Pension Annuity or Lump sum?

[A Gold One]

Hello,

This is my 1st post to this forum, but I have been respectfully enjoying the benefits of everyone’s collective wisdom here for a few years now.

Long story short - I retired 4 years ago and my wife and I are healthy. Our annual living expenses are primarily covered by annual rental and investment income, and any gaps we should be able to cover by a cash cushion. We do not anticipate needing tap an IRA until withdrawals are mandatory. I am a conservative investor by temperament – often to our detriment and at the expense of normal market gains.

The situation prompting my post is that I have a defined benefit plan from an old job that is eligible for 100% benefits when I turn 60 in a few months (i.e. if I delay taking benefits, I do not gain anything.). The monthly annuity with 50% survivor benefits (my wife is 13 years younger) would be $2,800. The lump sum payment would be $500,000.

I had been thinking that the lump sum would be taxed at ~35% on distribution and after a cursory look at investing the remaining amount and comparing that to the annuity, was inclined to just take the annuity for the peace of mind and lack of hassle. Then I discovered that I could open a new IRA and roll over the full amount without a tax hit. (I think this is correct…)

Having always assumed I would just take the annuity and forget about it, I am having trouble thinking through this clearly. My Morgan Stanley adviser recommends taking the lump sum and investing in some Blackrock funds with loads and pretty high expense ratios( BIICX for example). Based on ideas I’ve seen in this forum, I am inclined to open an IRA at vanguard and invest in something like VWINX or VTINX. I would be grateful for feedback about all this including any alternate ideas to suggest.

As a side question, when a fund is in an IRA, does it matter if the fund is designed to be tax efficient or not?
Thank you!

 

[Brat]

It doesn't matter if a fund is tax-efficient in an IRA, however, funds that aren't tax-efficient often have a lot of turnover in their investments so that aspect is worth a look.

I am now with Fidelity but our IRAs are almost 100% legacy VWELX which recently closed to outside investors. Vanguard funds purchased through Fidelity come with a fee so if you want a Vanguard mutual fund go there. BlackRock Midcap Growth is now available from Fidelity with no load.

 

[njhowie]

Yes, you can take the lump sum distribution rolling it to an IRA and there is no tax hit. However, obviously, when you withdraw from the IRA it will be taxable. When you do this rollover, try to do a trustee-to-trustee rollover. If your plan requires the check be sent to you, be sure the check is made out to your brokerage company (Vanguard) FBO (for benefit of) you. When I did this, mine required the check come to me - and they sent it in regular US mail...I was completely shocked they did this with a check so large.

My Morgan Stanley adviser recommends taking the lump sum and investing in some Blackrock funds with loads and pretty high expense ratios( BIICX for example). Based on ideas I’ve seen in this forum, I am inclined to open an IRA at vanguard and invest in something like VWINX or VTINX. I would be grateful for feedback about all this including any alternate ideas to suggest.

Your Morgan Stanley adviser gets paid to get you in to those Blackrock funds. Vanguard funds are a much better choice. Whatever the Blackrock funds offer, there is likely a similar Vanguard offering with minimal expenses/fees.

 

[OldShooter]

... My Morgan Stanley adviser recommends taking the lump sum and investing in some Blackrock funds with loads and pretty high expense ratios( BIICX for example). ...

Of course. This guy is not your friend and is not behaving like a fiduciary regardless of what the paperwork says. He is concerned primarily with his AUM fee. Ditch him.

(NB, Morgan Stanley's "Wealth Management" business is something like $3.5B total and about 25% goes to the bottom line. Does this sound like a business that is interested in helping its customers or in milking them?)

Read "The Coffeehouse Investor" and "The Bogleheads' Guide to Investing." Both are easy reads and IMO both will be financially beneficial for you. After reading them you will be better equipped to deal with the question you are asking.

 

[Running_Man]

I see that based on your ages a $500,000 annuity with 50% for survivor would pay $2,067. Of course your pension is better than that since you will get 100% if the survivor happens to be you. So the value if you were buying an annuity would be along the lines of 700K.

With a payout of 6.7% of the value of the annuity I think the annuity is the better financial decision.

As far as what your financial advisor offered, BIICX is a 35-50% equity that does far better in down markets and I would assume in your conversations with him the loss of capital may have come up as a concern, it does have annual fees of 0.7% but has high current income and 8% earnings over the last 10 years and about 9 percent YTD. It is a top long term performing fund and in the top quartile of it's group and has beaten the passive index benchmark, despite the fees by 1.25% average per year for the last 10 years. That being said I think the far better value is the annuity.

 

[brett]

Annuities should always be slightly less attractive because they are based upon a healthier group of people.

Individuals with heath challenges or early mortality rates in their families do not typically buy annuities. Annuity vendors are well aware of this.

You could look at combining an annuity with some term life to give you the best of both. IF the numbers work.

There are other valid reasons to take a pension instead of a commuted value. OTOH, commuted values are high at the moment because of the low interest rates.

 

[Rianne]

If we were offered a lump sum payment for DH pension, I'd take it. We plan to take (at 65) the 100%, no survivor benefit, but DH has life insurance to cover me. If I survive DH, after a year, pension stops. Why wouldn't one take the lump sum? There's a guarantee on the lump sum, no guarantee on health or longevity.

As far as the investment, roll over into Vanguard IRA.

 

[travelover]

I had to make the same choice. I took the annuity because I couldn't replicate it for the lump sum. If I'd needed to throttle my income to qualify for ACA subsidies it would have changed the equation.


I'd also ditch that advisor. He is not working for you.

 

[gwraigty]

Why wouldn't one take the lump sum? There's a guarantee on the lump sum, no guarantee on health or longevity.

This is what we did when my husband's company decided to offload their pension obligations to a then-yet-to-be-chosen insurance company. Most employees chose the lump sum, which was deposited into the 401k. All the spreadsheet analysis I did for a month didn't help, due to the unknown variables. The ultimate deciding factor was that my husband didn't like the idea that if he died, the pension got cut in half. No regrets.

 

[CardsFan]

For the annuity, with a 13 year age difference, I would look at a 100% survivor benefit (or at least 75%), if offered.

That said, I would still probably take the lump sum, because if something did happen to both of us, it can be inherited by our son. But if you do not have any close heirs, it probably doesn't matter either way, since it sounds like you don't really need the money to live your lifestyle.

 

[pb4uski]

I see that based on your ages a $500,000 annuity with 50% for survivor would pay $2,067. Of course your pension is better than that since you will get 100% if the survivor happens to be you. So the value if you were buying an annuity would be along the lines of 700K.

With a payout of 6.7% of the value of the annuity I think the annuity is the better financial decision.

As far as what your financial advisor offered, BIICX is a 35-50% equity that does far better in down markets and I would assume in your conversations with him the loss of capital may have come up as a concern, it does have annual fees of 0.7% but has high current income and 8% earnings over the last 10 years and about 9 percent YTD. It is a top long term performing fund and in the top quartile of it's group and has beaten the passive index benchmark, despite the fees by 1.25% average per year for the last 10 years. That being said I think the far better value is the annuity.

+1 The choice seems to be $500k cash now or $677k of value with the pension... I'd take a chance since you are both healthy and go with the pension.

 

[skipro33]

You didn't indicate if the pension has a COLA or is fixed at $2,800. (Drops to $1,400 if wife outlives you)
If the pension has a COLA of 2%, I'd probably go for the lump sum. If the pension has a COLA higer than 2%, mine has 5% cap, I'd go with the pension.

 

[A Gold One]

Great feedback and much to consider so far - thank you.

Skipro33 - the pension is fixed @ 2800 with no COLA.

 

[skipro33]

Great feedback and much to consider so far - thank you.

Skipro33 - the pension is fixed @ 2800 with no COLA.

In that case, I'd roll it to an IRA, invest in an index fund 100% equity (doesn't sound like you 'need' the money for your current living expenses) and take profits if and when you think you want some dough. Historically, 10% growth on something that mirrors the S&P500 will average out $4,166 a month, so even if you invest conservatively, and only see 6% growth, it's still same as the pension(annuity) AND you get to keep the original investment for an emergency.
Just having $500,000 and knowing you can liquidate if an emergency comes up provides a substantial peace of mind for many. Let it grow and you'll soon have enough to fund the expensive retirement home when you are really old. Lots of options if you take over the management of that 1/2M.

 

[MarieIG]

If we were offered a lump sum payment for DH pension, I'd take it. We plan to take (at 65) the 100%, no survivor benefit, but DH has life insurance to cover me. If I survive DH, after a year, pension stops. Why wouldn't one take the lump sum? There's a guarantee on the lump sum, no guarantee on health or longevity.

As far as the investment, roll over into Vanguard IRA.

We will be taking the 100 percent joint and survivor option. There was no additional cost to add a ten year certain on top of that (for one of the kiddos.) I've seen several instances when a widow thought there was life insurance, but when she needed it found out that the policy had lapsed. Terry also commented on this a while back. The cost of term goes up as the insured ages, and people tend to become forgetful. Moreover, with my husband's plan, no pension, no access to the (subsidized and comprehensive) health insurance, and if I die first, he gets an increased payout: at the single rate.

The pension will give us a reliable base income, more flexibility with the liquid assets, and a third leg of the retirement stool.

Obviously, YMM (and does) V.

 

[DrRoy]

With a payout of 6.7% of the value of the annuity I think the annuity is the better financial decision.

+1

 

[street]

One thing to keep in mind is, if you or your wife or you pass away earlier then expected, your remanding pension funds will be done also. If you take control of your money by taking the lump sum, in early death you have your funds to pass on to heirs. I for one want the control of that money and want to invest it rather then a monthly check. To me it is nothing more then an annuity that is betting you die early, so that investment firm can capture those remaining funds at death. JM2¢

 

[rothlev]

I would also look at how much secure guarenteed monthly income you have. If your social security covers most of your living expenses, then you may not need or want the pension. However if you have longevity on your side and save some of the monthly proceeds , I think both you and your estate will come out ahead on the pension. Also compute your wife's expenses if you should die first and she has to live on less income. She may be very happy to have the pension income.

 

[rothlev]

hypothetically - save and invest $1400 a month of your pension income for 20 years, then die , spend the other $1400. Say your investments grow at 6%. Now your wife has around $600k plus her survivor benefits of $1400 per month.

 

[target2019]

The situation prompting my post is that I have a defined benefit plan from an old job that is eligible for 100% benefits when I turn 60 in a few months (i.e. if I delay taking benefits, I do not gain anything.). The monthly annuity with 50% survivor benefits (my wife is 13 years younger) would be $2,800. The lump sum payment would be $500,000.

Using the math from the link below, take the annuity payment, based on the 6% test (or rule).

$2,800 * 12 / 500,000 = .0672 (6.72%)

https://clark.com/personal-finance-credit/when-you-should-take-lump-sum-over-pension/

When the percentage is below 6.0%, the hope is that you can reasonably beat the monthly payout by taking the lump sum and investing it properly.

In our situation, peeking behind the scenes of employer, we feel there is a risk factor that should be included in our calculation. The pension is 65% funded. I believe one should know (or find out) the funded status percentage.

 

[pb4uski]

One thing to keep in mind is, if you or your wife or you pass away earlier then expected, your remanding pension funds will be done also. If you take control of your money by taking the lump sum, in early death you have your funds to pass on to heirs. I for one want the control of that money and want to invest it rather then a monthly check. To me it is nothing more then an annuity that is betting you die early, so that investment firm can capture those remaining funds at death. JM2¢

Wrong on two counts.

The OP states that the pension is 50% survivor and DW is 13 years younger (47 vs 60)... so if the OP's DW dies then she continues to receive $2,800/mon for the rest of his life... if the OP dies then DW receives $1,400 for the rest of her life. To say that "if you or your wife or you pass away earlier then expected, your remanding pension funds will be done also" is wrong.

Also, there is no "investment firm" involved. This is a pension plan. Even of it were an annuity it would be an insurer and not an investment company... only a life insurer can issue an annuity. And even if it were an annuity issued by a life insurer, if an annuitant dies early the remaining funds are not profit to the life insurer, they serve to fund benefits for those who live longer.... and the same is true for the pension plan. I was the controller for an annuity line of business and our mortality gains and losses were negligible... by design... our pricing was designed to make our money on a spread... not on mortality... and this is common practice IME.

 

[target2019]

hypothetically - save and invest $1400 a month of your pension income for 20 years, then die , spend the other $1400. Say your investments grow at 6%. Now your wife has around $600k plus her survivor benefits of $1400 per month.

+1 - There are many ways to look at this decision. Your approach favors taking the monthly pension.

An additional thought about monthly pension, is that a lump sum taken by retiree, and placed into account managed by other(s), might see a drag on performance due to expensive funds and an advisor fee.

 

[Katiek]

There is a financial aspect to the choice and there is also an emotional aspect. How secure is your rental income. In another economic downturn, could there be gaps in that income?

How would you feel if you took the lump sum and the market had a significant downturn?

How large are your other investments? If you had an emergency and needed a large sum of cash up front, do you have other money for that?

It sounds like the financial choice isn't obvious here. Either option might pay more depending on certain circumstances, so a lot of the choice here is just which makes you feel more secure. On the plus side, don't get caught by analysis paralysis, because neither choice will be "bad".

Personally, I'd probably pick the annuity because I won't have other guaranteed monthly income (except for SS, and who knows if that will be "guaranteed" by the time I am eligible). I'll have to rely mainly on investment income, so having an annuity would be a bit of diversity and make me feel secure.

But other people would feel more secure with the lump sum and knowing they control the money. If you choose this, do not go with the Blackstone funds and the loads and AUM. A rollover to Vanguard or low cost Fidelity funds (if you want hte comfort of dealing with an in person contact) would make more financial sense.

 

[pb4uski]

hypothetically - save and invest $1400 a month of your pension income for 20 years, then die , spend the other $1400. Say your investments grow at 6%. Now your wife has around $600k plus her survivor benefits of $1400 per month.

And at a 4% WR that $600k would provide $2k/month of inflation adjusted income in addition to the $1,400/month pension benefit which would be worth about $800/month after 20 years of inflation... or in total about $2,800 of monthly income.

The other way the surviving spouse could be provided for would be with a term life insurance ladder on the OP designed so the death benefit provides for the $1,400 of pension benefit that is lost if the OP dies.

 

[gwraigty]

One thing to keep in mind is, if you or your wife or you pass away earlier then expected, your remanding pension funds will be done also. If you take control of your money by taking the lump sum, in early death you have your funds to pass on to heirs. I for one want the control of that money and want to invest it rather then a monthly check. To me it is nothing more then an annuity that is betting you die early, so that investment firm can capture those remaining funds at death. JM2¢

+1