Author Topic: Mid-career break and lump sum vs pension decision  (Read 706 times)

BornToRun77

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Mid-career break and lump sum vs pension decision
« on: October 21, 2018, 08:56:10 AM »
After a decade of work with my current employer (an international organization) I am starting to feel ready for a new adventure. I'm thinking of taking a year-long career break to recharge my batteries - I would like to start this in the next year or so. Later, I would like to start my own business.

I'm 41 years old, so the question is how to make this transition financially. If I leave my job before the end of the year, I take a lump sum of about $260k (after tax). If I stay longer, then I keep earning a salary, but also vest in the pension scheme, which starts paying at age 63. As a US citizen living abroad the past decade my tax deferred options for retirement are limited and I don't expect much from social security. I plan to stay abroad for now.

The pension is inflation linked Ė with 2% assumption I would get about $40k/yr (nominal) starting at 63, rising with CPI over time. I have the option to take the pension in euros or dollars depending on where I settle. Itís guaranteed by multiple governments and tax deferred until payments start. Iíve run the numbers and if I live to 90, it's equivalent of about a 4.8-5.0% after tax IRR on the lump sum, not including additional salary savings from working.

I donít need access to the money in the short term. One part of me says to take the lump sum and invest it (only option in taxable account), to keep control, maybe get a better return, and buy an annuity later. Or I could use it to invest in an apartment, but the rental yield would be a bit less than the pension.

Another part of me likes the pension as a diversification strategy and good longevity insurance (it's priced better than annuities) with a nice income floor to hedge portfolio volatility...albeit only after 20 years. In that case, I would keep the equity portion of my portfolio higher for longer. The pension also has a spousal and child benefit, though at lower rates.

My current portfolio is $815k, allocated as follows Ė
ē Between Equities and Fixed Income, I maintain a 70:30 AA. This is mostly in taxable, with $55k in IRAs.
- $400k in total market Equity ETFs (50:50 US: International)
- $170k in Fixed Income (mostly total bond fund and a HY savings account in France)
ē $150k Cash
ē $70k Annuity (this is a legacy investment I plan to cash out and reinvest according to my AA)
ē $20k Private equity in a startup

Would appreciate any insights on the decision. Thank you!

BECABECA

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Re: Mid-career break and lump sum vs pension decision
« Reply #1 on: October 21, 2018, 12:37:53 PM »
An inflation adjusting pension is so rare nowadays, I donít think Iíd even consider taking the lump sum payout. But I guess thereís a couple things that could make me change that statement:
1. Will you not vest until after you hit your FIRE date? In that case, then you donít need the pension, although I still might stay until vested if itís not too much longer just to have the peace of mind knowing that my permanent early retirement is extra assured and Iíll be able to do a lot more philanthropy.
2. Do you hate your job? If yes, how much? If youíd rather work forever somewhere else than until vested here, definitely take the lump sum.
3. Do you have some reason to believe that you wonít live to 63? Then take the lump sum now! Or do you have some reason to believe that youíre much less healthy than the average person that the actuaries based their lump sum payout on, and you donít expect to improve when youíre retired? If the opposite is true, then the lump sum is short changing you.
4. Do you not trust that the company will be solvent when you hit pension age? It doesnít sound like this applies since itís guaranteed by multiple governments.
5. Do you need the money for some lifesaving medical procedure? Again, doesnít sound like this applies since you said you donít really need the money in the near term.

Since you have almost all of your wealth in taxed accounts, cashing out this pension and putting it into another taxed account isnít very advantageous... itís not helping you fund your early retirement by bridging you to the age when your retirement accounts open up, and itís sticking you with a big tax bill in that first year and then increased taxes every year, which all eats into your gains. I donít think itís realistic to think that you can beat the pension by investing the lump sum yourself, given the tax disadvantage youíd be fighting against.

Youíve already noted that the pension is a good diversification to your portfolio, and that itís longevity and volatility insurance. I completely agree. But when you say ďalbeit after 20 yearsĒ, youíre discounting thatís actually the time that you need that the most. When youíre younger and the market is volatile, you can pick up extra jobs here and there if needed. When youíre over 63 that gets tougher.

Anyway, hopefully this has helped you make your decision!

BornToRun77

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Re: Mid-career break and lump sum vs pension decision
« Reply #2 on: November 01, 2018, 11:45:19 AM »
Thank you very much for the reply and sorry for my delay. Your points are very helpful in thinking through the issue!

Answers to your questions:
1. I would vest at the end of the year, so long before any FIRE date. In reality, I donít see myself permanently retiring Ė rather I would like to do independent consulting and have the freedom to take on (or not) projects when and where I want.

2. I donít hate my job, but I am not realizing my full potential. Itís no problem to stay until I vest, but if I stay much longer without a corresponding career boost (which would also boost the pension), I feel I am short changing myself out of other life experiences.

3. Iím pretty healthy, with grandparents in their mid-90s, so a longer-than-average life is something I am looking forward to!

4. Iím confident the organization (itís not a company but an international governmental body) will be solventÖand there is a realistic strategy in place to assure the financial sustainability of the pension scheme. That said, there are some risks around how my starting payments will be adjusted in the 22 year deferral period (it depends on inflation and changes in the salary scales, which have not always kept up with inflation), but once payments start they would be adjusted only by inflation.

5. No

Yes, the tax issues are the most difficult part to navigate here. Using https://www.portfoliovisualizer.com/ I calculate that to give myself a high probability of getting equivalent payments as the pension, I would need to turn the $260k into at least $850k in the next 22 years. That implies after-tax annual returns of 5.5%. This seems very doable, and it could be more, but only if Iím very tax efficient.
 
Iím still leaning towards vesting in the pension from a piece of mind standpoint, but given my age I have this lingering feeling Iím leaving money on the table by not taking the lump sum and investing itÖ

Thanks again!

The Fake Cheap

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Re: Mid-career break and lump sum vs pension decision
« Reply #3 on: November 01, 2018, 06:25:26 PM »
I would likely lean towards taking the pension at 63 if I was in your shoes.  This is mostly due to you already having 850K in liquid assets.  The pension would serve as a nice back up once you reach your 60's.  I'm not sure if I would take this route if the pension was from a typical corporation, but you seem to think it is secure through the international org. 

Questtion - Are there any other benefits to taking the pension, such as health coverage?

Maybe another possible option for you would be to take a leave form your postion for a year?  Just thorwing that out there.


BornToRun77

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Re: Mid-career break and lump sum vs pension decision
« Reply #4 on: November 04, 2018, 04:13:52 AM »
Thank you for the suggestions.

To my knowledge there are not health benefits, but assuming that I get married one day and have children, there are some additional allowances I would be eligible to receive that would boost the pension a bit.

Unfortunately I don't think it would work to take leave from my position for a year for various reasons.

The way I am starting to view the situation is that the pension is like a big fixed income allocation, which would work either in Europe or the US (I don't know where I will retire in 20 years). With that in my portfolio I can be more aggressive investing in equities relative to bonds. I don't like investing in bonds anyways, and there are not good ways for me to build any type of investment portfolio in Europe (where I live) because of US tax rules around passive foreign investment companies. So it takes care of a few issues that are hard to manage on my own: having investments in a currency where I live and may retire, tax deferral and less reliance on bonds in my portfolio.

My current job is also well paying, so if I stay and save a lot in the next year and invest it, I will offset some of that foregone lump sum. The second half of my career is likely to be more independent and freelance, so I think it makes sense to maximize all the different types of retirement and savings options I have now in the expectation that future cash flow may be more uncertain. This is the way I'm rationalizing it all...still a very tough decision.

Dee18

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Re: Mid-career break and lump sum vs pension decision
« Reply #5 on: November 04, 2018, 05:00:20 AM »
A minor fact to consider is that in some states pensions are not taxed.  The pension I will receive (not a government one) will be fully taxed in some states and not at all in others, although it will be subject to federal income taxes.  On the other hand, one downside is my pension is not something my daughter can inherit. (Where I work we donít have the option to cash out, so I donít have to make the choice you have.).

chasesfish

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Re: Mid-career break and lump sum vs pension decision
« Reply #6 on: November 04, 2018, 06:00:42 AM »
I would research how well the pension is funded.  If it appears to be well funded and managed responsibly, then take the inflation adjusted pension.

If you find any cracks in your research, take the lump sum and run

Finances_With_Purpose

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Re: Mid-career break and lump sum vs pension decision
« Reply #7 on: November 07, 2018, 09:12:00 PM »
Only @chasesfish mentioned the most important factor here to me: what are the odds that this org will still be around and as solvent three decades from now?  How well will it be managed then, when you're pulling contributions?  Will it still be funding pensions well?  Will someone there then misappropriate the cash (a la MF Global)?  What do they estimate their rate of return on their pension investments will be?  And what are those invested in? 

Personally, I would add a significant premium for pension-default risk to your calculations.  As it stands, you have a very large investment in one single organization (your employer) which may or may not be a good idea.  It's certainly not diversifying your investments. 

Even good companies get dragged down by their pensions every day, not to mention governments; a plan like that requires significant contributions, which makes the org itself less flexible should economic conditions change. 

Also keep in mind that your company offers the lump-sum option as well as the pension option, which means it will be even riskier if things ever look shaky.  The employees can all jump ship and take their lump sums before the cash is gone, leaving those who took the pension option with little or nothing.  (Here's one example from the past few years.) 

With the take-it-and-run approach, you at least have control over your own funds.  You don't want to compare an investment at the market rate of return with your pension rate of return.  That's comparing apples to oranges.  Instead, you have to adjust for the risk of having that many eggs in one basket.  The pension is worth a little less because it's comparatively riskier.  The org may set conditions that make the pension even riskier (see example above, for instance). 

All else equal, I lean against pensions unless, as @chasesfish mentioned, the research shows the fund is extremely well-managed and uses reasonable assumptions about things like rate of return.  It's a significant risk, and, frankly, the risks are often nebulous, hard to ascertain, and can change over time.  (For instance, as stocks have boomed, some funds increased their assumptions about rates of return...to rates that now look decidedly optimistic, and make those funds riskier.) 

For all those reasons, I lean against pensions in general, but YMMV. 

chasesfish

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Re: Mid-career break and lump sum vs pension decision
« Reply #8 on: November 08, 2018, 04:34:31 AM »
I'll add to what @Finances_With_Purpose said:

I work for an overly conservative institution in a highly regulated industry with a fully funded pension.   If I could get a lump sum option when I leave, I would still take it and run.   

We're actually so conservative I don't know how long shareholders will tolerate not making a reasonable return