Pension Choices

[scubamonkey]

I have several options as to how I (and DW) will receive my pension. Here are the choices of monthly payments:

Options                                 ME                      DW
5-year certain and life          5265                 5265
10 year "        "      "            5138                 5138
15 year "        "      "            4964                 4964
20 year "        "       "           4780                 4780
Single life annuity                 5317                   -0-
50% Joint and survivor         4996                 2498
75%  "        "       "               4849                 3636
100% "       "       "               4712                 4712
Lump sum              $691,068

Assume the following circumstances:
This scenario will start  on 5-1-2016. We will be 55 years old. We will have all children educated and gone, home paid off, and about
$1,300,000 in 401K,IRA, and Roth IRA. Assume that we are in good health in 2016.

Which pension option would you choose and why?

 

[brewer12345]

Are these sums monthly, annual, something else? Is the pension COLA'd? Annual expected expenses?

 

[scubamonkey]

Are these sums monthly, annual, something else?  Is the pension COLA'd?  Annual expected expenses?

These are monthly payments and are not COLA'd.

 

[justin]

The "5 year certain and life" option shows $5265 for you and your DW. How is that different from 100% joint and survivor which pays $4712?

 

[scubamonkey]

The "5 year certain and life" option shows $5265 for you and your DW.  How is that different from 100% joint and survivor which pays $4712?

The five year certain and life pays the amount to me for my life or if I die during the first five years it continues to pay my wife (or another beneficiary if she pre-deceases me) until a total of 60 payments are paid and then it ends. If I die after the five years then the payments will end at that time.

The 100% joint and survivor pays the $4712 as long as either me or my wife are living.

 

[justin]

Assuming
(1) the payor of the annuity was of top notch credit quality, and
(2) I was in average or better health,
I think I'd take the $5317/month "life only". Based on an average life expectancy of an additional 29.6 years for the average 55 year old, your payout for that average time period would amount to an internal rate of return of approximately 8.5%. Assuming nominal risk of the insurer, that's a pretty good nominal return.

With the 100% joint and survivor benefits, your expected joint life expectancy jumps by 6 years to an additional 35.6 years. The expected payout over that time period based on $4712/mo is close to a 7.5% internal rate of return.

The decision depends on so many factors though. Is the $1.3 million sufficient to provide for your wife if you die on day 1 of your pension and you have 0% survivor benefits? The decision really depends on your expenses. If you just had to optimize your expected return, I'd say take the "life only" option.

Do you want to leave part or all of the value of your pension to your kids?

 

[scubamonkey]

Justin,

Considering expenses she would need some income from the pension to continue ER. Without it she would probbaly have to go back to work - at least part time. She is quite capable of doing so (she is a patient care manager for a large hospital) although she may not want to.

As for the kids - our plan at this point is to take whatever inheiritances we receive and build on those (not spend them ) to pass on down, along with whatever residual is left in own estate.

Considering your previous assumptions, would there ever be a case to take the lump sum?

 

[justin]

Considering your previous assumptions, would there ever be a case to take the lump sum?

I checked on a quote for a $700,000 30 year term life insurance policy for a healthy 55 year old. $4400 per year. Here's a scenario to consider - take the "life only" payout option and get the 30 year term policy. You'll still get $4950 per month for 30 years, then $5317 from then on until you kick the bucket. That would give you an internal rate of return of 7.65% assuming (worst case) you die at 30 years and a day after retirement (ie - you collect 30 years worth of pension payments, but die the day after your life insurance policy lapses).

A "guaranteed" minimum of 7.65% return isn't bad - but in my opinion it is approximately what you would get from a diversified portfolio, although with less risk.

The credit risk of the annuity company (and the life ins. co. in my proposed scenario) are key elements of the analysis that can't be ignored when talking about periods of 30+ years.

 

[donheff]

I think I'd take the $5317/month "life only".

If I was your dear spouse I would kick you in your nads for that one Seriously, what if you died the next year - or in the next 10 years?

 

[justin]

If I was your dear spouse I would kick you in your nads for that one Seriously, what if you died the next year - or in the next 10 years?

See my earlier post where I proposed a scenario involving buying a 30 year term life policy for $700000 (the approximate lump sum value of the pension today). If your wife needs the income, get the policy. If you could find a better use for the $4400 per year the life insurance policy costs, then forego the policy (invest it for your kid's inheritance? a nice cruise each year?).

Buying the 100% survivor benefits will cost $7260 per year. That is a good bit of money that can be spent/enjoyed or invested (to provide support for DW in the event she survives you).

 

[Nords]

If I was your dear spouse I would kick you in your nads for that one    Seriously, what if you died the next year - or in the next 10 years?

He's just trying to make sure his spouse understands that he's worth more alive than dead...

 

[donheff]

See my earlier post where I proposed a scenario involving buying a 30 year term life policy for $700000 (the approximate lump sum value of the pension today).

Yep, I jumped before reading the follow-on post. Did you look at the term premiums after 5, 10, 15, years? I just dropped my term life last year and the premiums were on a steep upward trajectory. Of course, with passing time you could decrease the amount insured to match the decrease in the value of the missing joint pension -- complicated analysis.

 

[SteveR]

If I was your dear spouse I would kick you in your nads for that one    Seriously, what if you died the next year - or in the next 10 years?

Having been through this before I will offer some insight. My wife retired and we took the 10 year certain and life option for her. Mine was a straight pay till I die plan. Neither were COLA and no lump sum was possible.

We chose the 10 year and certain for several reasons.
1. Her health was not great and there was a possibility of an early death due to cancer.
2. Her pension was higher than mine (mine was slashed in a QDRO).
3. We knew we could do OK on our roll over IRAs if anything went wrong with either of us.
4. I was going to find another job for a few years to feather the nest.
5. We planned on having lower expenses at 5 years into our ER which would allow a lower income later but wanted a higher income early on for toys and debt reduction, etc.
6. SS was planned for age 62 for each of us; hers would have been 6 years before mine.
7. We took the "Level" option to her pension which essentially adds more from age 56 to age 62 but then reduces at age 62 to account for SS.
8. We worked through OUR numbers several times before we chose our options.

Reality Hit 7 months into retirement. She passed away and the 10 year certain pension is counting down for me. I am glad we did it that way since it allows me some financial flexibility I would not have had and my debts are being reduced to near nothing because of this cash flow.

Morale to the story............run the numbers based on your best guess of how long you might live. Look at past health history and family health history. Look at your fiances and see what works best for your situation. Nobody on a public forum can tell you what to do because we don't have all the details needed to make a choice for you. It is what works for you and your wife and your needs now and in the future. Nobody has a crystal ball and that makes this decision tough; especially since it cannot be changed.

Good Luck.

 

[justin]

Yep, I jumped before reading the follow-on post. Did you look at the term premiums after 5, 10, 15, years? I just dropped my term life last year and the premiums were on a steep upward trajectory. Of course, with passing time you could decrease the amount insured to match the decrease in the value of the missing joint pension -- complicated analysis.

I didn't look at premiums for less than 30 years. They would probably be a lot less, since the mortality rates shoot up for an 80-something year old vs. a 55 y.o.

Morale to the story............run the numbers based on your best guess of how long you might live. Look at past health history and family health history. Look at your fiances and see what works best for your situation. Nobody on a public forum can tell you what to do because we don't have all the details needed to make a choice for you. It is what works for you and your wife and your needs now and in the future. Nobody has a crystal ball and that makes this decision tough; especially since it cannot be changed.

Steve hit the nail on the head. It is pretty straight forward to do a net present value/internal rate of return calculation and optimize your expected outcome from a strictly financial point of view. Including the "soft" issues in your analysis is much more difficult.

 

[ats5g]

scubamonkey,

I just did a google seach for "pension maximization" and found some interesting links:

EF Moody wrote a short piece on pension maximization

From Florida Retirement System: Pension Maximization: Will It Work For You?

From Utah Retirement System: Pension Maximization.

Here are my thoughts. If you do go with 30 year term insurance, what happens if after 30 years, the term insurance ends, you die, and your wife gets zilch? However unlikely it is that you'll live this long, is that a chance your wife and you are willing to take. Permanent insurance is an option, although much more expensive.

You also may want to go to immediateannuities.com to see how much you would need in a lump sum to fund a certain $$ per month.

There is also a consideration of if you do take the highest payout option, and wife gets nothing when you die, does any retirement health benefits stop with your death as well.

- Alec

 

[justin]

Here are my thoughts. If you do go with 30 year term insurance, what happens if after 30 years, the term insurance ends, you die, and your wife gets zilch? However unlikely it is that you'll live this long, is that a chance your wife and you are willing to take. Permanent insurance is an option, although much more expensive.

There's a 50% chance that a 55 y.o. will live 30 more years to age 85.

But the bigger question is how much money does an 85 year old surviving spouse really need? She'll presumably have SS or SS spousal survivor benefits (right, OP?) and some portion of the $1.3 million portfolio to live off of, and medicare. Plus, you can bank the extra $2856 per year over the course of 30 years that you would get by going with the "life only" option plus 30 year term policy instead of the 100% joint and survivor payout option.

Saving the $2856 per year for 30 years and getting 8% returns on it will leave you with $350k at the end of the 30 year period. That could provide a nice continuing income stream or annuity payment for an 85 year old.

 

[ats5g]

There's a 50% chance that a 55 y.o. will live 30 more years to age 85.

But the bigger question is how much money does an 85 year old surviving spouse really need? She'll presumably have SS or SS spousal survivor benefits (right, OP?) and some portion of the $1.3 million portfolio to live off of, and medicare. Plus, you can bank the extra $2856 per year over the course of 30 years that you would get by going with the "life only" option plus 30 year term policy instead of the 100% joint and survivor payout option.

Saving the $2856 per year for 30 years and getting 8% returns on it will leave you with $350k at the end of the 30 year period. That could provide a nice continuing income stream or annuity payment for an 85 year old.

I think we're forgetting that the pension payments in the original post are all pre-tax, while the insurance payments are all post tax. So, the monthly income breaks down like:

single life annuity
monthly payment: $5,317
taxes: 25%
after tax: $3,988
monthly insurance: $367
net income: $3,621

100% J&S survivor annuity
monthly payment: $4,712
taxes: 25%
after tax: $3,534

Difference b/w the two is $87/month [$1,045 per year]. Now if we assume that the OP invests the extra $87/month, gets 8% return, incurs expenses of 0.25%, that'd be $117,780 after 30 years, without the return being taxed.

And if we assume 3% inflation, the real $$ after 30 years is only $66,499, without the return being taxed. So, if after 30 years, hubby dies, and wife gets no insurance to cover the lost pension, according to http://www.immediateannuities.com, and 85 year old female could get $836 per month, a far cry from the $4,712 she could've gotten if 100% J&S was chosen.

I have yet to see the pension max work in real life, but that doesn't mean it couldn't.

- Alec

 

[justin]

ats5g,

A flat 25% tax is very unrealistic to assume for $63000 of pension income. Given the standard deductions and exemptions for a married couple and assuming no other income, the overall tax rate would be around 10% federal, plus, say, 5% state.

Further, the amount you determined that the life only w/ term guy would have saved is $117,780 in nominal terms. Then you adjust it for inflation to get $66,499 which would yield $836 per month in real terms. Then you compare the real $836 per month to the $4712 nominal amount that the surviving spouse could have received under 100% J+S. To be fair, you need to compare nominal to nominal or real to real, not real to nominal.

Using the 15% tax rate and comparing nominal dollars to nominal dollars, the life only+30 yr term option would provide $1767 per year extra. Invested over 30 years at 8%, that would be around $200,000, which could then buy you an annuity of $2,574/mo versus $4712/mo that the 100% J+S spouse would get. 45% less for the remaining life of the surviving spouse. But you get a 50% shot at $700000 income tax free life insurance proceeds during the 30 year term coverage.

 

[scubamonkey]

scubamonkey,

I just did a google seach for "pension maximization" and found some interesting links:

EF Moody wrote a short piece on pension maximization

From Florida Retirement System: Pension Maximization: Will It Work For You?

From Utah Retirement System: Pension Maximization.

Here are my thoughts. If you do go with 30 year term insurance, what happens if after 30 years, the term insurance ends, you die, and your wife gets zilch? However unlikely it is that you'll live this long, is that a chance your wife and you are willing to take. Permanent insurance is an option, although much more expensive.

You also may want to go to immediateannuities.com to see how much you would need in a lump sum to fund a certain $$ per month.

There is also a consideration of if you do take the highest payout option, and wife gets nothing when you die, does any retirement health benefits stop with your death as well.

- Alec

You hit a major point I have not considered regarding the health insurance. I will check this out and find the answer. The current deal is that I can continue on my group plan at the group rate - but I don't know if that is true with the lump sum or if my wife can continue the coverage if i die.

 

[donheff]

Using the 15% tax rate and comparing nominal dollars to nominal dollars, the life only+30 yr term option would provide $1767 per year extra. Invested over 30 years at 8%, that would be around $200,000, which could then buy you an annuity of $2,574/mo versus $4712/mo that the 100% J+S spouse would get. 45% less for the remaining life of the surviving spouse. But you get a 50% shot at $700000 income tax free life insurance proceeds during the 30 year term coverage.

Pretty complicated. Figuring out that $700K is difficult. It is a big deal if it arrives toward the end of the thirty years but not so great if it arrives in year 1.

I guess if I was the spouse, wondering about my sunset years I would be asking what is really going to happen to that extra $1767/yr. Is it really going into an investment account that will be available if you kick before me? If not, shouldn't I (the spouse) get a big say in the call on whether to go with the spousal annuity versus insurance.

 

[ats5g]

ats5g,

A flat 25% tax is very unrealistic to assume for $63000 of pension income. Given the standard deductions and exemptions for a married couple and assuming no other income, the overall tax rate would be around 10% federal, plus, say, 5% state.

Further, the amount you determined that the life only w/ term guy would have saved is $117,780 in nominal terms. Then you adjust it for inflation to get $66,499 which would yield $836 per month in real terms. Then you compare the real $836 per month to the $4712 nominal amount that the surviving spouse could have received under 100% J+S. To be fair, you need to compare nominal to nominal or real to real, not real to nominal.

Using the 15% tax rate and comparing nominal dollars to nominal dollars, the life only+30 yr term option would provide $1767 per year extra. Invested over 30 years at 8%, that would be around $200,000, which could then buy you an annuity of $2,574/mo versus $4712/mo that the 100% J+S spouse would get. 45% less for the remaining life of the surviving spouse. But you get a 50% shot at $700000 income tax free life insurance proceeds during the 30 year term coverage.

Hi Justin,

Good point about the taxes. I re-did the calculations using the semi-correct fed and state taxes:

[edited] If we don't include inflation, I get something like $158,017 ending vaule [before taxes], which works out to $1,986 a month at age 85. I still think this could be deal breaker, given the spouse could've had $4,712 at 85. Especially since this whole pension max thingee was supposed to protect the spouse even though the husband took the single life annuity.

- Alec

 

[justin]

Hi Justin,

Good point about the taxes. I re-did the calculations using the semi-correct fed and state taxes:

If we don't include inflation, I get something like $158,017 ending vaule [before taxes], which works out to $1,986 a month at age 85. I still think this could be deal breaker, given the spouse could've had $4,712 at 85. Especially since this whole pension max thingee was supposed to protect the spouse even though the husband took the single life annuity.

It's a risk - but the only scenario in which it is a potential risk is if the husband lives past age 85 (approximately a 50% chance) and if the wife lives past 85 (approximately a 50% chance). The cumulative probability of these two events occuring (assuming the two subevents are independent) is 25%.

So the wife would have a 25% chance of being potentially at risk (the husband could still outlive his wife under this scenario and survivor benefits would be a non-issue - what are the odds that an 85 y.o. male would outlive an 85 yo female - maybe 30%?).

On the flipside, the term life insurance has a 50% likelihood of paying out $700000.

Sounds like a dice roll in the end.