Lump Sum Versus Annuity

[BeachOrCity]

I recently had to decide this same thing. I am 53.
My pension was basically 7%+ of the lump sum with 50% JS.

To me it was a no brained for the annuity.

Your pension is not quite as rich on a percentage basis but is still much better than you could buy on the open market. And for that reason I would take it.

You want a 3 legged stool pension social security and savings. THat makes it easier to handle if one of he legs has problems

 

[SpinDr]

Hello,

I was in a similar scenario awhile back and found this decision to be tough. What I did, which helped in my choice, was to take the lump sum and to run that sum out over a 40 year timeframe.

In that run-out I started matching what I would have received in pension payments as deductions from the lump sum annually when the pension would have started.

I used 4 different rates of return over that time period, 5%, 6%, 7%, and 8%. From relatively conservative to more ambitious.

With the 5% scenario I ran out of the lump sum at 34 years. All other scenarios either made it past 40 years or grew substantially. A side benefit of this exercise was to see the amazing differences in total return as the lump sum at 7% and 8% grew to many millions. Really, really reinforced my focus to reduce investment fees. A 1% difference in returns over 40 years was astounding.

To remain somewhat conservative with the payout I invested it in Vanguard Wellington and Wellesley. There are lots of other variables but that exercise helped in my decision.

Good luck!

 

[jazz4cash]

I'm surprised I never see any reference to a relative value disclosure in these discussions.
When I had to make this decision, the disclosure documents included a "relative value" calculation for each option (lump sum, straight life, J&S-Spouse @ 2/3rds, and J&S-Non-spouse). As I recall, lump sum vs. Straight life were within 2% of each other (e.g. relative values of 100% and 102% or something like that). The J&S-Spouse relative value was around 107% (e.g. megacorp was subsidizing the survivor benefit). Sure enough I could find annuities that were very close to the straight life payment, but when I included the survivor benefit, the outside annuity payments were quite a bit less.

 

[Midpack]

- I cannot split the money and take half lump sum, half.

You can take the lump sum and buy a $225K annuity and keep half. The annuity payouts you’re being offered aren’t that different from other annuity options.

there is probably a haircut on the J&S option plus you had his age entered incorrectly

He hadn’t shared his age or other details when I posted...

unless the market tanks again or you outlive the lump sum, then you are eating cat food.

Same risk as any other nest egg money re: cat food. The OP payout is not a wildly better annuity payout than the broad market, though marginally better it appears. If your personal risk aversion makes annuities appealing, by all means. Annuity insurance can fail too, though it’s very rare so far. No guarantees, but odds are one can do better with a WR scheme, and you can buy an annuity anytime with a lump sum. If the OP takes this annuity now, done deal. That is the right decision for some, wrong for others.

 

[Big_Hitter]

Same risk as any other nest egg money re: cat food.

except that this nest egg allows you to take the risk off the table in a manner not available outside the plan

 

[Jerry1]

Thanks for all the input. Unfortunately, it’s probably like our beloved when to take SS threads. No absolute right answer. My struggle is to balance my conservative nature (fear) against the potential benefits of the lump sum (greed?). As has been said, the thing to keep in mind is the blessing that my current position puts me in a place where I’ll likely be okay either way. Thanks, the discussion helps.

 

[Big_Hitter]

I'm surprised I never see any reference to a relative value disclosure in these discussions.
.

those disclosures only apply to the immediately available benefits, annuity or lump sum

they do not take into account the relative value of deferred options; for example, I recently received a lump sum offer from my prior mega:

immediate annuity = X
lump sum = 250X

relative value - lump sum is 125% more valuable than the annuity

but....if I defer the annuity 4 months, it becomes 1.32X

think I took the offer?

 

[TwoByFour]

When making the decision of annuity vs. lump sum, don't get too hung up on the relative values of the two. Risk is a huge factor when determining your retirement assets and cash flows so I would give that a lot of weight in the decision. An annuity *may* have low risk, depending on the details (e.g., is it COLA?). For us (retired) most of our recurring cost expenditures are covered by lowest risk cash flows (SS and an annuity). Our discretionary spending is covered by higher risk assets (equities and riskier fixed-income).

 

[Floridatennisplayer]

Those might be intriguing numbers but without knowing how old you are, what state you’re in and what the annuity terms are, I’m not sure how we can evaluate. But I put some assumptions in immediateannuities.com for a $450K SPIA and it generated as much as $29,676/yr for life. More $ than the options you’ve seen?

If you take the annuity now, I assume you’re locked in with no way out.

If you take the lump sum, you can always buy an annuity if you’d like in a month, year, five or whatever. And yields are still historically low at present so you will probably be able to buy an annuity with a better payout later if you want. And they get cheaper with age all else being equal while your lump sum grows?

I can’t imagine any company I’d be comfortable funding my pension/annuity for life if indeed yours is.

And there are other options for income as others have noted above.

Your decision, lots of options, choose wisely.

To me taking the lump sum was having your cake and eating it to...

This!!!!!

 

[Midpack]

except that this nest egg allows you to take the risk off the table in a manner not available outside the plan

At a cost, its not as though there’s no downside to taking the annuity - lower payout is probable. If you want a guarantee, it comes at a cost.

 

[savory]

How would you feel if the market dropped like it did in 2008 and suddenly your lump sum was worth a lot less . I retired in 2008 and the only thing that kept me sane was my pension which stayed stable while my investments dropped by a third .

This was my basic rationale for taking a pension. Related to this, my research suggested people with pensions had less worries in retirement. Not sure that is true but it has worked for me.

So, it is possible that my company and PBGC will go under or need to reduce my pension. Losing my pension does concern me. However, I use very little of my savings to support my lifestyle. So, like others have said, over the last 6 years my savings have grown to a point that I can maintain my lifestyle without my pension, if it should come to that.

Now if my pension stays in place and the market drops, I have virtually no worries. I also invest with a high percentage of equities as my view is long term.

So, as I stand now, I am 'saving' (not spending gains) for a big personal event, charitable giving, and/or inheritance for my children. I expect there are many on this forum who can say the same thing that are on pension or took the lump sum.

 

[HI Bill]

1) I don't want my $ held with my company for 30 years after I retire, so I'd take the lump sum.
2) I would not invest it in an annuity, especially, a fixed annuity, as there is no inflation protection.
3) I would just maintain AA, but that's just me.

 

[Floridatennisplayer]

Funny how a lot of people defend taking the lump sum and investing it and they calculate magical returns of 6%, 7%, 8%.

I’m the guy worried that the market will tank during my retirement years with losses of 25%, 40%, 50% which would be devastating...... I like annuities as a part of my portfolio for the protection of a big drop in the market.

 

[HI Bill]

Funny how a lot of people defend taking the lump sum and investing it and they calculate magical returns of 6%, 7%, 8%.

I’m the guy worried that the market will tank during my retirement years with losses of 25%, 40%, 50% which would be devastating...... I like annuities as a part of my portfolio for the protection of a big drop in the market.

Many of us see a great difference in taking an annuity from your former employer (who has a greater risk of going bankrupt in 30 years) and buying one from an annuity company. Just remember that if you have any sort of bucket approach that's good for 1-3 years of emergency funding in a downturn, you're likely to be ok. Assuming we don't go belly up like Greece did due to debt.

 

[street]

unless the market tanks again or you outlive the lump sum, then you are eating cat food

The company that holds the pension could tank then what do you do?

 

[Big_Hitter]

The company that holds the pension could tank then what do you do?

private pensions are insured (to certain limits) by the PBGC

 

[Cobra9777]

I took the annuity on a small non-COLA pension with a payout ratio of 6.5%. At the time, I remember running the numbers in FIRECalc and other tools. If you believe FIRECalc's rich history is indicative of the future, then I definitely traded off some long-term upside potential for more predictability. But our objective was to reduce the risk and uncertainty of relying too heavily on market performance and portfolio withdrawals to cover retirement expenses, especially early on. DW and I are more confident to spend on travel and hobbies early in retirement with a diversity of income streams. Not sure, but I think we might have been more frugal early on without the pension. With SS X2 still to come and a sizable portfolio outside the pension, inflation is not a major concern.

DW has a larger partial-COLA government pension that only had a partial lump-sum option, and it was not a very good option. So she took the annuity as well. By the time we take SS, our 3-legged stool will have 3 roughly equal-sized legs, which means about two-thirds guaranteed income, although that drifts lower over time due to the non-COLA/partial-COLA nature of the two pensions. Still, that may seem high to some, but we're comfortable with it. We are now 57 and 58 and I'm still a bit negative about the long-term viability of SS. And my own spreadsheets are less bullish than FIRECalc's history. Both pensions are well funded and well managed. So FWIW, that was our thinking on lump sum vs annuity.

 

[njhowie]

In all the replies, I don't see any which raise the possibility that the pensioner/survivor could pass away long before collecting anything close to the breakeven point of the lump sum. I always reminisce about the thread from someone who did everything "right", delayed taking SS until age 70, and then a few months before hitting 70, he gets diagnosed with pancreatic cancer.

Of course, we don't regularly consider the possibility, and you may conclude "Well, if I do pass away earlier than anticipated, what do I care, I can't spend it anyhow". However, it could be a significant amount which would be available to your family/heirs if you had taken the lump sum. Depending on the payout option you choose for the pension or annuity, you may only be guaranteed a certain minimum payout amount, or possibly no guarantee at all.

 

[Big_Hitter]

In all the replies, I don't see any which raise the possibility that the pensioner/survivor could pass away long before collecting anything close to the breakeven point of the lump sum.

valid concern, however....

like you said, if you (and your spouse) die before the break even point then you didn't outlive your assets, which is an important criterion in retirement planning: avoiding actuarial ruin

 

[Chuckanut]

valid concern, however....

like you said, if you (and your spouse) die before the break even point then you didn't outlive your assets, which is an important criterion in retirement planning: avoiding actuarial ruin

Good point.

It's about assuring a financial situation that gives best retirement, not squeezing the last dollar out of whatever pile it's hiding in.

 

[FIREHAPPY]

I had a similar situation / decision to make in 2015. My company gave employees a choice between lump sum or annuity. Unfortunately, the employees didn't know which firm would win the bid to provide the annuity prior to making a decision.

A large insurance company (contributor to the financial crisis) was on the list of possible annuity providers and I wasn't comfortable with the firm as a stable counterparty. I took the lump sum and invested the money in a total market index fund. I have been very fortunate with my decision given the stock market performance the last several years. It has worked out well for me thus far.

I might have chosen the annuity had i known which firm would win the annuity contract but have been very happy the $ in my 401k.

The lump sum option should offer (at least historically) best ROI if you are willing and able to manage through a downturn which WILL happen eventually.

I retired in 2016 and haven't looked back. Good luck on your decision!

 

[bada bing]

I have vested for 4 different mega-corp pensions. I have been bounced around a lot in my career. I was given the opportunity to lump sum out of 2 of the old pensions a couple years ago. In both cases I took the lump sum even though the annuity terms offered were slightly better than I could find on the open market. Both of these pensions were "Defined Benefit" type plans, which makes the prevailing interest rates an important component in calculating a lump sum.

I have one remaining old DB pension that I have not been offered a buyout of yet. I also have a current active Cash Balance plan with my current employer. I probably will take the annuity on the current plan, but wait until age 70 to annuitize. I'm probably stuck with the annuity on the remaining old DB pension.

The arbitrage strategy of taking the lump sums on the old DB pensions is working so far for me. If I can get better than interest rate returns in the interim and if interest rates increase in the interim, I will have the opportunity to buy an annuity in the future with better terms and with money that appreciated at a greater rate outside of the pension plan. So far the returns on my lump sums are well above annuity interest rates and the market interest rates are increasing.

I sort of doubt I will buy an annuity in the future, but the arbitrage play is a useful concept to evaluate a current annuity/lump sum decision.

 

[gwraigty]

I had a similar situation / decision to make in 2015. My company gave employees a choice between lump sum or annuity. Unfortunately, the employees didn't know which firm would win the bid to provide the annuity prior to making a decision.

A large insurance company (contributor to the financial crisis) was on the list of possible annuity providers and I wasn't comfortable with the firm as a stable counterparty. I took the lump sum...

This sounds like a similar situation to what my husband found himself in shortly after AIG got bailed out. The employees were not given a list of potential providers. They were told that they'd find out what firm would be servicing the annuity after the deadline for making a decision had passed.

There were other factors involved in his decision to take the lump sum, but that was a significant part of it.

 

[kyzymurgist]

One more thing that I don't think has been mentioned is the effect on ACA subsidy. If we had taken the full pension instead of partial lump sum, we would not qualify for Silver Plan CSR which would have a large negative effect on our finances. And our income would have been pushed over the tax subsidy cliff in many years.

This is a big consideration that is easy to overlook for those retiring before Medicare that must purchase health insurance in the market. It can be much easier to engineer your income without a big pension.

 

[Jerry1]

Again, thanks for all the comments. I’ll definitely have more questions for the FA and, I’m going to loop back with the company(employer) to make sure I understand the annuity. Especially what company is managing it. I know the pension obligation is funded, but I’m not sure if they purchase an annuity or if the pay out the annuity. I’d be more comfortable if a major insurance company manages the annuity and to make sure it’s PBGC insured.

From the FA, I’ll make sure the model my plan both ways so I can have a better basis for decision. I was only thinking of the market comparison, but I also want to look at the tax consequences of the cash flow in both cases.