Increase Pension vrs Cash to Def Comp?

[Joss]

My wife and I are 99% sure we're retiring on 12/28/07.

The leave policies where we are both employed allow us options that amount to either of these choices:

a. Apply all our excess sick and annual leave to time in service which increases our combined pensions by about $3000 annually.

b. Convert the maximum allowed leave to money which puts about $50,000 into deferred compensation (this makes it non-taxable until withdrawal down the road).

I'm thinking this is a no-brainer to go for the money. We're both currently healthy and and in mid/late fifties.

Any contrary opinions?

 

[MasterBlaster]

Using a 16X factor for a non-inflation indexed pension I calculate that either payout (lump sum or pension increase) is about the same.

So other than personal choice, this is not a no-brainer. The two payout methods are equivalent in my book.

 

[Joss]

So if the pension receives COLA's (commonly but not guaranteed), it would tip in favor of the pension?

 

[MasterBlaster]

When a pension has an inflation rider (ie. increases with inflation) then I would use a 25X factor to compare the two.

If that is the case then a $3k/year pension would be roughly equivalent to $75k. Notice that the 25X factor is equivalent to a safe withdrawal rate of 4 percent of a lump sum.

 

[Joss]

That's more complicated than I figured.

I just divided the $50K by the $3K to see it would take 16.7 yrs to receive it all through the pension.

Then I put the $50K in a spreadsheet and found that, untouched, an annual 4% return would increase it to about $94K in that time, with the growth being tax free.

Conversly, if I put the $3K in the 4% spreadsheet, but diminish each $3K annual amount by the income taxes, in 16 years it only grows to about $60K.

 

[MasterBlaster]

Unless you want to leave the money to your heirs, you need to pay income taxes on the lump sum whenever you spend it. So reduce the $94k by your tax rate before you compare numbers.

Presumably you will spend the $3k/year as it is paid. To do that you would need the lump sum ($50k) now to generate the payment stream. Depending on how your pension payment stream is configured, you may be able to direct the money into an IRA type account and defer the taxes until some years later.

 

[Joss]

Thanks for your patience. I appreciate the help.