Pension annuity or lump sum?

[alexf]

Hello, I have a question about retirement income for my parents. My mom is about to retire and she has the option of taking her pension as an annuity or a lump sum. I’m looking for some advice about what she should do.

• The annuity would be $36,700/year (no cost-of-living adjustments), and the lump sum would be $419,500.
  
• They have $1.2 million in traditional IRAs/403bs and a $190,000 paid-off house.
  
• Their combined social security is $68,000/year.
  
• Not sure what their annual expenses are but I would guess ~$60,000.
  
• Mom is 65, dad is 70, both are about average health.
  

From other posts here, it seems like the community is split. Some prefer rolling the lump sum into an IRA because you can control the investments and you don’t have to worry about the pension fund going under. Others prefer the annuity because it diversifies income streams. I just wanted to see what the thoughts are for my parents’ numbers. Many thanks.

[MoseyingAlong]

What's their annual spend?
Will SS cover it?

Does the pension have any inflation protection?

What are their goals? Spend a lot while alive, leave a larger estate?

That info will help guide the advice.

[alexf]

Good points, @MoseyingAlong.

What's their annual spend? Will SS cover it?

This is the one thing I don't have hard numbers for, but I would guess $60,000/year. So SS will probably cover it in most years, barring unforeseen expenses.

Does the pension have any inflation protection?

The annuity does not have any inflation protection/COLA.

What are their goals? Spend a lot while alive, leave a larger estate?

Somewhere in the middle. They would like to start traveling more, but they have also said they would like to leave something behind.

[Playing with Fire UK]

Is there longevity in their family medical history? Or any history of overspending/impulse control in your parents? Either could tip the balance to an annuity.

[alexf]

Is there longevity in their family medical history?

Mom's side seems to live longish. Her mother died at 89 and her father is still alive at 92.

Or any history of overspending/impulse control in your parents?

No not really. They haven't touched the $1.2m in their IRA/403bs. I'm actually more worried about impulse spending with the annuity. I worry that an excess of retirement income will build up in their bank account and they'll find things to spend it on :P

[Playing with Fire UK]

Is there longevity in their family medical history?

Mom's side seems to live longish. Her mother died at 89 and her father is still alive at 92.

Or any history of overspending/impulse control in your parents?

No not really. They haven't touched the $1.2m in their IRA/403bs. I'm actually more worried about impulse spending with the annuity. I worry that an excess of retirement income will build up in their bank account and they'll find things to spend it on :P

That's a fair concern.

That longevity would nudge me towards an annuity, particularly for a younger wife. But it isn't a slam dunk either way.

[norajean]

The internal rate of return implied by the annuity is 8%.  I would take the annuity for sure unless your parents think the chance is high they would both pass away in the next ten years, in which case the lump sum would leave behind something for heirs.  Imagine, if they took the lump sum and used a SWR of 4%, it would be about $16,000 the first year, vs $36K for the annuity.

[reeshau]

What is the funding level of the pension?  Is it a private plan, or a public one?  Is it a group plan? (That is, mingled with other companies / unrelated fields)  No promise is worthwhile if it is likely to be broken.  Also, is she retiring under and early retirement program, or the "normal" retirement age? (As defined by the pension plan)  Early retirement benefits are classified differently by the PBGC, and are more at risk than the regular rules.

It is in vogue for private companies to hand over their pensions to insurance companies.  This is probably better from a risk standpoint, but it also recalculates the benefits based on the account value.  (My Dad experience GM's handover to Metlife)

 https://news.bloomberglaw.com/employee-benefits/pension-buyouts-likely-to-be-bolder-if-not-bigger-in-2019

Your parents seem to have their expenses covered through SS + pension, or SS + IRA, so they are well-covered.  It's not a matter of survival, but more a matter of stress / sleeping well at night / managing future potential disappointment.  As retirement scenarios go, It's not bad at all.  The right decision is whatever they are most comfortable with, after being fully informed of the above.

[alexf]

Thanks for the comments @reeshau.

What is the funding level of the pension?  Is it a private plan, or a public one? Is it a group plan? (That is, mingled with other companies / unrelated fields)

How can I find out the the funding level of the pension? It is a religious, non-profit healthcare group.

Also, is she retiring under and early retirement program, or the "normal" retirement age? (As defined by the pension plan)  Early retirement benefits are classified differently by the PBGC, and are more at risk than the regular rules.

She is retiring at full retirement age.

[reeshau]

How can I find out the the funding level of the pension? It is a religious, non-profit healthcare group.

They should be telling her regularly.  You can sleuth it out, though, based on their regulatory filings.

Here is a quick how to:
http://pensionrights.org/publications/fact-sheet/how-well-funded-your-pension-plan

Don't freak out if it's less than 100%--pensions invest for retirement just like we do, so they expect to grow more than inflation.  But it should be a solid 80% or higher.  If not, ask the plan administrator how they are addressing the underfunding.  If there is no response (or a bad response) then it's time to consider taking the nest egg and running.

I would have more faith in the future pension status of a religious, nonprofit healthcare group than I would a major city or large public company at this point.  The former are chronically underfunded, with no political appetite to raise money (i.e. taxes) to make up the difference, nor to reduce promises to practical levels.  And the latter are just trying to freeze and move to 401(k)'s.

[alexf]

Thanks again @reeshau.

Here is a quick how to:
http://pensionrights.org/publications/fact-sheet/how-well-funded-your-pension-plan

From what I've found, it's a single-employer plan. The market value and actuarial value match exactly...seems a little suspicious. I'll ask if she's ever received a Form 5500 from the plan.

Are there any hard statistics on pension funds? How many fail, how much do they cut benefits, etc?

[reeshau]

The best I can come up with is to look at the publications from the PBGC, which is the government insurer behind pension plans.  This isn't going to give you a failure rate, though--their primary reporting is on trustees plans-those that have already failed.  So it's not much better than anecdotal.  But there are plenty of examples.

https://www.pbgc.gov/open/index

I see that JC Penney is the latest...

[Runrooster]

Thanks again @reeshau.

Here is a quick how to:
http://pensionrights.org/publications/fact-sheet/how-well-funded-your-pension-plan

From what I've found, it's a single-employer plan. The market value and actuarial value match exactly...seems a little suspicious. I'll ask if she's ever received a Form 5500 from the plan.

Are there any hard statistics on pension funds? How many fail, how much do they cut benefits, etc?

I worked for PBGC in their terminated plans section. I wouldn’t worry about her losing benefits that way as she is well under the max of $68000. But you mentioned that it’s a religious group so I’m not clear on whether they are insured by the pbgc at all. If they filed a 5500 then that’s fine. I’m not sure where you got that market value and actuarial value are the same, but I agree that sounds sketchy.

[rmorris50]

Wow, take the annual payout and divide by the lump sum and you get an implied 8.75% return. I would definitely take the annuity unless

1. Parents health is really bad and they don’t expect to live long or

2. You don’t have faith the employer will be able to make good on the annuity payments in the future.


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[alexf]

Thanks for the comment @Runrooster.

But you mentioned that it’s a religious group so I’m not clear on whether they are insured by the pbgc at all. If they filed a 5500 then that’s fine.

Now that I've started digging a little more, I discovered that the employer was sued in 2016 specifically to challenge the religious exemption of its pension plan: https://www.pionline.com/article/20190607/ONLINE/190609898/ssm-health-care-reaches-60-million-settlement-in-church-plan-case

"Participants claimed that the plan did not meet statutory requirements to qualify as a church plan exempt from the Employee Retirement Income Security Act of 1974. The alleged violations included failing to provide summary plan descriptions, annual reports or funding notices, and underfunding the plans. The settlement requires the employer to fully fund the plan for 10 years, contribute $15 million per year to the plan from 2019 to 2022 and make additional payments to workers who received their retirement savings in a lump sum."

[Runrooster]

So that’s barely a year old settlement so they’re still massively underfunded. Also it looks like they are not covered by the pbgc even after the lawsuit. I have no idea how the pbgc would go about covering an old plan like that anyway except to start from 2019 which wouldn’t help you much.

I’m leaning towards the lump sum.

[Dicey]

I checked with DH, who's eligible to retire next year. The lump sum offering is super low, so we won't be going that route. Decision made.

[reeshau]

@alexf , I found some good detail on the pension plan in the annual report, located here:  https://www.ssmhealth.com/resources/about/financials/reports
Detailed pension info is in item #13.

I see why there was a lawsuit in 2016:  the company froze the plan that year.  Some senior people are allowed to accumulate benefits through the end of 2020, then switch to a defined contribution plan.  Others were switched beginning 2016.

I see a projected benefit obligation at the end of 2019 of $2,468,145,000 and net assets of $1,670,642,000.  This leaves an unfunded obligation of $797,503,000, which shows up as a liability in the balance sheet.  So, they are 67% funded, as of now.  While the numbers have changed, this is consistent with 2018 levels--so, not noticeably changed by the settlement contributions.

It's not unusual, but I also don't like that their pension funds are commingled with their endowment investments.  The "so what?" about that is if some investment tanks, then the endowment can't bail out the pensions--they're both SOL.  And the company has a number of partnerships and hedge funds invested, which are less liquid that stocks and bonds.

obviously, @Runrooster will have a better professional opinion.  I think in your mom's case, it's a good thing the plan is frozen, as the liability is capped and they can catch up on contributions.  But if they settled (i.e. had to be negotiated up to) $15M per year, that's not really going to make a dent on $787M shortfall.  And given junior employees were moved out in 2015, these future liabilities won't be so far out in the future.

It's an ongoing, healthy company, but I would say that funding level is a minimal amount--if they were a public company, they would be getting a lot of questions about it.  Clearly the lump sum will get your mom less, but the company has also not been prioritizing their pensioners when thinking about their finances.

[alexf]

Thanks @Runrooster and @reeshau! You've both been very helpful.

Don't freak out if it's less than 100%--pensions invest for retirement just like we do, so they expect to grow more than inflation.  But it should be a solid 80% or higher.  If not, ask the plan administrator how they are addressing the underfunding.  If there is no response (or a bad response) then it's time to consider taking the nest egg and running.

Now I know that the funding level is only 68%, and I can't see any way it could possibly approach 100% (unless there is some huge amount of money I'm missing). As you said, another $15-30 million won't make much difference against a shortfall of $790 million. And they had to be sued into contributing even that. So all of this would favor the lump sum.

How valid would it be to compare the lump sum against 68% of the annuity as a more realistic trade-off? That is, $36,700 * 0.68 = $24,900? Then the return rate is only 5.9% and the time horizon is 17 years.

[Runrooster]

I don't think the 68% comparison works.

The problem is that if a lot of people realize the low-funding rate, they will all take lump sums and deplete the account.  Your Mom might see a year or two of benefits, then nothing. 

[alexf]

The problem is that if a lot of people realize the low-funding rate, they will all take lump sums and deplete the account.

It sounds like you think 68% is low enough that you would take the lump sum, even given the relatively high annuity payments?

[Runrooster]

The problem is that if a lot of people realize the low-funding rate, they will all take lump sums and deplete the account.

It sounds like you think 68% is low enough that you would take the lump sum, even given the relatively high annuity payments?

Probably.  I mean, it doesn't sound like they're on the brink of bankruptcy, but the pension plan is already frozen and they're still underfunded.
How do you think they did with covid?  I work for a healthcare company right now and all the doctors took no salary for 6 months.  Plus we got the PPP loan.
It's hard, but yeah, take the lump sum.

[simonsez]

You've gotten great advice all around but consider allocation as well.  Many treat a pension as part of their bond allocation.  Whichever decision is made, just remember to keep the allocation lined up with the Investor Policy Statement if available (or if one doesn't exist, whatever your parents are comfortable with moving forward).

Congrats to your parents!