Author Topic: Critical pension decision and your input  (Read 6546 times)

paddedhat

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Critical pension decision and your input
« on: May 07, 2014, 01:53:44 PM »
I'm hoping to get many different angles, and opinions on this issue, and need to make a decision fairly shorty. We are a married couple, 50 & 55 Y.O with me (husband) being the younger. We are debt free, and live a frugal existence. I recently liquidated a custom homebuilding business,  and my wife is about to retire from a 30+ year career as a school teacher. The issue is further complicated by the fact that she is seriously disabled, having had a brain injury that left her paralyzed on one side . This took place nearly twenty years ago, and she continued with her career, and raising our kids.

Our current financial situation is as follows:
Vanguard IRA   $364K
Prudential IRA   $127K
Vanguard ETFs  $418K
Home               $141K
vehicles            $71K

Total                 $ 1,121K

Now for the confusing part. No matter what happens to me in the future, the wife is going to be well cared for financially. She should end up with a yearly income of $70-80K (adding pension and Social Security), and have no major concerns with health care costs either. OTOH, I need to start covering my own heath care out of pocket. If I would outlive her, any income other than investments is highly dependent on the pension option we select. With that in mind the following pension selection options are on the table

#1  Disability, without survivor benefit.                          $5232/month
#2  Disability, w/survivor benefit of $3969/mn                $4676/mn
#3  Standard without survivor benefit                              $4525/mn
#4  Standard without survivor AND rolling
      a $161,500 cash balance over to an IRA                     $3737/mn
#5 Standard with survivor benefit of $3969/mn                 $3669/mn
#6 Standard with $3969 survivor and removing
      $161.5k  cash balance for IRA roll over                        $3278/mn

The roll over cash is not available if a disability option is chosen. The cash is only available if selected initially, once you pull the trigger, it's done. The pension is pretty unlikely to enjoy any cost of living adjustments, since the system is underfunded, and small, to insignificant COLAs happen every decade, if that. There are no taxes on pensions or Social security in this state, or locally, but federal taxes apply. Some of my IRA assets were inherited, so I have a forced distribution of $12K or so annually. It is taxed, but not penalized. Other than that there will be no income, or asset withdraws as I have no need, or interest, doing so.

So, what would you do. Take the maximum disability amount and risk the lack of "insurance" that comes with not having a survivor's pension?  Give any weight to being able to remove the $161K from the system?  See about getting a term life insurance policy for her?  I haven't got a clue as to the best option here, and I welcome your input. Thanks.
« Last Edit: May 07, 2014, 02:00:18 PM by paddedhat »

MDM

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Re: Critical pension decision and your input
« Reply #1 on: May 07, 2014, 02:47:49 PM »
Could you clarify the difference between option #1&2 vs #3&5?  Between those, there appears no reason for you to choose #3or#5 if #1or#2 is available - but do you get to choose or will someone else tell you which you can use?

dandarc

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Re: Critical pension decision and your input
« Reply #2 on: May 07, 2014, 03:01:44 PM »
Is the pension benefit indexed to inflation?

paddedhat

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Re: Critical pension decision and your input
« Reply #3 on: May 07, 2014, 03:18:14 PM »
MDM
Sorry, this is confusing, but #1  and #3 reflect a typical choice If you have no interest in providing for a designated beneficiary after your death. #3 being the value of the pension for a typical retiree with her service record, #1 being the same pension for an employee who qualifies as totally disabled. #2 and #5 are the same situation, but a reduced month payment, based on the spouse continuing to receive the full monthly payment in the even of the retiree's death.

The decision is made by the retiree alone. If I had to narrow my concerns to two issues, the first would be. Does the value of taking possession of $161K to invest outweigh the severely reduced monthly payment when taking this route. I don't believe that it possibly can, but I would never let $161K on the table without a bit of reflection, and I value opinions on this. My second concern would be the risk of taking the largest payout #1, with no safety net if I out live her. Being younger, and healthier, that is a probability.

paddedhat

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Re: Critical pension decision and your input
« Reply #4 on: May 07, 2014, 03:22:03 PM »
Is the pension benefit indexed to inflation?

Unfortunately no. As I had mentioned, COLAs are a battle, and when one happens, which is often 10-15 years apart, they are almost meaningless.

GregO

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Re: Critical pension decision and your input
« Reply #5 on: May 07, 2014, 03:43:42 PM »
First off, I'll say that i think this is definitely a situation where you should talk to a financial planner.  You have significant assets here and have to weigh a lot of different risks here.  I'm sure a financial planner can help you with ways to mitigate a lot of them.

As for your questions, I agree with you that there isn't much benefit to taking the lump sum payout unless you are very worried the pension funds are going to dry up.  Even if you made a 7% return off of the lump sum, it doesn't cover the monthly difference they offer you.  With the disability options available, I don't think the Standard options can compare.

After running some possible scenarios in excel, I was thinking #2 made the most sense.  Then after your last statement about your concern about your wife's health, I think that makes #2 an even better choice.  You would not have to outlive her long to get that money 'back' that you are giving up in your monthly payments.  And with the survivor benefit, you are negating a very large risk of her passing away and the pension payments ending.  I think the $6700 annual difference is well worth it.

But as you hinted, there may be other ways to negate the risk.  If I were you, I'd look into life insurance policies and see if the "insurance" the pension is giving you with a survivor benefit clause is a good deal or if you could get that same benefit by taking out life insurance.  There may also be other ways of setting it up too, which is why I'd suggest talking to a financial planner.  You also have to consider taxes, which may be another very big issue that a planner can assist with.
« Last Edit: May 07, 2014, 03:45:19 PM by GregO »

Lans Holman

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Re: Critical pension decision and your input
« Reply #6 on: May 07, 2014, 03:46:21 PM »
MDM
Sorry, this is confusing, but #1  and #3 reflect a typical choice If you have no interest in providing for a designated beneficiary after your death. #3 being the value of the pension for a typical retiree with her service record, #1 being the same pension for an employee who qualifies as totally disabled. #2 and #5 are the same situation, but a reduced month payment, based on the spouse continuing to receive the full monthly payment in the even of the retiree's death.
But I think the question is what is the difference between 1 and 2 as a group compared to 3 and 5.  How does the "disability" pension differ from the "standard"?

The decision is made by the retiree alone. If I had to narrow my concerns to two issues, the first would be. Does the value of taking possession of $161K to invest outweigh the severely reduced monthly payment when taking this route. I don't believe that it possibly can, but I would never let $161K on the table without a bit of reflection, and I value opinions on this. My second concern would be the risk of taking the largest payout #1, with no safety net if I out live her. Being younger, and healthier, that is a probability.

Trying to do some back of the napkin math but these numbers are weird.  Choosing 4 over 3 costs you about $800/mo, choosing 6 over 5 only costs about 400.  If you invested the 160k and used 4% as your safe withdrawal rate, that would be about 6400/yr. 
Similar challenge with looking at the survivor benefits.  Actuarially a 50 yr old male and 55 yr old female are both looking at about another 30 years life expectancy, but that doesn't account for her health.  Suppose she lives 20 years and you outlive her by 10.  The reduction is between 500-900 depending on the plans.  If you invest that difference for 20 years, it adds up pretty nicely (~250-500k, assuming 7% returns), but not enough to replace those 10 years of survivor benefits.  I feel like I'm making too many assumptions and guesses here, though.
One thing I can say with some certainty is that your wife sounds like a tough cookie.

MDM

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Re: Critical pension decision and your input
« Reply #7 on: May 07, 2014, 04:04:16 PM »
MDM
Sorry, this is confusing, but #1  and #3 reflect a typical choice If you have no interest in providing for a designated beneficiary after your death. #3 being the value of the pension for a typical retiree with her service record, #1 being the same pension for an employee who qualifies as totally disabled. #2 and #5 are the same situation, but a reduced month payment, based on the spouse continuing to receive the full monthly payment in the even of the retiree's death.
But I think the question is what is the difference between 1 and 2 as a group compared to 3 and 5.  How does the "disability" pension differ from the "standard"?
Lans, yes that's it - thanks for stating the question more clearly.

Catbert

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Re: Critical pension decision and your input
« Reply #8 on: May 07, 2014, 04:14:08 PM »
Two possible issues that might affect you (assuming you're in the US.): 

You indicated that the decision of whether or not to opt for survivor's benefit was the retirees alone.  Actually the spouse is the only one who can wave the survivor  benefit This pension law provision was the result of some ugly surprises by widows.

If your wife is a school teacher did she pay into SS while she was a teacher?  Many government employees don't.  Even if she earned SS through other jobs or hopes to get a spousal benefit from your SS, her SS will be offset by her pension.  (The applies only if she didn't pay into SS while she was earning her teacher's pension.)   

Poorman

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Re: Critical pension decision and your input
« Reply #9 on: May 07, 2014, 04:16:55 PM »
MDM
Sorry, this is confusing, but #1  and #3 reflect a typical choice If you have no interest in providing for a designated beneficiary after your death. #3 being the value of the pension for a typical retiree with her service record, #1 being the same pension for an employee who qualifies as totally disabled. #2 and #5 are the same situation, but a reduced month payment, based on the spouse continuing to receive the full monthly payment in the even of the retiree's death.

The decision is made by the retiree alone. If I had to narrow my concerns to two issues, the first would be. Does the value of taking possession of $161K to invest outweigh the severely reduced monthly payment when taking this route. I don't believe that it possibly can, but I would never let $161K on the table without a bit of reflection, and I value opinions on this. My second concern would be the risk of taking the largest payout #1, with no safety net if I out live her. Being younger, and healthier, that is a probability.

To address your first concern, it appears to me you would need a certain guaranteed return on the $161k to make it worth taking possession, depending on the scenario, either #4 or #6:

#4)  5.9% = (4,525 - 3,737) x 12 / 161,500

OR

#6)  2.9% = (3,669 - 3,278) x 12 / 161,500

Personally, under scenario #4 I wouldn't do it because 5.9% guaranteed on the money is a good deal.  Under scenario #6 it's a closer call at only a 2.9% guaranted return on the money, and I would consider putting it into stocks/bonds.


Regarding your second concern, I think of it as a life insurance policy.  The cost of this life insurance is $556 per month assuming you are torn between scenarios #1 & #2.

$556 = 5,232 - 4,676

Each year, it's costing you $6,672 for this insurance and if she lives another 30 years it's costing you a total of $200,000.  You said COLA increases aren't too likely, which means in inflation-adjusted terms you may never make that difference up.  You'll have to outlive her by a certain number of years for it to break even, but we don't know what future inflation will be, so it's impossible to calculate.  If you don't have reason to believe she will pass away sooner than average life expectancy, I don't think it's worth it.

You seem to have enough assets to support yourself should your wife pass away first.  Therefore, I recommend you "self-insure" by not opting for the survivor benefit. 

paddedhat

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Re: Critical pension decision and your input
« Reply #10 on: May 07, 2014, 04:19:45 PM »
First off, I'll say that i think this is definitely a situation where you should talk to a financial planner
Not only is this solid advice, but we are rounding up a list of "fee only" planners to interview on this issue.

After running some possible scenarios in excel, I was thinking #2 made the most sense.  Then after your last statement about your concern about your wife's health, I think that makes #2 an even better choice.  You would not have to outlive her long to get that money 'back' that you are giving up in your monthly payments.  I think the $6700 annual difference is well worth it.
This is why the first thing I told her, as we left the meeting today was, "don't worry, that MMM site I waste time on is full of folks who will help me get some clarity". The whole concept of the split between #1 & #2 verses how quickly it would be recovered if she passed, is something that I hadn't even processed yet.

If I were you, I'd look into life insurance policies
So far, my research indicates that it's a similar situation to a person with serious pre-existing conditions buying health insurance, pre ACA. It's available to a severely disabled buyer. It's horrifically expensive, and much of what I see online is folks paying high costs for small amounts to prevent saddling their loved ones with burial costs.

 Suppose she lives 20 years and you outlive her by 10.  The reduction is between 500-900 depending on the plans.  If you invest that difference for 20 years, it adds up pretty nicely (~250-500k, assuming 7% returns), but not enough to replace those 10 years of survivor benefits.  I feel like I'm making too many assumptions and guesses here, though.

Odds are that the difference between #1 and #2, or $556 would be the actual choice here. I really wanted to provide the other options to cover the possibility of grabbing the $161K available.  I appreciate all the assumptions and guesses a lot. I have no idea what next month will bring, with regard to her health and stability, so were all guessing.

One thing I can say with some certainty is that your wife sounds like a tough cookie

LMAO, if you only knew. I knew her mom and grand mom. They both were tough, stubborn, old Russian ladies that you did not even think of screwing with. If I wasn't several decades younger and the size of a pro ball player, they would actually scare me. The mom got remarried, late in life, and my BIL and I both had the same comment. "Sure feel sorry for that poor guy, eh?"

Thanks

paddedhat

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Re: Critical pension decision and your input
« Reply #11 on: May 07, 2014, 04:44:02 PM »
Each year, it's costing you $6,672 for this insurance and if she lives another 30 years it's costing you a total of $200,000.  You said COLA increases aren't too likely, which means in inflation-adjusted terms you may never make that difference up.  You'll have to outlive her by a certain number of years for it to break even, but we don't know what future inflation will be, so it's impossible to calculate.  If you don't have reason to believe she will pass away sooner than average life expectancy, I don't think it's worth it.

Excellent analysis. Actually in this specific case, is it reasonable to say that the lack of COLA keeps the math a bit simpler?  Using a total of $200K, it would take (as a worst case scenario) my living an additional 38 months to balance out the yearly loss. In reality that is the likely outcome. 

You indicated that the decision of whether or not to opt for survivor's benefit was the retirees alone.  Actually the spouse is the only one who can wave the survivor  benefit This pension law provision was the result of some ugly surprises by widows.
Interesting. I took the question to be more about the possibility of this being an administrative decision, not one being made by a husband and wife. Makes sense though. I grew up in a steel mill bedroom community. It always shocked me to see how many widows ended up with nothing when the husband died.

If your wife is a school teacher did she pay into SS while she was a teacher?  Many government employees don't.  Even if she earned SS through other jobs or hopes to get a spousal benefit from your SS, her SS will be offset by her pension.  (The applies only if she didn't pay into SS while she was earning her teacher's pension.)   
She is fully paid into SS, including all of her years in the classroom.

dandarc

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Re: Critical pension decision and your input
« Reply #12 on: May 07, 2014, 05:01:18 PM »
Sorry I missed the line about the COLAs.

I think everyone else has a lot of the angles covered.  Basically:

If your wife lives many more years, #1 or #2 work out the best.

If she passes soon (no reason for us to believe she will), #6 was the best choice.

In between, it gets mushy - the only clear losers are #3 and 5, but I'd still lean to #1 or 2, personally.

I'd personally take #1 because I'd want to be betting on her living a long, happy life, and because even if she doesn't, your other assets would be enough for me to feel OK from a financial standpoint.

dandarc

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Re: Critical pension decision and your input
« Reply #13 on: May 07, 2014, 05:09:16 PM »
See if you can't find out 100% if she qualifies as "totally disabled" or not before you make your decision - if she doesn't (School might say, look she continued to work for 20+ years . . . ) the monthly amounts are $800-1000 closer together - that might make me take a harder look at the 161K cash out and / or the survivor benefit.

Poorman

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Re: Critical pension decision and your input
« Reply #14 on: May 07, 2014, 05:16:33 PM »
Each year, it's costing you $6,672 for this insurance and if she lives another 30 years it's costing you a total of $200,000.  You said COLA increases aren't too likely, which means in inflation-adjusted terms you may never make that difference up.  You'll have to outlive her by a certain number of years for it to break even, but we don't know what future inflation will be, so it's impossible to calculate.  If you don't have reason to believe she will pass away sooner than average life expectancy, I don't think it's worth it.

Excellent analysis. Actually in this specific case, is it reasonable to say that the lack of COLA keeps the math a bit simpler?  Using a total of $200K, it would take (as a worst case scenario) my living an additional 38 months to balance out the yearly loss. In reality that is the likely outcome. 


The problem is that suppose she passes in 25 years, based on the historical rate of inflation, the value of today's dollar will be worth 50% in 25 years.  That means $200,000 in today's dollars will only have the purchasing power of $100,000, so to break even you need to collect $400,000 in survivor's benefits to recoup the $200,000 you put in.  The math isn't perfect because inflation happens over time, but I'm hoping you see what I'm trying to illustrate.  Inflation will extend the timeline to break even by an unknown amount of years. 

If you think the likelihood of outliving her by 5 years exceeds the likelood of you passing first or within 5 years of her, then it's probably worth it to get the survivor benefit.  Based on average life expectancies, I don't think it makes sense, but you'll have to weigh her health issues and decide how that changes the equation.

SunshineGirl

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Re: Critical pension decision and your input
« Reply #15 on: May 07, 2014, 05:28:27 PM »
I think you should take the survivor benefit, most definitely. Removing the health situation, I am in a similar position and would never not take the survivor benefit. It's just a way of protecting yourself.

paddedhat

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Re: Critical pension decision and your input
« Reply #16 on: May 07, 2014, 05:42:27 PM »
See if you can't find out 100% if she qualifies as "totally disabled" or not before you make your decision - if she doesn't (School might say, look she continued to work for 20+ years . . . ) the monthly amounts are $800-1000 closer together - that might make me take a harder look at the 161K cash out and / or the survivor benefit.

Unfortunately, this isn't one of those cases where her total disability is in question. The case is extraordinarily well documented, and will be reviewed by a state appointed doctor, not the school itself. The "off the record" response from the state employee handing her paperwork was, "in twenty seven years of handling these cases, it's really difficult to remember a case where disability was denied, and most were far less serious".

 The school itself is extraordinarily cooperative in assisting us with this for several reasons. One is that she had a full time aide who was, by law, supposed to be with her, every day, all day. Her principal didn't think the law and directive from the assistant super. applied to her, and assigned the aide to different duties. Late last year, the wife fell hard, while working alone, and was not found in an unoccupied classroom until the next bell. We have a tacit understanding that the district is pretty grateful that we let the matter drop, and is behaving accordingly.

 The whole concept of, "if you take a standard retirement, you have the option of rolling $161K into your own IRA" is something that I wasn't even aware of until today's meeting, and why I wanted to get the collective's view on the "non-disabled" option. Absent that recently discovered fact, a "normal" pension wouldn't even be in consideration.

Thanks for all the input.

Cassie

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Re: Critical pension decision and your input
« Reply #17 on: May 07, 2014, 06:35:49 PM »
I think seeking an expert's advice is good but I would choose #2 but I like safety.  When my hubby & i both retired we took the smaller pensions with survivor benefits. WE looked at buying life insurance instead but at our ages/health it was way too expensive.

Clover

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Re: Critical pension decision and your input
« Reply #18 on: May 07, 2014, 06:39:18 PM »
#1  Disability, without survivor benefit.                          $5232/month
#2  Disability, w/survivor benefit of $3969/mn                $4676/mn
#3  Standard without survivor benefit                              $4525/mn
#4  Standard without survivor AND rolling
      a $161,500 cash balance over to an IRA                     $3737/mn
#5 Standard with survivor benefit of $3969/mn                 $3669/mn
#6 Standard with $3969 survivor and removing
      $161.5k  cash balance for IRA roll over                        $3278/mn

My favorite choice is option 6.  If it were me, I would want the 161k up front rather than a promise to pay me later.  I'm a cynical sort - this might not be as big of an issue for you.

As you just stated, the greatest risk to you is that you outlive your wife and you have declined the survivor benefit.  Let's assume that she lives for another 20 years (age 75) and you outlive her by 10 years (age 80).  Also, I'm using the KISS method and ignoring rates of return and inflation.  Let's just focus on how much you will get from the plan under the two options that fall on the opposite ends of the spectrum.

Option 1:  5232 x 240 =1,255,680

Option 6: (3278 x 240) + (3969 x 120) + 161,500 =1,406,500

If she dies sooner (sorry, that sounds so crass) option 6 becomes even more attractive.  If she lives longer or you die earlier it becomes a wash.

dandarc

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Re: Critical pension decision and your input
« Reply #19 on: May 08, 2014, 09:36:54 AM »
This is just begging for a present-value analysis:

https://docs.google.com/spreadsheets/d/1uXB0Hak5zIGpxZXOq3WoRb8AEugB7yLLxGbqq_qdr9o/edit?usp=sharing

I've pre-loaded with options 1 and 6 presented as they seem like the most "different" options.  Make a copy and play around with the years / inflation rate / pension options if you'd like - you'll see how changes in several factors can affect the hypothetical "best" decision.

Of course, you can't know all of the inputs in advance, so take it for what it is worth - look at some "what-if" scenarios and make your best educated guess - I'd say all of the options look reasonably good, so it really boils down to what you think is going to happen over the next 30+ years, and how much / what types of risk you are comfortable with.

dandarc

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Re: Critical pension decision and your input
« Reply #20 on: May 08, 2014, 11:13:22 AM »
Sorry to keep posting, but this topic interests me - I really should look for a job in the finance industry.  Updated the sheet to have all 4 options (#1 A, #2 B, #4 C, and #6 D) - there's only 4, so why not have em all?

Playing with this, I'm leaning more and more towards option #2 - seems the least sensitive to the inputs.  Option #4 only works out if both you and your live a relatively short time (10 years or less for her, you outlive her by only 1 or 2 years).  Option #1 is the most volatile.  Option #6 is pretty stable too, but the break-even between #2 and #6, at 3% inflation is your wife living 11 or more years - going back to "I would bet on her living a long life".

GregO

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Re: Critical pension decision and your input
« Reply #21 on: May 08, 2014, 11:39:59 AM »
Sorry to keep posting, but this topic interests me

I think we must be cut from the same cloth.  I also made a NPV spreadsheet yesterday to compare these alternatives when I read this.  I also think this is really interesting and kept thinking about it since I read this thread yesterday.  I also agree with you that the analysis made me lean towards #2.

What I keep going back to when I think about this is that it's not necessarily about maximizing the benefit.  A lot of retirement planning is about minimizing risk.  If they both live long lives, they most likely aren't going to miss that $500 a month they gave up.  In the same vein, if they both pass away early, they won't ever need that lump sum that would have made it the better choice.  But if the wife passes away early, then the OP is in a much more vulnerable spot.  He has retirement assets, so he should be fine.  But he'd be in a much more vulnerable position than if he had a guaranteed monthly income.  That seems like more risk than they need to take.

The other glaring risk is inflation.  But I'd argue that having the guaranteed income allows the OP to keep his investments in a much more aggressive allocation where he should be able to match, or beat, inflation.  When the buying power of the pension begins to be not enough to support them, then they can start moving some money into stable assets that they can draw off of.  But having assets that they should not need for many years provides a lot of flexibility with the assets they do have.

I just don't see many alternatives where they will be in a better financial position by taking any of the other options.  Now if the goal is to maximize their wealth over their life, then there's definitely arguments to be made for taking option 1 or a lump sum payout...

electriceagle

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Re: Critical pension decision and your input
« Reply #22 on: May 08, 2014, 06:13:54 PM »
The NPV spreadsheet is a great idea -- you should definitely go through each option in detail using an NPV analysis.

That said, you can probably find the best answer by looking for information dislocations.

Lets compare #2 to #1: Essentially, option #2 is #1 with a life insurance policy that pays an annuity instead of a lump sum. Could you go onto the open market and buy a 30 year term life policy on your wife that pays $3900/mo to you for $600/mo? Probably not; since she is disabled, your premiums for this policy would be through the roof. (The information that she is disabled is used against you in the life insurance example but not in the pension w/survivor benefit scenario).

Now, lets compare #6 with #5 and #4 with #3. With a 4% SWR, the $161k is worth about $540/mo. This is more than the difference between #5 and #6 but less than the difference between #3 and #4.

One piece of information that is missing is the health of your pension plan. You may have 50 years to live; is the plan funded by Detroit property taxes or Beverly Hills property taxes? Is there a backup like the PGBC that covers underfunded pensions for teachers? If so, what is the limit of coverage? The $161k should get multipliers for both the lack of COLA increases and the risk of pension fund bankruptcy, but it is difficult to say how large that multiplier should be.