Help! Annuity or Lump Sum Decision

[Running_Man]

Quote:

Originally Posted by wmc1000 BCG - I ran your numbers but left the CPI index checked and it returns a 58.1% success rate. Setting the inflation rate to zero IMHO doesn't allow prices to increase yet just because his pension is non-cola'd doesn't mean his expenses never increase.

The proper treatment is comparing a non-indexed annuity against a lump sum not whether or not $405,000 can withstand a 36K per year inflation adjusted withdrawal 6 years from now. The idea is to understand the effect this one piece will have on the overall portfolio and the chance the portfolio will perform better than the annuity, not the OP's expenses. As such not having inflation is the proper factor in the analysis.

[Cobra9777]

Quote:

Originally Posted by wmc1000 BCG - I ran your numbers but left the CPI index checked and it returns a 58.1% success rate. Setting the inflation rate to zero IMHO doesn't allow prices to increase yet just because his pension is non-cola'd doesn't mean his expenses never increase.

That's not correct. This analysis has nothing to do with OP's actual expenses. It's simply testing whether or not a $405K lump sum could support 30 years of $36.7K non-COLA withdrawals, given historical market returns. Big_Hitter says no way, while offering no analysis. BCG says yes-way and offered a FIRECalc-based analysis.

Having said that, I think there was a mistake in what BCG posted. He ran 30 years which INCLUDED the 6 years prior to starting the annuity, so only 24 years of payments.

I ran it differently... On the start page I put zero expenses, 405K and 36 years. I left the retirement date as 2017. Then I entered off-chart spending of 36.7k starting in 2023 with no inflation. Result was 83.8% and $675K average ending balance. Same result in ********.

Again, as I posted before, I'm not advocating the lump sum. I agree with Running_Man, this is a tough call. I just don't think there's an obvious case in favor of the annuity, especially if you believe that future market returns will be similar to the past.

[Big_Hitter]

just to clarify, i said "no way" to the 97% success rate leaving 2M to kids

I'm also not advocating either decision.

[Blue Collar Guy]

Quote:

Originally Posted by wmc1000 BCG - I ran your numbers but left the CPI index checked and it returns a 58.1% success rate. Setting the inflation rate to zero IMHO doesn't allow prices to increase yet just because his pension is non-cola'd doesn't mean his expenses never increase.

I agree with the second half. I know his expenses will go up, thats what the rest of his nest egg is for. But the 405K will only pay out the 36.7K, and it never goes up.Its not 36.7k constant dollars. its 36.7 till death .

[flintnational]

Quote:

Originally Posted by Running_Man The proper treatment is comparing a non-indexed annuity against a lump sum not whether or not $405,000 can withstand a 36K per year inflation adjusted withdrawal 6 years from now. The idea is to understand the effect this one piece will have on the overall portfolio and the chance the portfolio will perform better than the annuity, not the OP's expenses. As such not having inflation is the proper factor in the analysis.

+1

[alaska55]

What happen to all the predictions of low return for the next 10-20 years. I'm pretty sure some of the same people saying take the lump sum are the same posters talking about low returns. I never said take the annuity, I said depends on the OP overall situation. BCG if you think you can make 405000 last 30 years with 36700 WD rate, i got a gold mine for sale. 36700 WD for 30 years is 9%. I put in 405000 for 30 years, 3% cpi, 60/40 with 5 year treasuries. Guess what 2.6 success rate.

[pb4uski]

Here is my FIRECalc result looking that a scenario of taking the lump sum, investing it in a 75/25 portfolio and then beginning $36,700 benefit payments in 6 years.

Spending = $36,700, Portfolio = $405,000. Years is 43 (to age 100 since OP is 57). Then add a non-inflation adjusted pension of $36,700 a year in 2017 and non-inflation adjusted off-chart spending of $36,700 a year beginning in 2023... to offset that withdrawals will not start until 6 years from now when OP is 63. Set inflation to fixed at 0%. All other factors default, so 75/25 portfolio.

There is a 75.0% success rate... or a 25% chance that he will run out of money... vs a 0% chance if he takes the annuity. OTOH, if he takes the lump sum and invests it and things turn out favorable then he might have $3.6 million on average.

How lucky does he feel?

Quote:

Here is how your portfolio would have fared in each of the 104 cycles. The lowest and highest portfolio balance at the end of your retirement was $-3,492,104 to $17,859,668, with an average at the end of $3,646,332. (Note: this is looking at all the possible periods; values are in terms of the dollars as of the beginning of the retirement period for each cycle.) For our purposes, failure means the portfolio was depleted before the end of the 43 years. FIRECalc found that 26 cycles failed, for a success rate of 75.0%.

Then, using the Investigate tab, solve for the spending level with 99% success.

Quote:

A spending level of $30,498 provided a success rate of 99.0% (104 total cycles, of which 1 failed).

P.S. I used the pension/off-chart spending rather than $0 spending and just non-inflation adjusted off-chart spending beginning in 6 years so I could later solve for the spending level that equates to a 99% success rate.... if you use the $0 spending approach then that feature doesn't work.

[alaska55]

How did you come with $32700 spending?

[pb4uski]

Quote:

Originally Posted by alaska55 How did you come with $32700 spending?

I messed up... updated to $36,700 above.... lowers success rate from 89.4% to 75%.... generally consistent with Cobra9777's analysis except I used 43 years (to age 100).

[alaska55]

This is a good read by Jim Otar on annuities and Zone Strategy.

http://retirementoptimizer.com/articles/Article105.pdf

[Blue Collar Guy]

Quote:

Originally Posted by alaska55 What happen to all the predictions of low return for the next 10-20 years. I'm pretty sure some of the same people saying take the lump sum are the same posters talking about low returns. I never said take the annuity, I said depends on the OP overall situation. BCG if you think you can make 405000 last 30 years with 36700 WD rate, i got a gold mine for sale. 36700 WD for 30 years is 9%. I put in 405000 for 30 years, 3% cpi, 60/40 with 5 year treasuries. Guess what 2.6 success rate.

Wheres the gold mine? So you think its a 2 % success. Interesting. Ill need to assay that mine. And now were going out to age 100, and its at 75 %. Ill stand by my 30 year numbers at 97 % with 2 million on average left over. Lets take it to age 110 I bet Its even a lower success rate. When you come back to reality, let me know.

[alaska55]

Quote:

Originally Posted by CRLLS I'm with BCG. As a matter of fact, I did take a lump sum a few years back. A wise choice was to keep it at the co and take the annuity at age 65. One thing I evaluated was that even though the annuity was larger to start after some years, taking a 4% from the lump sum (and increasing with COLA) the lump sum came out higher. 2nd) anything left should both DW And I cease living, the kids would benefit where the Annuity would not give that benefit. 3rd) I was not comfortable with someone else having my family future in their hands. 4th) now..... the way the pensions are currently running, in some cases, the PBGC(?) is allowing pensions to short pay everyone, even those already collecting before they default. This prevents the pensions from going bust and defaulting to the PBGC. So future payment at promised levels is no guarantee anymore. I'll take my lump sum at 75(ish)% now, thank you. This is a group of varying thoughts and practices. Nobody knows for certain which is the best life decision until we are dead and gone. Only in hindsight is vision 20/20.

In 2015 your pension guarantee was around 60K, anything below that was not reduced, you're well under that. Is your pension even covered by PBGC? This is for a single payer, if your in a multi employer plan all bets are off.

[pb4uski]

Quote:

Originally Posted by CRLLS ....4th) now..... the way the pensions are currently running, in some cases, the PBGC(?) is allowing pensions to short pay everyone, even those already collecting before they default. This prevents the pensions from going bust and defaulting to the PBGC. So future payment at promised levels is no guarantee anymore. I'll take my lump sum at 75(ish)% now, thank you.....

This is a great example of a little knowledge being dangerous.

What you are reffering to only applies to multi-employer plans and the OP's plan is not a multi-employer plan.

[bada bing]

One other small factor you have to account for when you model using something like FIREcalq is the guarantee of the lump sum to the estate in the event of an early demise. You are getting an advantage by taking the lump sum that can be modelled by including the cost of a term life policy that declines in payout from the full lump value to zero over the life expectancy. It is a not insignificant advantage for the lump in the early years. Of course, if you outlive life expectancy you have to start an addition to the annuity side.

Another factor is that inflation in the future will skew the advantage towards the lump sum. There is a potential for a big difference in modelling results based on inflation assumptions. I think it is correct to anticipate lower real returns on market portfolios in the future, but that may very well mean something like 8% nominal returns, 5% inflation and 3% real returns. That type environment will decimate a non-cola'd pension value.

I personally elected to take a lump sum about a year ago with similar cost/benefit to the OP, although my pension was only about 1/3 the size. The offer I received was not "fair" compared to the cost of a SPIA, but that isn't nearly the whole picture. You have to input assumptions about market returns, future segment rates and especially future inflation.

[Turboslacker]

I face the same dilemma. Ran actuary numbers and researched pros and cons. Changed my previous decision and will choose the lump sum instead of lifetime pension payments. Key drivers are 100% control of my investment $, much more investment options, no COLA pension, able to inherit to kids unlike a pension, uncertainty any company will remain solvent, don't trust govt pension backup plan.

[flintnational]

OP here. If you take the lump sum and assume a 75/25 AA with an average annual return of 8% after taking annual distributions of $36.7k you are left with about $2M at age 93 . However, look at the WR for the first few years. And this assumes you get 8% between age 57, current age, and 63. IMO, A poor sequence of returns early on would put this plan in jeopardy. Like others, I think the threshold rate that must be overcome to show a benefit for the lump sum is about 5.75%. While probably achievable in the long term, it might not survive in the short term.

Lump Sum
$405,000
Return
Age 8.00%

58 $437,400
59 $472,392
60 $510,183
61 $550,998 Effective Distribution
62 $595,078 WR
63 $605,984 6.06% $36,700
64 $617,763 5.94% $36,700
65 $630,484 5.82% $36,700
66 $644,223 5.70% $36,700
67 $659,060 5.57% $36,700
68 $675,085 5.44% $36,700
69 $692,392 5.30% $36,700
70 $711,083 5.16% $36,700
71 $731,270 5.02% $36,700
72 $753,072 4.87% $36,700

[flintnational]

Quote:

Originally Posted by bada bing I personally elected to take a lump sum about a year ago with similar cost/benefit to the OP, although my pension was only about 1/3 the size. The offer I received was not "fair" compared to the cost of a SPIA, but that isn't nearly the whole picture. You have to input assumptions about market returns, future segment rates and especially future inflation.

Quote:

Originally Posted by Turboslacker I face the same dilemma. Ran actuary numbers and researched pros and cons. Changed my previous decision and will choose the lump sum instead of lifetime pension payments. Key drivers are 100% control of my investment $, much more investment options, no COLA pension, able to inherit to kids unlike a pension, uncertainty any company will remain solvent, don't trust govt pension backup plan.

Thank you both. It is a tough decision.

FN

[pb4uski]

Another way to look at the annuity/lump sum decision is if you had the lump sum and had the opportunity to purchase a SPIA at favorable rates compared to a commercially available SPIA market rates, would you take advantage of the opportunity (not unlike the decision to defer SS is essentially buying a COLAed SPIA by making monthly premium payments the time of deferral).

Also, there is an aspect of how much of your spending do you want from guaranteed income sources.

In theory, unless you have achieved your target percentage of guaranteed income those who prefer pension benefits over the lump sum should also be the same people who would lean towards deferring SS. I know that is true in my case.... we intend to defer SS to at least FRA and perhaps age 70 and we also took the pension rather than the lump sum... in both cases it is like buying something that is on sale and a good deal. The pension increased our guaranteed income sources as a percent of our spending from ~45% to 54% (but my pension was ~1/2 of the OPs).

[flintnational]

Quote:

Originally Posted by pb4uski Also, there is an aspect of how much of your spending do you want from guaranteed income sources.

This is probably the largest personal factor I am considering. We can achieve a SWR without this pension (currently at 3%). OTOH this pension, the DW's small future pension and our SS at about age 64/65 cover our inflation adjusted budget. Accordingly, this structure has allowed us to keep a fairly aggressive stock allocation at 70% (We will likely never need this money). With the annuity option, I can let the stock allocation drift even higher in the future. If I take the lump sum, I will be reducing portfolio diversification and will need to take additional risk to achieve a reasonable return on the payment.

FN

[gayl]

Quote:

Originally Posted by flintnational One time lump sum offer $405k (may not be available in the future) Annuity option - Non Cola

personally, I took the annuity option but mine has a 4% annual cola max whereas yours will be diminished by inflation.