interest assumption on the difference could be used, and would push out the breakpoint. It would also affect the payback, which I did not calculate. Also, you can use firecalc to compare putting some money in annuities with a portfolio. The annuity is really a type of insurance against living too long....and against major portfolio losses early in retirement.

There are advantages, and disadvantages. The choice is really a personal one, and can only be partially quantified with investment comparisions. My post was really to illustrate the disadvantage with respect to inflation. If you put some scenerios into firecalc, you will see failures in the 1970's with portfolios subject to inflation. According to Dory, to put a fixed annuity into firecalc, enter it as a negative, non-inflation adjusted, withdrawal adjustment.

Wayne