Author Topic: Pension Lump Sum Option  (Read 4258 times)

Grimstock

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Pension Lump Sum Option
« on: April 13, 2015, 03:10:45 PM »
Hello to my once and future finely-feathered friends,

Many have opined about the benefits of accepting a lump-sum pension payment vs. the guaranteed annuity option at retirement on this forum and in others.  I wanted to ask anyone with insight who is kind enough to share with me to weigh in on the particulars of the lump sum option that my company has just offered me. 

Specifically, I was given the option of an immediate lump sum payment of ~$72K.  Otherwise, I could elect to take a lump sum when I leave the company or keep the pension and begin receiving an annuity of ~$20K/year in the year 2040. 

I am currently 39, have ~$500K in taxable and tax-deferred investment accounts, and would like to leave the corporate world in the next five years or so. 

Any insight is greatly appreciated.  Thanks in advance!

 

 

CPA CB

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Re: Pension Lump Sum Option
« Reply #1 on: April 13, 2015, 04:19:38 PM »
Grimstock,

Using your Age (39) and assuming a payout from 65 to death (80.81 by current estimates), with a 5% discount rate (i.e. real rate of return) the present value of your $20k/annum pension is $54,200 ...

It appears as though the buyout, using these assumptions, is well worth-while.

Jeremy E.

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Re: Pension Lump Sum Option
« Reply #2 on: April 13, 2015, 04:23:11 PM »
I don't believe you've given enough information, but I would like to warn you that if you take a lump sum payment of $72k that you haven't paid tax on yet, that could be taxable income on top of what you are already making this year, example: if you were going to make 60k taxable income, you would pay around $7k in federal taxes with about a 12% total federal tax percentage, but instead if you took a $72k lump sum payment on top of that, you would instead pay about $25k in federal taxes with about a 19% total federal tax percentage.  So be sure that if you are doing anything with a lump sum, that you make sure it goes into a retirement account and you don't get taxed on it. As far as the rest of the question, if I were you I would put my 2 weeks in tomorrow, transfer the pension to an IRA if that's an option, and retire. If you take 3.5% out of $572k, that's $20,000/year.  If you don't think you can live on $20,000 per year, your new job can be learning to live more efficiently. Once you are able to do that you can spend your free time doing whatever you want.

CPA CB

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Re: Pension Lump Sum Option
« Reply #3 on: April 13, 2015, 04:37:54 PM »
I don't believe you've given enough information, but I would like to warn you that if you take a lump sum payment of $72k that you haven't paid tax on yet, that could be taxable income on top of what you are already making this year, example: if you were going to make 60k taxable income, you would pay around $7k in federal taxes with about a 12% total federal tax percentage, but instead if you took a $72k lump sum payment on top of that, you would instead pay about $25k in federal taxes with about a 19% total federal tax percentage.  So be sure that if you are doing anything with a lump sum, that you make sure it goes into a retirement account and you don't get taxed on it. As far as the rest of the question, if I were you I would put my 2 weeks in tomorrow, transfer the pension to an IRA if that's an option, and retire. If you take 3.5% out of $572k, that's $20,000/year.  If you don't think you can live on $20,000 per year, your new job can be learning to live more efficiently. Once you are able to do that you can spend your free time doing whatever you want.

Agreed - my calculation is pre-tax vs. after tax - something to consider.

If you want to do this calculation yourself:

The Actuarial PV Multiplier at 5% to life is: 17.226
At Age 65: 14.516

Subtract the two and it is 2.71 - multiply this by the annual earnings amount for your present value today (assuming you're a male born June 30, 1976)


Grimstock

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Re: Pension Lump Sum Option
« Reply #4 on: April 13, 2015, 05:06:31 PM »
Thanks CPA CB and Jeremy E.   

CPA CB: The Actuarial Multiplier data is very helpful.  Thanks again. 

Jeremy E:  If I were to take the lump sum, I would definitely roll it into an IRA or my company 401k.  My company 401k has mostly lousy investment options, so I would be inclined to just roll it over into an IRA.  That said, I would love to hear if there are any reasons why I may want to consider rolling it into my company 401k instead.  I also have both traditional and Roth IRAs, so any additional insight from anyone on the forum as to where to best put the rollover amount is welcome.

On a grander note, I would love to retire very soon and am excited about how much closer this cash payout gets me to that goal!  That said, I do have a wife who is staying home with my two kids under 5 years old, so I'm a bit apprehensive about getting out too early.  With all of THAT being said, my wife is Costa Rican, so we definitely have an option to quickly and easily escape the high cost of living in the United States.   

Is there anyone out there who thinks it makes better sense to take the guaranteed annuity considering the fact that I already have a fair amount of money in the market? 



 




MDM

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Re: Pension Lump Sum Option
« Reply #5 on: April 13, 2015, 07:24:22 PM »
Specifically, I was given the option of an immediate lump sum payment of ~$72K.  Otherwise, I could elect to take a lump sum when I leave the company or keep the pension and begin receiving an annuity of ~$20K/year in the year 2040. 
One way to look at this: what investment return would you need on the $72,000 such that in 25 years it would generate $(20,000/12)/mo?

In other words, solve [$72,000 * (1 + i/12)^(25*12)] * i/12 = $1,666.67 for i.

Comes out to 6.09%.   If you think you can do better, take the lump sum.  If you are satisfied with that return, take the 2040 annuity.

The interest hurdle is lower if you plan to deplete the principal over time, so another way to look at this: what investment return would you need on the $72,000 such that in 25 years you would have a "reverse mortgage" over, say, 20 years that would generate $(20,000/12)/mo?

In other words (using Excel's PMT function), solve PMT(i/12,20*12,-72000*(1 + i/12)^(25*12)) = $1,666.67 for i.

Comes out to 5.02%.   If you think you can do better, and don't mind depleting the money over 20 years, take the lump sum.  If you are satisfied with that return take the 2040 annuity.

Note that all interest rates discussed here include inflation - however much that will be.

greatrussian

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Re: Pension Lump Sum Option
« Reply #6 on: April 14, 2015, 11:03:04 AM »
Is there anyone out there who thinks it makes better sense to take the guaranteed annuity considering the fact that I already have a fair amount of money in the market?

I would keep the annuity for a few reasons.
  • It is guaranteed for life. Basing the present value of a benefit on life expectancy calculations are usually misleading, since there is a fairly high probably that you will live longer than that expectation - usually there is a greater than 1 in 2 chance you will live beyond your life expectancy.
  • The lump sum is based on average experience which is 2 decades old at this time, and there is a good chance you will live longer than that experience suggestions.
  • The pension benefit provides diversification similar to a long-term bond. This is an asset that is hard to find in the market, but generally does well when stocks are doing poorly. For example, long-term treasuries returned 20% last year.

CPA CB

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Re: Pension Lump Sum Option
« Reply #7 on: April 14, 2015, 01:48:23 PM »
Is there anyone out there who thinks it makes better sense to take the guaranteed annuity considering the fact that I already have a fair amount of money in the market?

I would keep the annuity for a few reasons.
  • It is guaranteed for life. Basing the present value of a benefit on life expectancy calculations are usually misleading, since there is a fairly high probably that you will live longer than that expectation - usually there is a greater than 1 in 2 chance you will live beyond your life expectancy.
  • The lump sum is based on average experience which is 2 decades old at this time, and there is a good chance you will live longer than that experience suggestions.
  • The pension benefit provides diversification similar to a long-term bond. This is an asset that is hard to find in the market, but generally does well when stocks are doing poorly. For example, long-term treasuries returned 20% last year.

Not to get too picky here - but...

1) Life expectation - the actuarial present value calculation takes mortality into account throughout the entire model, which is to say that it factors in the early death risk. That being said, every day you successfully live adds time to your longevity (since you didn't die) but if you're looking for a valuation today, the risk of death tomorrow exists. To say this is misleading is very much incorrect, as the alternate view is assuming you'll live longer in life (in spite of evidence to the contrary).

2) The statistics are based on the Canada Life Tables for 2009-2011. This is as recent as it comes, and is an accurate reflection of life today. Keep in mind that living in the US, there may be a small discrepancy in figures overall, but this is unlikely to make a material change.

3) If you smoke, drink excessively (14+ drinks per week), or have a bad family medical history, your chance of hitting life expectancy takes a dramatic step down.

That being said - there are risks in terms of taking the money now - will you be able to consistently gain a real return of 5% over the next 25 years? Does access to the funds mean that you'll choose to deplete sooner?

Unfortunately these are not simple questions to answer - but at least by bringing it up here you're getting a plethora of advice.

Good luck!