Decision Time: Pension Payout Annuity vs Lump Sum

[Renewed]

This is my first post here. I am very recently retired and just discovered this site. I need to make a final decision on my pension payout within the next 2 weeks I have read through several threads here and on Bogleheads but I am still struggling with this decision so I thought I would post here for some feedback. Below is some information about me and my current thought processes regarding this decision. Have I missed anything? Is my thinking flawed about one of these issues? I know this is a very individual decision but what would you do if you were me and why?

I am 61. I do not want to plan for a legacy. In addition to my pension I have ~ 1.6 million in savings (almost all in 401k). I plan to delay SS to age 70.
In the past several years I have spent ~ 75k/year (this includes taxes, and some travel already). I would like to increase that to around 90k to allow for increased travel in my early years of retirement.

My pension payout choices are as follow:
- a non-COLA’ed PHBC guaranteed annuity of 74.5k/yr OR
- a lump sum of 1.1 million
- It is one or the other, no option to take some as an annuity and some as a lump sum.

So here are my current thoughts:
- My goal of increased spending in earlier years seems to favor the annuity. Mostly because I think I will feel safer spending with the annuity. My spending goal will require a ~1% WR. If market does well I would feel comfortable increasing that to a 2-2.5% WR . I would be fine on the annuity alone if the market declines. With the lump sum planned spending of 90k/yr would be a 3.85% WR, decreasing once SS kicks in. However, unless the market was doing really well I don’t think I would feel comfortable spending more but maybe that is being too frugal.
- Tax implications would favor the lump sum. I could better optimize income in early years allowing more ROTH conversions.
- Simplicity: favors annuity, it is essentially a paycheck

Considering risks:
- Longevity (most family members have live to late 80's and some to late 90's, even 100): given inflation risk of non-COLA’ed annuity and market risk of lump sum I am not sure how this plays out. Lump sum might provide more income in later years if the market does well.
- Cognitive decline with aging: favors annuity as much simpler overall. I would not have to manage my investments to support spending.
- I think my biggest risk with the annuity is inflation as my pension is non-COLA’ed. I feel like the default risk is minimal.
- Biggest risk of lump sum is obviously market risk (sequence of return risk)

Your thoughts would be much appreciated.

 

[heeyy_joe]

Take the annuity. Legacy, schmegacy.

 

[clifp]

Checking a couple of online quotes 1.1 million gets you an annuity of $66,500. So your pension gets you about 12% more than you could get in the open market which would sway me to go for the pension. Especially because you have a considerable amount of none pension savings to use in emergency or for the once in a life time splurge.

 

[FLD3C]

+1

 

[rodi]

Welcome.

What a wonderful problem to have - you have two great options.

Since the annuity payout is more than you could buy with the lump sum - I'd go with the annuity. Your 1.6M nest egg will be able to cover the $15k you need to supplement the pension - even with inflation adjustments.

 

[pb4uski]

+1 I like the pension in your circumstances.

 

[nun]

You don't mention if you are married......and whether the annuity is a single life?

Given your circumstances with considerable other investments I can see how the annuity is tempting. Buy if you live an actuarial life span of say 83 years the underlying interest rate of your annuity is 3.8% and you are also annuitizing 41% of your portfolio and that's higher than I'd like to go. I'd probably take the lump sum.

Whatever you do you should be fine given your anticipated spending. I just cashed in a DB pension....admittedly a small fraction of yours....and dumped it into Vanguard Balance Admiral Index and I'll see if I can beat what i would have got from the pension.

 

[2B]

Welcome to the forum.

As you see, you're getting diverse answers to help confuse you more. You do have a good problem. Either path has its own risks and benefits.

You have one of the better choices for pension cash outs that I've seen. Going by the earlier post, getting 88% of what it would cost to buy a comparable annuity is pretty good. That tempts me to take the cash.

Delaying SS will give you an inflation adjusted annuity of somewhere around $40k/yr at age 70 (increased for inflation). You can start paying yourself this now if you take $360k out of your "take the cash" portfolio of $2.7MM - leaving $2.34MM. Taking the other $50k you want to spend is only 2.1% of your portfolio.

If you take the annuity, you have the same $360k put aside to pay you your SS leaving $1.24MM in your "take the annuity" portfolio. However, you are now getting $114.5k/yr in spending without touching your portfolio.

What is the PHBC guarantee like? If over the limit, I would definitely go for the cash. I would personally take the cash because I distrust insurance companies. The pension is the conservative, traditional approach. Do you want to leave any money to anyone? Do you have a spouse you have to include in the plan?

My unsolicited recommendation no matter what you choose is to consider spending more money.

 

[Midpack]

My pension payout choices are as follow:
- a non-COLA’ed PHBC guaranteed annuity of 74.5k/yr OR
- a lump sum of 1.1 million
- It is one or the other, no option to take some as an annuity and some as a lump sum.

You've already gotten some good replies.

However, the third option is also available to you. If you want part pension and part lump sum, you can the lump sum and then buy an annuity yourself with whatever portion you'd like.

You should get quotes of your own, but the single life quote I got online using your current age showed an annual income of $$66.5K, so the pension/annuity may be more generous than you can buy on your own.

As for your other concerns, if you haven't seen this before, a good way to organize your thoughts IMO.

 

[travelover]

How confident are you that the pension will always be paid? If it is secure, I'd go with the pension, you've got enough cash to mitigate the risk.

 

[nun]

Generally the younger the person getting the lump sum offer the better the interest rate will appear. The IRS segmented (rates based on corporate bond rates)

Minimum Present Value Segment Rates

and longevity tables should be used to calculate the lump sum and the younger you are the more years use long term bond rates of around 5%. I've had 2 recent lump sum buyout decisions to make and did different things, both are lifetime pensions/annuities. I'm 53 with a 31 year actuarial life expectancy

1) $35366 or $2244/year at age 53...the implied interest rate is 4.9%.....I took the lump sum

2) $263k now or a COLA'ed (currently capped at 3%) $20k/year at age 55. If the COLA is 0% the implied interest rate is around 5.5%, with an annual 2% it's 7%.....I took the pension.

 

[nun]

How confident are you that the pension will always be paid? If it is secure, I'd go with the pension, you've got enough cash to mitigate the risk.

For me the interest rate of around 4.3% just isn't good enough (that's higher than the 3.8% I initially calculated because I underestimated the OPs life expectance, using the IRS tables the OP can expect to live another 24 years) .....and I'm a big fan of using SPIAs. pensions, and SS to cover basic retirement expenses. Maybe I'm market timing annuity rates here, but the OP has enough cash to indulge in that a bit.

 

[Cobra9777]

I faced the same decision not too long ago. My pension was a bit smaller than yours, but the payout ratio was almost identical and it was also non-COLA. The rest of our situation is very similar as well, including the legacy comment.

I took the annuity. Main reason was to reduce the risk and uncertainty of relying too heavily on market performance and portfolio withdrawals to meet 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. With SS still to come and a sizable portfolio outside the pension, inflation is not a major concern.

The tax implications of taking the annuity are the biggest drawback, IMO. We pay ordinary income rates on the annuity payments instead of potentially zero for qualified dividends and capital gains. Plus, ACA subsidies are now out of the question, and Roth conversions would be too small to make any meaningful dent in RMDs. Definitely a lot to think about. For us, the diversity of income streams was paramount.

Your post is extremely comprehensive and well-written. So it's clear to me that you've already thought this through and researched it adequately. In our case, the pension lump sum was a smaller percentage of total financial assets. So, our 3-legged stool has 3 roughly equal-sized legs. Your pension leg is a bit bigger, but I'd still go with the annuity in your case.

 

[Renewed]

Wow. Thanks so very much to all of you who have responded. Yes, I am quite lucky to have such a dilemma . You all have have given me some things to think about.
Cobra 9777 you hit the nail on the head regarding why I am leaning toward the annuity. I think I would tend to be overly frugal in my early years out of fear. Thanks also for the compliment on my post. I have been studying/thinking about this for the past year.
Nun, interesting information regarding interest rate, I am not sure I fully understand. I will need to research that more. How are you calculating this? What interest rate would lean you toward the annuity.
Midpack- I had not seen that chart. I probably overlooked it before. Very helpful.
Regarding the questions raised. I am not married so no survivor benefits needed.
I think my pension is pretty safe. It is 95% funded at this time. The PBGC limit is less than my pension at my current age. By age 68 it is more than my pension.

Any further thoughts will be appreciated.

 

[nun]

Nun, interesting information regarding interest rate, I am not sure I fully understand. I will need to research that more. How are you calculating this? What interest rate would lean you toward the annuity.

All you do is take the number of years you are expected to live from an actuarial table, the annual pension amount, the lump sum and solve for the interest rate in a present value equation. Your numbers show that if you were to invest your $1.1M and you averaged 4.3% annual return you'd be able to withdraw $74.5k for 24 years....at which point you'd have nothing left. If you plan on living longer than age 85 your implied interest rate would be greater. So, if you think you can do better than 4.3% average annual return or if you think you'll die young you might take the cash.....but if you want risk free income, or expect to live into your 90s, you might take the pension.

Interest rate is a bit of a dubious way to assess an annuity because so many other factors are important and it's really an insurance product rather than an investment. Normally I'd worry about annuitizing 41% of your assets as you might do better over the long run with more equities, but you have lots of other assets and if you prioritize low risk I can see a good argument for it. Basically you'll probably be ok whatever you do.

I'm currently doing a long term experiment with the small lump sum I got from my DB pension. I dumped it all into a new Vanguard Balanced Admiral Index account and I'll see how it goes. I need at least 4.9% annual return to beat the pension payout assuming I live to 84. I'll report back in 31 years........hopefully

 

[Renewed]

Thank you Nun, that makes sense. Almost all my family members have lived into the late 80's minimum with many into their 90's. My grandmother to 101 so I feel I need to plan for an extended life span. However, who knows what the future holds.

I have been working with various retirement calculators today using a real return of 3.25% for a 50:50 portfolio and the outcomes seem better with the pension than the lump sum.

My biggest concern with the pension is, of course, the worst case scenario of default on the my employer's part. The pension is 95% funded @ this time which is reassuring. But the recent proposed change of the guarantees for multi-employer pensions is worrisome, especially as it could affect current retirees and the decreases are significant. My pension is through a single employer but still this gives me pause.

So, I still have a week or two to decide. Today I am leaning toward the lump sum. I can alway buy a SPIA later. Yesterday I was leaning toward the pension. I may just end up flipping a coin.

 

[Walt34]

I may just end up flipping a coin.

You're in a pretty good position either way so that would work.

I can't add to what the others have written other than I'm a fan of simplicity, especially for my dotage so for that reason alone I'd lean toward the annuity. But it does seem like a "Ford vs. Chevy" choice, either will get you there.

 

[nun]

Thank you Nun, that makes sense. Almost all my family members have lived into the late 80's minimum with many into their 90's. My grandmother to 101 so I feel I need to plan for an extended life span. However, who knows what the future holds.

I have been working with various retirement calculators today using a real return of 3.25% for a 50:50 portfolio and the outcomes seem better with the pension than the lump sum.

If you use 3.25% as a return the scenario with the pension will eventually win out as it's internal rate is 4.3% projecting to age 84.....if you go longer the pension get's better. But if you used 6% in your planning you'd have to live to 99 for the pension to catch up with the lump sum.

If your pension had a COLA it would be a slam dunk. Right now I think it's a toss up and really depends on your philosophy. I almost stayed with the BD pension I cashed in because if I lived to 84 the internal interest rate was 4.9% and that's 0.9% more than I use to do my projections, but the amount was so small that I decided the lump sum was more worthwhile. I'm definitely going to buy into the larger COLAed DB plan offer I have because the equivalent interest rate could end up being very attractive and I think annuitizing about a 1/5th of my retirement assets to cover 2/3rd of my income needs is a good use of the money.

 

[scrabbler1]

Just this week I have been learning about the various options for the two parts of my pension plan. One is the frozen pension (since 2001) and the other is the Cash Balance (CB) plan which replaced it for employees of my old MegaCorp who were not grandfathered into remaining in that plan. From 2001-2008, when I left MegaCorp, the CB plan continued to grow through pay credits and interest credits. Since 2009 I have continued to receive interest credits only.


I worked part-time from 2001-2008 so the CB plan doesn't have a huge balance but I have various options with regard to how to withdraw money from the CB, and I can do different things with the two plans. The CB offers me a lump sum as well as annuity-type payouts. I can convert the CB to a rollover IRA and withdraw money from it, subject to taxes and, if I withdraw before age 59.5, the 10% early withdrawal penalty. I might take this option if I happen to need cash in my late 50s although it would cost me a little extra. I could even convert it to a rollover IRA before age 55 but my options would be further limited.


I hope that MegaCorp's freezing of the old pension helped its financial stability so when I begin collecting from it in my 60s it won't be going broke. Employees hired in 2002 or later were not enrolled in the pension plan at all, only the CB plan (until 2005 when the CB was closed to new hires).

 

[Ticker]

I took the lump sum even though the pension was 95+% funded. Had I taken the pension, I would have received several monthly payments since my retirement, incurring some tax liability and depleting some of the lump sum. As it now stands, I have not had a need yet to withdraw any money, and when I do need it, I will control the amount of the withdrawals. I very much enjoy the control.

 

[harley]

I took the lump sum even though the pension was 95+% funded. Had I taken the pension, I would have received several monthly payments since my retirement, incurring some tax liability and depleting some of the lump sum. As it now stands, I have not had a need yet to withdraw any money, and when I do need it, I will control the amount of the withdrawals. I very much enjoy the control.

Did your lump sum roll into an IRA? If so, even if you don't need it you'll have to take it starting at 70.5. And you won't get to control the amounts, either. Except upwards. I'll be pushed into that boat then too, minus whatever I manage to convert to a Roth beforehand. With 11 years to go, hopefully I can make a decent sized dent.

Of course if you are going to need it between 59.5 and 70.5, then you're right. You'll have some control.

 

[Ticker]

Did your lump sum roll into an IRA? If so, even if you don't need it you'll have to take it starting at 70.5. And you won't get to control the amounts, either. Except upwards. I'll be pushed into that boat then too, minus whatever I manage to convert to a Roth beforehand. With 11 years to go, hopefully I can make a decent sized dent.

Of course if you are going to need it between 59.5 and 70.5, then you're right. You'll have some control.

Yes, I rolled it into an IRA. I ER'd last year at 60, and fully expected to have to start some withdrawals during 2014, but I got lucky and didn't have to. The Annuity would've kicked in immediately.

Still working on an investment allocation that will accommodate the withdrawals, though.

 

[jollystomper]

When I retire I will have a similar choice, with roughly the same amounts. I plan to take the annuity for simplicity purposes, since we also have other savings. The pension + SS when we decide to take it will cover our living expenses and our withdrawals will be for "fun" stuff.

If I wanted to spend more time managing my money I would consider the lump sum, but once I retire I hope to simplify my financial life.

 

[Renewed]

Again thanks to everyone who has replied. I am still going back and forth but again leaning toward the pension. The feedback here has been helpful to me.

 

[Renewed]

Update- Pension Funding Information

Just as I was getting ready to send in my paperwork deciding on the annuity I received the most recent funding notice. Which, of course, gave me a pause. I thought I would post the information and see if it changes anyone’s mind in regard to my pension, especially as my pension will be greater than the guaranteed limit until I reach age 68. I do feel the organization I worked for is stable but it is in health care and who knows what will happen politically in the coming years.

I will send in the final paperwork on Wed.

Here is the information I received. I do not fully understand what the difference between the MAP-21 and non MAP-21 interest rates are and the paperwork is not that clear. Is anyone knowledgeable about this and it's significance in regards to the funding of the pension.

Funding Target Attainment:
92.32% with MAP-21 interest rate (IR), 75.69% without MAP-21 IR
Prior funding the year prior:
98% with MAP-21 IR , 80% without MAP-21 IR- 80%
The year before without MAP-21 IR was 80%

I really appreciate everyone's thoughts as I make this decision. Your thoughts have helped shape my decision.