Cash out pension?

[Curmudgeon]

I've researched the general topic of cash vs pension, but I think the specifics here make it unique:

My current age is 54, I was recently laid off, my employer has granted me a tiny pension which has several options for how to take it. The baseline guarantee for the pension is $1414 per month, non-COLA, once I reach age 65. That amount will never change, regardless of what inflation etc. does before or after that date. All other options are derived from that base using actuarial estimates of inflation, life expectancy, etc.

One option is to cash out now; the current cashout value is around $127K. If I work backwards from $1414 at age 65 to a $127K NPV, it comes out to around 5% annual interest. I don't think we'll see an average of 5% inflation over the next 11 years, so it seems like they're giving me a bit of a haircut on the cashout. Indeed, I called Fidelity and asked them how much it would cost me today to purchase an annuity that would pay $1414 at age 65, and they quoted me around $190K. So I would definitely get shortchanged if I took the cash.

On the other hand, the pension is non-COLA, and so waiting 11 years (over which, I'm guessing, we will probably see higher inflation than what we've seen over the last decade) could mean taking a pension with a significantly reduced real value.

So, the question is, do I take a haircut today, or wait 11 years and hope that inflation doesn't give me the haircut over time? (I'm not really looking for a "do this/that" answer, just trying to understand what methods I should be using to evaluate this choice.)

If I expect inflation to remain constant, I think the obvious answer is to wait and take it at age 65 (or later). There's no place I could invest $127K today that would give me a guaranteed $1414/mo annuity in 11 years (5% APY with 0 risk). On the other hand, if inflation goes up, it's quite possible that an investment of $127K today would get me better than $1414/mo, in constant dollars.

 

[Danmar]

Hard to make predictions that far out. Best prediction of future inflation is probably current inflation? An ageing population might keep interest rates and inflation lower than otherwise. My view is ,everything else being equal or the right price ,( when does that happen?) you should always go with the pension. It reduces your risk in retirement especially longevity risk.

 

[Brat]

Consider investing $127T in a balanced fund such as Wellesley Income. It's average annual return over the last 10 years is 7.10%. Assuming similar returns your $127 would be about $270 assuming it was rolled over to an IRA. When you are 65 you can then invest this money (or not) in an annuity.

The tough task would be keeping your hands off that investment for 11 years.

 

[Curmudgeon]

Thanks!

Yes, I do like the aspect of longevity insurance. But, there's no reason I need to commit to that now. For example, if we thought we were going to have runaway inflation over the next decade, perhaps the smarter thing to do would be to cash out now and invest it, then at some later date use the appreciated $$ to purchase a lifetime annuity, that would pay MORE than $1414/mo.

But, as they say, the hardest thing to predict, is the future.

 

[COcheesehead]

The cash now options are usually in the pension funds favor. That is why they offer them.

 

[daylatedollarshort]

We took our pensions as annuities partly for diversification - so we'd have multiple uncorrelated income streams in retirement, since our portfolio is stocks and bonds. Our pensions are private and close to 100% funded with the PBGC as a backstop, so the money is fairly secure. If I had a poorly funded, nonfederal public pension I would have taken the lump sum.

 

[DJRR]

What is your liquidity situation and the viability of the plan? What % of your expected spending does $1,414 represent? Have a spouse or heirs?

If you take the cash you control the money and when you can spend it. You also take on the risk of the investment returns, but can pass anything left to spouse or heirs.

If your plan is shaky or significantly underfunded then take the money and run.

Otherwise you are giving up some guaranteed floor income for cash liquidity and some potential upside for good returns and a worst case reduction of say ~ 50% if your investments go really bad.

If you need $50k for an emergency do you have another way to get it or would this money be helpful?

 

[Pilot2013]

Be sure to check if the Pension "remains" if you die before starting the pension benefit.

I was offered a cash out of a Pension benefit, and asked a financial "friend" about the valuation they were calculating. Luckily, she had be ask this specific question, and there was no beneficiary provision until AFTER I started the Pension benefit. If I kicked the bucket before starting it, it just disappeared.

I took the cash and rolled into my 401k. The old bird in the hand principle.

 

[pb4uski]

Be sure to check if the Pension "remains" if you die before starting the pension benefit.

I was offered a cash out of a Pension benefit, and asked a financial "friend" about the valuation they were calculating. Luckily, she had be ask this specific question, and there was no beneficiary provision until AFTER I started the Pension benefit. If I kicked the bucket before starting it, it just disappeared.

I took the cash and rolled into my 401k. The old bird in the hand principle.

That would be very unusual in my experience. Usually it would go to a spouse or if you are not married to your kids/heirs.

 

[Pilot2013]

That would be very unusual in my experience. Usually it would go to a spouse or if you are not married to your kids/heirs.

That was my thought as well, but apparently there are cases, specifically with "non contributed" pensions where this is the case. Mine was with a VERY large (privately held, not US) automotive parts manufacturer, and I confirmed the loss of the pension upon death if before retirement. I have another Defined Contribution Pension with a different, publicly traded and US based company that has a beneficiary designation. I was very glad my friend suggested I check.

 

[pb4uski]

A 65 yo male would need $268k today to buy a fixed annuity with a $1,414/month benefit. It is doubtful that your $127k lump sum can grow to $268k in 11 years. You would need to earn 7%/year.

I would stick with the pension benefit.

 

[Samuel Adams]

Stick with the pension. They offer this hoping the the money will entice you to leave. They don't offer it to help you; they offer it to help them.

Sure there are some funds here and there that are earning big. But to really earn big you need big to begin with, like billions. My pension fund has more than 70 billion in it, and with that kind of number they can afford the best possible advice and constant changing, and so they generally earn 6-8% every year. You will never find anyone to help you do that with a paltry $127K. Maybe if you had 10 million.

I have friend who had their entire retirement nest egg in mutuals; thye lost 2/3 of it and are still working. I ahve other friends who had it in T-Bills, cd's, stocks, mutuals, REITS, bonds, foreign currency, property, and precious metals. When the market tanked, other investments rose. You could do that, but that takes effort and lots of publications.

And if the market tanks again, which it periodically does, then if it was all in mutuals you could be out the principle that you invested. Stock market people always say this time is different but it never is. The older you get the less likely you could ride out a loss back to your starting point.

 

[Teacher Terry]

I would take the pension.

 

[pb4uski]

.... I have friend who had their entire retirement nest egg in mutuals; thye lost 2/3 of it and are still working. ...

WADR Sam, I'm not sure what your friends did but many of us here invest in mutual funds, didn't come close to losing 2/3 (perhaps 1/3 at most) and hung in there are are doing great now.

The stalwart Vanguard Wellesley Income Fund declined 19% during the great recession but has more than doubled since the trough and has had an average annual return of 7% over the last 10 years. Many conservative 40/60 funds would have performed similarly.

 

[REWahoo]

WADR Sam, I'm not sure what your friends did but many of us here invest in mutual funds, didn't come close to losing 2/3 (perhaps 1/3 at most) and hung in there are are doing great now.

+1

Sounds like his friends weren't sufficiently diversified in their investments and sold at the bottom. Anyone who maintained a reasonable asset allocation, who didn't panic and sell at the market low, is now doing very well.

 

[harley]

Sure there are some funds here and there that are earning big. But to really earn big you need big to begin with, like billions. My pension fund has more than 70 billion in it, and with that kind of number they can afford the best possible advice and constant changing, and so they generally earn 6-8% every year. You will never find anyone to help you do that with a paltry $127K. Maybe if you had 10 million.
...
And if the market tanks again, which it periodically does, then if it was all in mutuals you could be out the principle that you invested. Stock market people always say this time is different but it never is. The older you get the less likely you could ride out a loss back to your starting point.

In reality, pension funds don't really do any better than market returns despite all their "best possible advice", although at their size it's hard to define exactly what "the market" is. Their target is 7.5% (recently lowered from 7.75%), but many experts think it should be more in the 6% or less range. They won't do that because it automatically decreases their funding level. But investing in the total stock/bond market gets you returns on par with what the big pension funds earn.

TOTAL CALPERS FUND NET RATE OF RETURNS
[FONT=Palatino Linotype,Palatino][FONT=Palatino Linotype,Palatino]Fiscal year to date ended [/FONT][/FONT]
[FONT=Palatino Linotype,Palatino][FONT=Palatino Linotype,Palatino]6/30/2015 [/FONT][/FONT]
[FONT=Palatino Linotype,Palatino][FONT=Palatino Linotype,Palatino]2.4% [/FONT][/FONT]
[FONT=Palatino Linotype,Palatino][FONT=Palatino Linotype,Palatino]3 years for period ended [/FONT][/FONT]
[FONT=Palatino Linotype,Palatino][FONT=Palatino Linotype,Palatino]6/30/2015 [/FONT][/FONT]
[FONT=Palatino Linotype,Palatino][FONT=Palatino Linotype,Palatino]10.9% [/FONT][/FONT]
[FONT=Palatino Linotype,Palatino][FONT=Palatino Linotype,Palatino]5 years for period ended [/FONT][/FONT]
[FONT=Palatino Linotype,Palatino][FONT=Palatino Linotype,Palatino]6/30/2015 [/FONT][/FONT]
[FONT=Palatino Linotype,Palatino][FONT=Palatino Linotype,Palatino]10.7% [/FONT][/FONT]
[FONT=Palatino Linotype,Palatino][FONT=Palatino Linotype,Palatino]10 years for period ended [/FONT][/FONT]
[FONT=Palatino Linotype,Palatino][FONT=Palatino Linotype,Palatino]6/30/2015 [/FONT][/FONT]
[FONT=Palatino Linotype,Palatino][FONT=Palatino Linotype,Palatino]6.2% [/FONT][/FONT]
[FONT=Palatino Linotype,Palatino][FONT=Palatino Linotype,Palatino]20 years for period ended [/FONT][/FONT]
[FONT=Palatino Linotype,Palatino][FONT=Palatino Linotype,Palatino]6/30/2015 [/FONT][/FONT]
[FONT=Palatino Linotype,Palatino][FONT=Palatino Linotype,Palatino]7.8% [/FONT][/FONT]

https://www.calpers.ca.gov/docs/forms-publications/facts-at-a-glance.pdf

Average annual performance
As of09/30/2016

Total Stock Mkt Idx Inv

1 Year 3 Year 5 Year 10 Year Since Inception 04/27/1992
14.85% 10.29% 16.20% 7.41% 9.26%

This one I had to fudge to get it to display at all, but the numbers are accurate. https://personal.vanguard.com/us/funds/snapshot?FundId=0085&FundIntExt=INT

Also, even during the Great Depression nobody who wasn't highly leveraged lost everything including principal. It would truly have to be different this time (like an extinction level event) in order for that to happen. If you are going to make outrageous claims about the dangers of investing in the stock market, please at least include links for reference so people can interpret the data themselves.

 

[Running_Man]

Ususally a pension will offer a cash in at different times, as you get older the cash in should raise for time and with interest rate changes the amount can increase as well, can’t you just defer the decision for now?

 

[panacea]

Take the annuity. Sounds like your best bet from the information shared. And I agree about maintaining some diversification in retirement income streams. If you don't have any other annuities, it adds a nice layer of fixed income to Social Security benefits.

 

[Mdlerth]

Tax impact

I am always curious about these pension cashouts. Under what circumstances are they immediately taxable? Does it depend on the whim of the ex-employer how it gets disbursed? If you get a current year tax bill for the lump sum, does your estimate of 127k reflect that?

My own employer recently offered a limited pension cashout, but it did not include me so I never got the details, whether they cut a check or dropped it into the 401k.

 

[pb4uski]

Typically, a lump sum distribution is rolled into a tIRA so it is not a taxable event... it is taxable when IRA distributions are taken.

If the participant is crazy enough to take the lump sum in cash (not roll it into an IRA) then it is taxable when received and typically creates a big tax bill.

 

[Big_Hitter]

If the participant is crazy enough to take the lump sum in cash (not roll it into an IRA) then it is taxable when received and typically creates a big tax bill.

plus a potential 10% hickey

 

[Chuckanut]

I have looked at pension buyouts for several people over the last few years. In each case there seems to be an 'instant gratification tax' attached to the buyout that makes it a poorer deal than simply getting the monthly check.

The one guy who did take the lump sum was working for a company that he did not think was financially stable and he was worried that he might be shunted off to the federal pension guarantee program which did not fully protect his ample pension. So he took the buyout.

 

[harley]

I have looked at pension buyouts for several people over the last few years. In each case there seems to be an 'instant gratification tax' attached to the buyout that makes it a poorer deal than simply getting the monthly check.

The one guy who did take the lump sum was working for a company that he did not think was financially stable and he was worried that he might be shunted off to the federal pension guarantee program which did not fully protect his ample pension. So he took the buyout.

Well, I'm the other guy. I worked for a mega, and I watched them screw people over time and again. It wasn't so much that I didn't think they'd stay solvent, it was more that I didn't trust them to not find it was cheaper for them to default or do some other dastardly act resulting in my pension being negatively impacted. So I took the lump sum, invested it, and am quite happy with the results. And I still don't trust them.

 

[Danmar]

Well, I'm the other guy. I worked for a mega, and I watched them screw people over time and again. It wasn't so much that I didn't think they'd stay solvent, it was more that I didn't trust them to not find it was cheaper for them to default or do some other dastardly act resulting in my pension being negatively impacted. So I took the lump sum, invested it, and am quite happy with the results. And I still don't trust them.

Wow, working there must have been terrible? My experience was exactly the opposite. I trusted my employer completly to do what they said they would do. In fact they have always gone above and beyond. Even in retirement. Feel very lucky.

 

[NoiseBoy]

That would be very unusual in my experience. Usually it would go to a spouse or if you are not married to your kids/heirs.

I don't know how unusual it is, but I can report that this how it works for the pension plan of my US Fortune 100 megacorp. If unmarried, you cannot name a beneficiary, and the only way to have benefits extend beyond your death (after starting the payouts) is to select the 10 year guaranteed payout option, which reduces your monthly benefit amount.

There is no payout at all if I die before starting my pension. Their money, their rules. Nevertheless, I feel lucky to even be in the running to get a pension as the plan is now frozen to new entrants, and benefits will stop accruing in 3 more years for everyone. I am 29 months away from reaching the minimum age to start benefits. Oh, and no lump sump option either.

To the OP's question, how important is the pension amount at age 65 to your retirement plans? Myself, I would be leery of assuming that you will get 6% - 7% on your money for the next 11 years (if you invest the lump sump.) The inflation adjusted CAGR of the S&P 500 since 1/1/2005 is 5%.