Author Topic: Should I take a lump-sum pension distribution?  (Read 2395 times)

skyrefuge

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Should I take a lump-sum pension distribution?
« on: June 10, 2013, 09:31:17 PM »
It seems I haven't seen this topic here before, but forgive me if this has been hashed over a million times.

I have a corporate pension from a company I no longer work for. It promises to pay out $9000/year when I turn 65, which is 29 years from now (I'm 36). From a Mustachian budget level, that number sounds pretty awesome, except that it's not inflation-adjusted, and $9000 in 2042 will barely be enough for a couple of rolls of toilet paper.

Last month, the pension plan opened a window in which we can choose to instead take a lump-sum distribution.  The lump-sum offer is $29k. Should I take it?

Here's an analysis I did. I wanted to figure out what size endowment I would need in 2042 to produce $9k of income per year. Playing around in FireCalc, it appears that if I don't make yearly increases in withdrawals for inflation, I can withdraw at about 5.8% to achieve a similar level of 30-year success as the standard 4%-but-increasing-with-inflation withdrawal-rate. $9k is 5.8% of $155k, so to get an equivalent benefit, I would need to turn today's lump-sum of $29k into $155k over the next 29 years. That equates to approximately a 6% annualized rate-of-return.

Given then fact that a 6% rate-of-return of the next 29 years sounds healthy-but-not-impossible, and there is some non-zero chance that the pension could fail to pay out as promised in 29 years, I'm tempted to take the lump-sum (which I would keep tax-deferred in an IRA).

For further background, my investments are currently about $750k (essentially all index funds), my yearly expenses about $22k, and I'm still working. So the choice doesn't have a huge effect on my financial picture, but I still want to make the optimal one. I currently expect no other sources of annuitized income in retirement besides Social Security, so one of my thoughts in favor rejecting the lump-sum would be just to have a sort of diversification in forms of retirement income. I'm planning to live to at least 100.

Are there any factors I'm missing? Anything that makes this decision different for a Mustachian vs. a normal person?  I'm assuming the actuaries/IRS calculate the lump-sum amount in such a way as to make the arguments in favor of either decision equal and the choice impossible, but maybe there is a Mustachian-factor that throws the math in favor of one route over the other? (just as it might be an easy decision for a non-Mustachian who "needed" a brand-new Infiniti)  Is there any history of pension plans making "better offers" further down the line if enough people don't take them the first time around?

Jamesqf

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Re: Should I take a lump-sum pension distribution?
« Reply #1 on: June 10, 2013, 10:10:11 PM »
Do you have dependents, or expect to have them before you would start collecting the pension?  Depending on the plan, the pension could well die with you, the distribution (and any growth) would pass to your heirs.

FWIW, in a similar situation, I took the distribution.

happy

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Re: Should I take a lump-sum pension distribution?
« Reply #2 on: June 11, 2013, 03:42:11 AM »
I'm not an expert in pensions etc.

If your math is correct, then as a Mustachian I'd take the lump sum and invest it as you plan to do since as you say there is a small chance of the pension not being there if the plan collapses. If you invest it yourself you know you have it. One question would be whether you believe you can equal the return of the pension fund manager -  but since you have accrued 750k you probably know what you are doing. On the other hand the pension fund pays the fund manager so they have a cost you don't.

The main danger would be for non-Mustachians who would spend it!

Khanjar

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Re: Should I take a lump-sum pension distribution?
« Reply #3 on: June 11, 2013, 03:44:28 AM »
I'd take the lump sum, because I don't trust pensions, and yeah, from a mathematical standpoint it does seem a valid option.

Don't forget about taxes though.

BPA

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Re: Should I take a lump-sum pension distribution?
« Reply #4 on: June 11, 2013, 04:43:33 AM »
I'm debating this right now.  I'm 5 years off receiving a defined benefit government pension plan.  The issues are that I'm a government employee and don't trust future governments not to reduce the benefits, I'm not married but have children and so as James pointed out when I die, so does the money, and from an income tax standpoint, I won't require the yearly amount I'll be getting and will be able to save taxes by not drawing as much as the pension plan would pay out.

Part of me wants to take the money and run, but then part of me thinks that it's a DBP and 2/3 of it will be indexed for inflation.  I've got five years before I need to make a decision though.

Honest Abe

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Re: Should I take a lump-sum pension distribution?
« Reply #5 on: June 11, 2013, 04:54:09 AM »
Check to see if they're distributing it into a tax-advantaged vehicle to avoid paying taxes on it.

Otherwise, the 6% rate of return you're expecting that you need sounds like the same exact math they did to arrive at that $9k number. Why not just take the money and control it yourself?

SnackDog

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Re: Should I take a lump-sum pension distribution?
« Reply #6 on: June 11, 2013, 05:55:51 AM »
The pension payout is based on an actuarial estimate of your longevity and interest rates.  Interest rates can only go up from here, so the lump sum is likely to be reduced (higher interest forecast means lower lump sum required to deliver equivalent future balance or cash flow).

Your analysis is correct as far as the math.

The lump sum will give you infinitely more flexibility for accessing the money how and when you want to including giving it (or what is left of it) to heirs if you die (or pension may or may not transfer to your spouse).  You have more potential for appreciation and also more downside if you make bad investment decisions.  If you are sued or divorced you could also lose  it all - something which is not true with a pension (although pension payments could be factored in an alimony award).

You have to decide how this all fits in with your entire investment scheme.  Some people like the security of a pension or annuity payment as a guaranteed benefit, like social security, on which to layer the gravy from investment savings.

I would probably take the lump sum.  Your employer wants out from under the pension burden, which suggests they may not have confidence in the future financial strength to fund it.

Good luck!

Reepekg

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Re: Should I take a lump-sum pension distribution?
« Reply #7 on: June 11, 2013, 08:24:07 AM »
I've been spending too much time with my pension actuary wife, so keep in mind I'm not actually an expert. Just a guy on the internet expert.

Looks like your math makes sense and the choices are equivalent assuming 6% returns, but why would you allow the transfer of risk from the company to you without being compensated for assuming that risk? There is a reason companies want to offload their defined benefit pension liabilities. They're stuck paying you even if the market doesn't return 6%.

You already have $750k exposure to the market. Assuming the risk for this retirement money because you think can get maybe 8% instead of 6% is super aggressive... assuming a lot of risk with potential for marginal gains.

I'd also add that I'd like to see MMM do something on pensions, because the "my pension will be taken away!" fears are in the media and coming from the same complainypants place as "No one can afford healthcare!" and "social security is a ponzi scheme!" There are actually a lot of regulations like ERISA that require promised pensions to be funded and insured and paid, and the fact that there are rules which make it tough to cut benefits is one of the reasons companies are opting to switch to defined contribution plans so as not to promise pensions in the first place. Public sector pensions are a bit more worrying because the government can legislate themselves out of their responsibilities, balanced by unpopularity among pension recipient voters.

There is no prize for being self-reliant in retirement investing. I'd never lump sum a pension without being paid to do so. Let the company hold the risk.
« Last Edit: June 11, 2013, 08:38:23 AM by Reepekg »
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BPA

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Re: Should I take a lump-sum pension distribution?
« Reply #8 on: June 11, 2013, 05:16:24 PM »
Quote
I'd also add that I'd like to see MMM do something on pensions, because the "my pension will be taken away!" fears are in the media and coming from the same complainypants place as "No one can afford healthcare!" and "social security is a ponzi scheme!" There are actually a lot of regulations like ERISA that require promised pensions to be funded and insured and paid, and the fact that there are rules which make it tough to cut benefits is one of the reasons companies are opting to switch to defined contribution plans so as not to promise pensions in the first place. Public sector pensions are a bit more worrying because the government can legislate themselves out of their responsibilities, balanced by unpopularity among pension recipient voters.


http://www.mrmoneymustache.com/2013/01/29/pension-schmension-retire-on-your-own-terms/

Where I live pensions are currently guaranteed up to $1000/month but that could change with a change in government.  Private sector pensions have been drastically cut for many retirees and future retirees here.  I am also a public sector worker.  When it happens in the private sector, the trend is the public sector gets hit next.  Besides, I'm sure that if some politician said, "You've lost your pension.  Why shouldn't they?" people would vote for that person in droves.  It seems to be human nature.

Thus, I do not believe I am deluded or paranoid or a complainypants about this issue.  I simply want to make the best financial decision for me.  You have made a lot of assumptions.  That is one of the reasons people need to be smart and careful not to follow the advice of people who think they are experts on the internet. 

Reepekg

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Re: Should I take a lump-sum pension distribution?
« Reply #9 on: June 11, 2013, 05:52:48 PM »
Thus, I do not believe I am deluded or paranoid or a complainypants about this issue.  I simply want to make the best financial decision for me.  You have made a lot of assumptions. 

I'm pleased to agree with this:
Quote from: MMM
A high probability that your pension plan will pay out at least a significant part of the planned $40,000/year

Since the OP is from Chicago, Canadian trends and rules were not relevant.

Assuming risk is different from making an assumption.
« Last Edit: June 11, 2013, 06:03:01 PM by Reepekg »
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aj_yooper

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Re: Should I take a lump-sum pension distribution?
« Reply #10 on: June 11, 2013, 05:53:05 PM »
OP, I think your math is correct regarding the IRR and the value of an annuity at age 65.  As BPA points out, however, there are ERISSA requirements that would probably cover your at 65 pension which the company wants to avoid.  You could also be a failure in the bet, but you are not 'insured'.  Look into the ERISSA aspect somewhat more.  If you turned down the company offer, they might try again. 

Interesting question.
The stock market is not an actuarial table with a known outcome.  Taylor Larimore on Bogleheads Forum

On_a_slow_boat

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Re: Should I take a lump-sum pension distribution?
« Reply #11 on: June 12, 2013, 12:34:31 AM »
To the OP -  I was able to match the 29,000 they are offering you using your age (36) and annual expected benefit at 65 ($9,000). 

The calculation you are getting is described in IRS section 417(e) , basically if your pension offers you a lump sum instead of the annuity there is a minimum value of that LS they must offer (they can give more). They used something close to a 4.6% interest rate and a life expectancy that has you living to about 82.5. The way to check this is grow the 29,000 with 4.6% interest to age 65 then start taking out 9,000 in the middle of each year while crediting the remaining balance with 4.6% interest. You will get down to $0 around year 17. Rough math.

So based on the life expectancy the calculation is expecting 1/2 people do die before 82 and the other half to live longer.

So this is a difficult decision:
- If you think you can earn more than the 4.6% that points towards taking the LS
- If you think you will live longer than age 82 that points towards taking the annuity.

Two posters made great points in saying that you already have a lot of risk in the market. With a pension the risk of your life expectancy being long and the returns being poor is now the pensions problem not yours. By taking the LS - you are effectively moving the upside and downside to you.

Some factors you may want to consider:
- What would your benefit be from the plan if you took it at age 55?  If they gave you 7,000 10 years earlier for example would that change your decision?  Maybe you should ask for an estimate at an earlier retirement age. The Lump Sum calculation you are provided with does not have to by law include the value of the benefit at an earlier than 65 age... so there could(??) be a subsidy you don't know about.
-Joint & survivor annuities - The plan may offer a generous and subsidized death benefit. Would you value the benefit more if it was (for example) $8,500 paid to you while you are alive and then to your spouse if you pre-decease her?  Again ask for the estimate for J&S options.
- About trusting if the money will be there. Prior posters are quite correct in noting that ERISA does offer some protections. Currently ERISA qualified plans have to pay premiums to a gov't agency called the PBGC to insure the benefit.  They step in and take over both the assets and liabilities of the pension fund should the company go bankrupt. Currently, the PBGC is guaranteeing payments for people up to 57,500 a year. So under current law your benefit is well within the guarantee limits.
- About a better offer?  Who knows anything is possible, but if rates rise the value they offer to you in the lump sum will continue to decrease. If the company is dead set to get rid of the pension it is possibe they could purchase an annuity with an insurance company for all those people who turned down the lump sum. Once the annuity is purchased you will no longer have the option to take the Lump sum, but will still have all the annuity options you were entitled to under the pension.

hope this helps
 

Financial Threedom

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Re: Should I take a lump-sum pension distribution?
« Reply #12 on: August 03, 2013, 03:18:02 PM »
I'm a little late to this post, but some great thoughts here.  As someone who works in pension admin(in Canada), I would like to add my two cents.  I don't think anyone mentioned anything about additional benefits such as health or dental insurance that might be available to you if you decide to keep your money in the DB plan.  My other thoughts are that since you have 750K invested in the market or otherwise, it probably wouldn't hurt to diversify a bit and keep this money out of the market, and leave the liability to your current employer.  I hope this helps.