Lump Sum Versus Annuity

[Jerry1]

Interesting thing happened today. I'm at a point where I need to decide on my pension distribution. I can take a lump sum of about $450K or an annuity. Most people I worked with, similar to those on this forum, said to take the lump sum. When I started my planning (specific planning), after I left work, I went to Fidelity and that advisor proposed to do something tied to bonds. They called it their Core Bond Strategy and said with $500K minimum, they could cash flow about $24K per year (similar to my annuity). Interesting though that the average coupon on the bonds was only 3%, so I guess they were planning on a spend down of principle.

The interesting thing is today, I went to a highly recommended FA. Fee only and a fiduciary. Also this FA is recommended by my old boss and another friend who both were VP's at my company. It was our first meeting, but I sent them my financials ahead of time. They recommended that I take the annuity. They recommended taking a 2/3'rds survivor benefit which pays out $2,255 per month (about $27K per year). This is about a 6% withdraw rate until one of us passes.

I've been told by another guy that wanted to sell me an annuity that he couldn't do as well as the work annuity and I know that the company has fully funded their pension liability (know the CFO and I've seen the statements), so I believe that this is indeed a good annuity. But still, I was surprised by the recommendation. Overall, the basis of the recommendation was to take this and along with SS and my basic needs would be met. I would still have about $1.5M to have for cash and market investment as a hedge against inflation.

Before I go to our second meeting, I'd like to get some thought from the group on this. To be honest, it does sound good to me and DW to lock in some security, but given that this is the only FA or person to recommend this, I'm a little taken aback and would like to discuss.

 

[DrRoy]

In the case of a pension, I think the annuity pays well and gives you diversification from your other investments.

 

[MI-Roger]

You already sort of answered these questions in your post, but for the benefit of others who may reference it in the future here they are.

1. Do you trust your employer to remain financially solvent for 30+ years into the future?
2. Is the company provided retirement plan a pension or an annuity?
3. Who is guaranteeing the annuity if not a pension?
4. Will you be receiving the documentation for a personal annuity that is to be purchased by your employer, or do they have one large general annuity plan for everyone?
5. Is the company annuity plan 100% pre-paid or is it pay-as-you-go, meaning annual contributions will be required from the employer?
6. What legal teeth do you have if the employer does not pay, of if the employer changes plans to your detriment in the future?
7. Can the annuity be raided by the company or debtors?

When faced with a similar decision I chose the lump sum and bought my own annuity for guaranteed retirement income.

My answers to this list of questions were:

• No,
• Annuity (formerly a pension),
• No Information Provided or Available for all of the others.

The Pension Benefit Guaranty Corporation was established by the Feds for a reason...........

 

[albireo13]

One way I look at things is:


1. for a lump sum scenario, you have built in 100% survival benefit assuming you have set up your wife as beneficiary.
2. so, to compare apples to apples, I compare the 100% survivor benefit annuity payout against the lump sum.


I'm not that excited about annuities. Why not keep and invest your lump sum and dip into it monthly as needed? Is it just convenience that drives us to want a monthly "paycheck" automatically showing up??

 

[RetireBy90]

I would look at it as a choice of guaranteed income (pension or annuity) or another asset such as a portfolio of stocks and bonds that provide earnings for your income.


Once you decide on guaranteed income or portfolio returns, then you can look at the different options in that category.


Your pension returns $27K or about 6%. Historically, a portfolio has returned about 7% (with much more volatility) or about $31K. In both cases you will have returns for you and DW regardless of who goes first. However, with a portfolio you will have several options that would be important to me. 1) I can take less or more at my discretion as circumstances change; 2) I will have my portfolio intact to leave to whoever I want. Also, I will risk not achieving my 7% or even 6% return and run out of that source of income. If you take a pension, there is a risk that in 10 years or more that the current competent leadership also retires and as others take over the stability of your company changes. Remember GE ? Perhaps not a high probability but it is a risk with a pension.


My decision would be based on 1) What other sources of income do I have; 2) Am I confident that I will get something from SS and how much of my required budget will it cover; 3) Am I interested in leaving assets to the family or a charity.


You may want to consider at a split, say 50% pension and 50% lump sum you can invest into a portfolio if that is an option. I like having multiple sources of income so if one is damaged others are still there.


It is early and I tend to go on and on and on, but hopefully I may have raised something to think about you haven't thought about.

 

[street]

For all the reasons above it feel lump sums are better. I'm in control with my money means more to me then the annuity.

My lump sum has over doubled in 6 years. I don't need the this money so it will keep growing till I do. I have full control is a key to my decision for me. Annuities you pay for those guarantee's some way and for managing that money there is costs.

I can say everyone has a different look on this subject. The pension works for some and think lump sum is a bad deal.

 

[Dawg52]

I'm not that excited about annuities. Why not keep and invest your lump sum and dip into it monthly as needed? Is it just convenience that drives us to want a monthly "paycheck" automatically showing up??

Many of us have simply set up automatic w/ds from our brokerage acct. Serves as our paycheck. I have thought about annuities as another means of diversifying but could never pull the trigger. Perhaps when I really get old.

 

[MI-Roger]

Added Perspective on 30+ years of financial stability

Consider the following when answering Question #1 of my earlier post, "Do you trust your employer to remain financially solvent for 30+ years into the future?"

My Dad hired into General Motors in 1965 at age 50. GM was the world's largest company that year.

My Dad retired from General Motors in 1980 at age 65. GM was the world's second largest company that year.

My Dad lived less than 14 years after retirement, but had he lived the general expection of 30 years post retirement he would have seen GM close dozens of plants (including his), sell or close entire divisions of the company (including his), and declare bankruptcy!

So as you consider your answer to question #1, remember a sanitized version of the famous Clint Eastwood line from his Dirty Harry movie. "Do you feel lucky?"

 

[MI-Roger]

I'm not that excited about annuities. Why not keep and invest your lump sum and dip into it monthly as needed? Is it just convenience that drives us to want a monthly "paycheck" automatically showing up??

In my case there are two reasons. The first is the convenience item that you identified. The second is a concern that at some point in the future I may no longer have the mental acuity to self manage my income investments.


An automatic withdrawal from a brokerage account is another means to this same end, although possibly with less guarantees.


And for those who choose the Lump Sum / Cash Out option, insist your check be delivered by an express service (FedEx, DHL, UPS etc.) and pay the small additional fee. My $750K Pension Cash-out check came printed on a fold-over postcard like a motor oil rebate, in the general mail! I do not remember being asked by Fidelity(!) if I desired the enhanced delivery service as I would have gladly paid the fee. Demand it for yourself!

 

[Philliefan33]

I will have to make the lump sum vs monthly pension payout decision in six years. The points made by the various replies will all be factors.

I will also play with the math regarding PA state income tax. Income reported on a 1099R is not subject to PA state income tax, interest and dividends are taxed at 3.07%. The tax advantage is one more “pro” on the pension column, assuming we continue to live in PA

 

[Midpack]

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...

 

[joeea]

But still, I was surprised by the recommendation.

Why were you surprised?

Overall, the basis of the recommendation was to take this and along with SS and my basic needs would be met. I would still have about $1.5M to have for cash and market investment as a hedge against inflation.

Do you value having all of your basic needs met by a guaranteed, partially inflation-protected stream of income for the rest of your lives?

Before I go to our second meeting, I'd like to get some thought from the group on this. To be honest, it does sound good to me and DW to lock in some security, but given that this is the only FA or person to recommend this, I'm a little taken aback and would like to discuss.

Remember, you only spoke to one financial adviser who wasn't attempting to sell you something.

Depending on your goals, the decision between a lump sum and an annuity is a math problem. Hopefully the fee-only fiduciary financial adviser talked with you about your goals, and did the math for you. If you don't understand the conclusion, you should ask for the details.

While in general a lump sum gives you flexibility, having an income stream cover your basic needs gives your other $1.5M a ton of flexibility.

Consider your age (how old are you and your spouse, anyway?), what kinds of returns you can expect from your investments, your expected expenses in retirement, how much you can expect from social security and when.

I'm not surprised that in some cases taking a pension via annuity comes out better than a lump sum. Sometimes it's much better. Sometimes not. It often just depends on the numbers (assuming you are correct about the stabiity of the company and the funding of the pension).

 

[Jerry1]

Wow, you guys are early risers. Thanks for the thoughts and information. To answer a couple questions:
- I’m 57 and DW is 62
- I cannot split the money and take half lump sum, half annuity
- I was surprised by the recommendation only because no one else had recommended it. I’ll get into the math with them in future meetings. I will also have the model out the lump sum alternative.
- Yes, I’m very conservative and having an amount that at least feels guaranteed is very appealing to me. However, leaving nothing to my kids (out of that money) is the biggest negative for me.

Thanks!

 

[Car-Guy]

I went through this same decision some years ago. Even read about this topic on this forum at the time (and many times since then). Same question, and it seems the same concerns/answers each time. My first impression was to take the lump sum. I thought about it until my head hurt but in the end I went with my first impression and have never regretted it.


I think it gets down to personal situations and preferences for the most part but of course payout values and risk tolerance play into it.

 

[Jerry1]

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...

My actual numbers on immediateannuities.com ended up being $1,955 for a Life annuity.

 

[jim584672]

Some states exempt pension income from state taxes, something to consider if it applies to you.

 

[Big_Hitter]

I'm not that excited about annuities. Why not keep and invest your lump sum and dip into it monthly as needed? Is it just convenience that drives us to want a monthly "paycheck" automatically showing up??

because it is very easy to outlive the lump sum

 

[CaptTom]

...I would still have about $1.5M to have for cash and market investment as a hedge against inflation...

To me, if you already have 1.5M invested, either the pension or the annuity seems to make sense, sort of like diversification. I'd go that route.

It sounds like the pension is the slightly better deal, assuming your're confident in its long-term stability. Otherwise, this may be the one case where an annuity makes sense to me; as a hedge against your main source of income (the investments) somehow failing.

 

[Moemg]

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 .

 

[plsprius]

Assuming a life expectancy of 30 years and so a 30 year draw-down period, the $450K lump sum would produce:

a monthly distribution of $1,897.22, equivalent to $22,766.62 annually, even if invested in extremely conservative 30 yr US treasuries at 3%.

Plus, you keep the principal! Big advantage! And, treasury income is exempt from state taxes.

The major risk here is that inflation gets out of control, and the value of the treasuries declines. So, if it were me, I probably would invest in 2 yr. treasuries at 2.7% currently, for about a 4% lower initial payout ($1,825.19).

Thus, annuities don't look so good now that interest rates have started to rise, with the risk of future higher inflation...I'd take the lump sum.

PS. Edit to add: it occurs to me that this $450K is probably a tax-advantaged pension (like a 401K or similar) so the lump sum distribution should/would be rolled into an IRA. In that case, the treasury interest would be state taxable when withdrawn from the IRA. All of the other considerations still hold, however...and for me the annuity would still loose.

 

[Lewis Clark]

Keep in mind that the coupon rate on the bonds is highly likely to be different than the actual effective yield, depending on the current bond prices.

 

[Big_Hitter]

A
Thus, annuities don't look so good now that interest rates have started to rise, with the risk of future higher inflation...I'd take the lump sum.

His annuity option is $27K a year, irrespective of prevailing interest rates.

In a traditional DB plan, interest rates have nothing to do with the immediate annuity, just the lump sum.

 

[Big_Hitter]

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?

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

 

[Big_Hitter]

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

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

 

[joeea]

- Yes, I’m very conservative and having an amount that at least feels guaranteed is very appealing to me. However, leaving nothing to my kids (out of that money) is the biggest negative for me.

Makes sense.

Your model will tell you if it is better to completely cover your basics for the rest of your life and leave around $1.5M+ to your kids, or invest around $2.0M, draw it down over both of your lifetimes, then see what remains as a legacy. Much of that depends on anticipated expenses, and some assumptions about market performance, future inflation, longevity, etc.

You'll likely be just fine either way. Hopefully you and your adviser will come up with what seems optimal.