Roll Pension or Take Annuity

[Johanson]

Assuming I retire from my current employer, I can either take my pension as a lump sum (and roll into my 401K or an IRA) or take a non COLA monthly annuity payment. Making assumptions, I'm looking at a $200,000-240,000 lump sum or a monthly payment of $1000-1200 at the time of retirement that would pay until I die with no survivor benefit. If I don't start drawing on the pension, the payments go up about 5%/year.

Putting that aside for a moment, my plan is to retire around 57 or 58 and getting most of my income until I'm 59 1/2 from my 401K, which I expect to have $800,000-1,000,000 in it. I'm also planning to keep at least 200% of what I think I'll need for living expenses and taxes in the 401K and rolling the rest into an IRA. I figure this will give me more flexibility with investing but the 401K has very low fees for their funds. I also have a Roth IRA but I expect that to only make up about 5-7.5% of my portfolio when I retire. I also plan on having a taxable account before I retire but don't have one yet and there will be no significant assets in it. Also, I have a higher than average tolerance for risk.

Having said all that, would you think it better for me to take the lump sum and roll it, take the annuity payments as soon as I retire, or live "entirely" off the 401K and take the lump sum or annuity payments some time after I retire? I had been thinking that taking the monthly payment was the way to go but now I'm thinking I can get a better return taking the lump sum and investing it.

 

[DEC-1982]

Two comments based on my experience:

1. I found the value of the annuity was better than the lump sum. And if you think about it, there is a reason a lot of companies are pushing the option of a lump sum. It's better for them than the individual. One could say win-win but I don't believe this is true for most individuals.

2. Of two annuities, the payments for one annuity went up sharply if I waited till 65, and the payments for the other did not go up very much. I started the annuity where the payments did not go up significantly if I waited. If you can figure out the payments if you start immediately, and the payments if you wait, and estimate how many payments you will get in each case, you can do the math and come to a more informed decision.

 

[Johanson]

Two comments based on my experience:

1. I found the value of the annuity was better than the lump sum. And if you think about it, there is a reason a lot of companies are pushing the option of a lump sum. It's better for them than the individual. One could say win-win but I don't believe this is true for most individuals.

2. Of two annuities, the payments for one annuity went up sharply if I waited till 65, and the payments for the other did not go up very much. I started the annuity where the payments did not go up significantly if I waited. If you can figure out the payments if you start immediately, and the payments if you wait, and estimate how many payments you will get in each case, you can do the math and come to a more informed decision.

I have looked into holding off on payments and it comes out to 5%/year.

 

[nun]

Your pension numbers need to be more accurate to make a real decision.

If we assume you live for 25 years past age 58 then the possible pay out rates range from 5% to 7.2% and the discount rates are between 1.8% and 5.2%.

The higher numbers are ok, but the lower ones are terrible.

 

[Johanson]

Your pension numbers need to be more accurate to make a real decision.

If we assume you live for 25 years past age 58 then the possible pay out rates range from 5% to 7.2% and the discount rates are between 1.8% and 5.2%.

The higher numbers are ok, but the lower ones are terrible.

That's about the best I can do right now but the high side mainly comes from retiring later with an income fudge factor. The low side comes from retiring earlier with income on the low side.

 

[DEC-1982]

I hope this helps.

From The Charles Schwab Guide to Finances: After Fifty

Q19: Should I take my pension as a lump sum or monthly payments?

There are pros and cons. The lump sum can be very tempting. But before you take the money and run, it is important to crunch some numbers. The longer you live, the more valuable the annuity option becomes.

Example: You are 65. You have a choice between a lump sum of $300,000 and a single annuity of $2,000 per month ($24,000 per year). If you live to 78 1/2, you will get the same amount either way. ($24,000 * 12.5 = $300,000). If you die earlier, you'll get more with the lump sum. If you die later, you'll get more by taking the monthly payments.

Behind the Scenes: Calculating Annuity Returns

On the surface, it looks like you are making 8% ($24,000 / $300,000 = 8%). But an annuity is structured to pay out both interest and return of principal, leaving a zero balance, based on an asssumption about how long you will live.

If you assume you will live another 20 years, the annuity's return is 4.96%. In other words, if you were to take the lump sum and invest it on your own, you would have to earn an average annual return of 4.96% to do as well.

The longer you live, the higher the annual return turn out to be. If you assume that you will live another 25 years, the return increases to 6.24%. If you die sooner, the return goes down. For example, if you only live 15 years, the annuity's return falls to 2.37%. If you live less than 12 1/2 years, the annuity return is negative.

 

[Johanson]

I hope this helps.

From The Charles Schwab Guide to Finances: After Fifty

Q19: Should I take my pension as a lump sum or monthly payments?

There are pros and cons. The lump sum can be very tempting. But before you take the money and run, it is important to crunch some numbers. The longer you live, the more valuable the annuity option becomes.

Example: You are 65. You have a choice between a lump sum of $300,000 and a single annuity of $2,000 per month ($24,000 per year). If you live to 78 1/2, you will get the same amount either way. ($24,000 * 12.5 = $300,000). If you die earlier, you'll get more with the lump sum. If you die later, you'll get more by taking the monthly payments.

Behind the Scenes: Calculating Annuity Returns

On the surface, it looks like you are making 8% ($24,000 / $300,000 = 8%). But an annuity is structured to pay out both interest and return of principal, leaving a zero balance, based on an asssumption about how long you will live.

If you assume you will live another 20 years, the annuity's return is 4.96%. In other words, if you were to take the lump sum and invest it on your own, you would have to earn an average annual return of 4.96% to do as well.

The longer you live, the higher the annual return turn out to be. If you assume that you will live another 25 years, the return increases to 6.24%. If you die sooner, the return goes down. For example, if you only live 15 years, the annuity's return falls to 2.37%. If you live less than 12 1/2 years, the annuity return is negative.

Taking the annuity is definitely the better choice to me as far as return compared to the lump sum. What's tripping me up is would it be better for me to take the lump sum and invest it for a better gain. In my case, the break even point is a little over 16 years but that is assuming I don't take the lump sum and invest it. I also assume I'll live another 25 years after I retire so I would need to make another $60,000 from the lump sum to break even. I'm using $1200/month vs. $240,000 lump sum.

 

[rodi]

Pension vs lump sum. You need to see what annuity the lump sum would buy. Get some quotes for a single premium income annuity (SPIA). When I did that I learned that my lump sum would buy a much smaller annuity.... So I kept it as a pension.

The other factor to consider is the idea of a 3 legged stool. 1 leg is your savings, another is social security, and the third is a pension or rental income or other income stream. The idea is that if you have multiple income streams you'll be better able to survive unknown impacts to one of your income streams. (Market corrections, Changes to SS, pension haircuts, real estate corrections, etc.)

 

[DEC-1982]

What's tripping me up is would it be better for me to take the lump sum and invest it for a better gain. In my case, the break even point is a little over 16 years but that is assuming I don't take the lump sum and invest it. I also assume I'll live another 25 years after I retire so I would need to make another $60,000 from the lump sum to break even. I'm using $1200/month vs. $240,000 lump sum.

The question becomes "invest in what".

The annuity is "guaranteed", well let me say the risk is low. An equivalent would be relatively safe bonds. You are highly unlikely to get 6.24% with bonds today.
You might say "I am going to put it in the stock market and get the long term return of 8-10% a year". But it comes with risks.

Another approach is you take the guaranteed income and take more risks with your existing portfolio, knowing that you have a safe income stream coming in from elsewhere. But don't take more risks without putting in a great deal of thought.

Unfortunately, there isn't always an "easy" or "right" answer; it all depends. In my case, I was looking out for the next 40 years (100% self and spouse), and it was a no-brainer.

Hopefully you will get more feedback from other folks in this forum. Good luck.

 

[Johanson]

I guess another factor might be if I end up getting a spouse or a spouse equivalent. I might want to take the lump sum in that case because it has no beneficiary provision. I'll worry about that when and if that happens.

 

[Danmar]

I was faced with the same choice when I retired. Each case will be hinge on the actual numbers of course, but as Dec-1982 stated having an annuity is much less risky than self investing. I've been retired 10 years and have collected my pension for about 4 1/2 years. Getting that deposit every month really provides peace of mind to me. Also, in my case, I was able to elect a 100% survivor benefit. Really glad I took the pension, even though I probably would have done better investing the lump sum, given the good markets recently. Will future markets be as good? A lot of doubt on that one.

 

[stepford]

The OP has two distinct decisions. Annuity vs. Lump sum and how long to delay before commencement. The first depends largely on how generous a lump sum is offered and on the financial stability of the annuity provider. If the annuity is from a rock solid provider then I'd ascertain its value by comparing with estimates from the calculator at immediateannuities.com. If the lump sum offered is more than ~90% of this estimate I would seriously consider taking it. If, however, like many of us the OP is offered an amount significantly less than this (the number was around 60% in my case) then the annuity is the better deal.

The decision of when to take the annuity is more complicated and factors in not only the rate of increase in the annuity payment vs. delay before commencement, but a whole host of individual and external factors (spend rate, other income sources, longevity, taxes, inflation, etc.) and is best determined by doing a detailed analysis using your choice of retirement income calculator. For me it turned out there was an advantage in delaying a year and then it was roughly a wash for the next few years. As a result I opted to commence my pension 15 months after retiring, but every individual's case is different and the OP will need to run the detailed numbers.

 

[kcowan]

This boils down to the choice between a DB Pension and a DC converted to annuity. It boils down to the specific numbers. As Danmar said, the last 20 years have been extremely good to equity investors with 2 notable exceptions: 2000 and 2008. So lump sum would have been better if kept in equities.

I have seen studies that say to keep your lump sum in equities until age 72 then buy a life annuity. It was because the average life expectancy brings the cost of the annuity down.

Having drawn a megacorp DB Pension for 24 years, I am not current on specifics. But there seems to be more uncertainty right now than there has been for years.

 

[nun]

That's about the best I can do right now but the high side mainly comes from retiring later with an income fudge factor. The low side comes from retiring earlier with income on the low side.

OK, but you need to pair the lump sum/pension with a retirement date to do a sensible calculation. You can't make the decision without an official pension forecast, that should be your priority.

However, f we assume you'll retire at 58 and live another 25 years and get $1000/month or a lump sum of $200k then the payout rate is 6% and the discount rate is 3.4%. I would take the lump sum with those numbers.

 

[Johanson]

OK, but you need to pair the lump sum/pension with a retirement date to do a sensible calculation. You can't make the decision without an official pension forecast, that should be your priority.

However, f we assume you'll retire at 58 and live another 25 years and get $1000/month or a lump sum of $200k then the payout rate is 6% and the discount rate is 3.4%. I would take the lump sum with those numbers.

That will be easier when I get closer to retirement. I am 52 now and the pension is based on my compensation. I generally make an extra 20-25% each year due to overtime. But, that has varied over the past few years to be as low as 15% and higher than 30%.

I just ran the numbers assuming a 3% salary increase every year and 20% in overtime (Bonus in the calculator) each year. I have my retirement date as my birthday and draw date as the earliest commencement date (following month).

Age Monthly Lump Sum
57 $1058 $211,300
58 $1131 $221,653
59 $1214 $233,333

I have run the numbers in the past with the draw date being in the future and both numbers always go up 5% each year. Thanks for all the replies so far!!!

 

[pb4uski]

I find the below useful in making those decisions. I shows the amount that your investment of the lump sum amount would need to return to fund the monthly benefits to certain ages... assuming you start benefits at age 58... or alternatively the "return" from the decision if you take the annuity rather than the lump sum.

So for example, if you take the lump sum, invest it and earn 3.5%, the fund will last 24 years and then be gone.... or if you die after 24 years then you will have received a 3.5% return on the investment of the lump sum.

How lucky do you feel?

Lump Sum		221,653
Monthly benefit		1,131
Age	n	IRR
58	0
59	1	-98.2%
60	2	-80.3%
61	3	-59.7%
62	4	-44.2%
63	5	-33.1%
64	6	-25.1%
65	7	-19.2%
66	8	-14.8%
67	9	-11.4%
68	10	-8.7%
69	11	-6.5%
70	12	-4.8%
71	13	-3.3%
72	14	-2.1%
73	15	-1.1%
74	16	-0.3%
75	17	0.5%
76	18	1.1%
77	19	1.6%
78	20	2.1%
79	21	2.5%
80	22	2.9%
81	23	3.2%
82	24	3.5%
83	25	3.7%
84	26	4.0%
85	27	4.2%
86	28	4.3%
87	29	4.5%
88	30	4.7%
89	31	4.8%
90	32	4.9%
91	33	5.0%
92	34	5.1%
93	35	5.2%
94	36	5.3%
95	37	5.4%
96	38	5.4%
97	39	5.5%
98	40	5.6%
99	41	5.6%
100	42	5.7%

 

[nun]

I find the below useful in making those decisions. I shows the amount that your investment of the lump sum amount would need to return to fund the monthly benefits to certain ages... assuming you start benefits at age 58... or alternatively the "return" from the decision if you take the annuity rather than the lump sum.

So for example, if you take the lump sum, invest it and earn 3.5%, the fund will last 24 years and then be gone.... or if you die after 24 years then you will have received a 3.5% return on the investment of the lump sum.

How lucky do you feel?

Lump Sum		221,653
Monthly benefit		1,131
Age	n	IRR
58	0
59	1	-98.2%
60	2	-80.3%
61	3	-59.7%
62	4	-44.2%
63	5	-33.1%
64	6	-25.1%
65	7	-19.2%
66	8	-14.8%
67	9	-11.4%
68	10	-8.7%
69	11	-6.5%
70	12	-4.8%
71	13	-3.3%
72	14	-2.1%
73	15	-1.1%
74	16	-0.3%
75	17	0.5%
76	18	1.1%
77	19	1.6%
78	20	2.1%
79	21	2.5%
80	22	2.9%
81	23	3.2%
82	24	3.5%
83	25	3.7%
84	26	4.0%
85	27	4.2%
86	28	4.3%
87	29	4.5%
88	30	4.7%
89	31	4.8%
90	32	4.9%
91	33	5.0%
92	34	5.1%
93	35	5.2%
94	36	5.3%
95	37	5.4%
96	38	5.4%
97	39	5.5%
98	40	5.6%
99	41	5.6%
100	42	5.7%

Those are the numbers I came up with too.....IMHO the pension not a good financial deal. There will be cash flow and personal circumstances to factor in as well.

 

[Johanson]

Thanks for all the feedback! It's greatly appreciated!