Pension Payout-- Lump sum, or defer?

[john6221]

I switched companies a few years ago but not without first vesting in the pension plan at my former employer. Today, I received a notification that they are providing a window where we can do one of three things:
1. Receive a lump sum and take it as cash or roll it over into an IRA. $13,000 is the payout. Subject to taxes and IRS penalty if taken as cash.
2. Receive annuity in the form of $75/month starting in December 2014 and continuing until I die
3. Defer all payments until I'm 59.5, or whenever I chose. If I wait until age 66, I would get $375/month until I die.

Right now I am torn between options 1 (in the form of IRA roll-over) and 3. Option 2 seems silly.

But I'm struggling with how to compare the two options.  Any ideas? Thanks.

[Middlesbrough]

I switched companies a few years ago but not without first vesting in the pension plan at my former employer. Today, I received a notification that they are providing a window where we can do one of three things:
1. Receive a lump sum and take it as cash or roll it over into an IRA. $13,000 is the payout. Subject to taxes and IRS penalty if taken as cash.
2. Receive annuity in the form of $75/month starting in December 2014 and continuing until I die
3. Defer all payments until I'm 59.5, or whenever I chose. If I wait until age 66, I would get $375/month until I die.

Right now I am torn between options 1 (in the form of IRA roll-over) and 3. Option 2 seems silly.

But I'm struggling with how to compare the two options.  Any ideas? Thanks.

How old are you?
What would be your expected rate of return if invested?
When would you need the money in retirement?

[dragoncar]

I switched companies a few years ago but not without first vesting in the pension plan at my former employer. Today, I received a notification that they are providing a window where we can do one of three things:
1. Receive a lump sum and take it as cash or roll it over into an IRA. $13,000 is the payout. Subject to taxes and IRS penalty if taken as cash.
2. Receive annuity in the form of $75/month starting in December 2014 and continuing until I die
3. Defer all payments until I'm 59.5, or whenever I chose. If I wait until age 66, I would get $375/month until I die.

Right now I am torn between options 1 (in the form of IRA roll-over) and 3. Option 2 seems silly.

But I'm struggling with how to compare the two options.  Any ideas? Thanks.

How old are you?
What would be your expected rate of return if invested?
When would you need the money in retirement?

I might go w/ option 2 depending on answers to the above

What's your tax bracket?

[viper155]

Roll, roll, roll got ta fill my soul. Alright........[the Doors]

Roll it over young man. Ti yi yi yime....is on your side [The Rolling Stones]

[Beric01]

Isn't this a pretty simple future value of money calculation? You've figured out your expected rate of return, and said you don't need the money now. So the question is: "which choice will maximize my total earnings by the time I hit [life expectancy date]?" If you can beat the annuity by investing in the market, roll into the IRA. If not, take the annuity - you can assume that annuity disbursements are reinvested into the market.

[MDM]

1. Receive a lump sum and take it as cash or roll it over into an IRA. $13,000 is the payout. Subject to taxes and IRS penalty if taken as cash.
2. Receive annuity in the form of $75/month starting in December 2014 and continuing until I die
3. Defer all payments until I'm 59.5, or whenever I chose. If I wait until age 66, I would get $375/month until I die.

Assuming you will live 50 more years, get 5% after-inflation returns, tax rate = 25%, inflation = 3%, and have an option to wait 34 years for a higher monthly annuity:
n = 50
r = 5%,
t = 25%
i = 3%
m = 34.

Present Value of options:
1. $13,000
2. $75 * 12 * (1 - t) * (1 - (1 + r)^-n) / r = $900 * 0.75 * (1 - 1.05^-50) / .05 = $12,322
3. $375 * 12 * (1 - t) * (1 - (1 +r)^-(n - m)) / r / (1 + i)^m = $4500 * .75 * (1 - 1.05^-16) / .05 / 1.03^34 =  $13,389

Given the uncertainties in r, t, i, and m, for the values chosen it's reasonable to say all options are ~equal - not too surprising if the former employer has good actuaries.  So just pick one and don't look back.

Except for one thing: in option 1 you get to defer taxes in the IRA.  If you expect to be in a lower (e.g., 15%) tax bracket in retirement, option 1 gets my vote.  Otherwise it's back to a 3-sided coin flip.

Brief background on the formulas (edification for some, and an opportunity to critique for others):
Calculation for option 2 is for annuity present value.  See the first formula in http://en.wikipedia.org/wiki/Annuity_(finance_theory).
Calculation for option 3 is for annuity present value at age 66, discounted back to today's value based on assumed inflation.

[dragoncar]

Isn't this a pretty simple future value of money calculation? You've figured out your expected rate of return, and said you don't need the money now. So the question is: "which choice will maximize my total earnings by the time I hit [life expectancy date]?" If you can beat the annuity by investing in the market, roll into the IRA. If not, take the annuity - you can assume that annuity disbursements are reinvested into the market.

Yep, easiest way is to use the NPV calculator in Excel.  We also need to estimate when you'll die.  Then plug in all the future income streams, the rate of return, and see what has the highest NPV. 

[SnpKraklePhyz]

MDM - it is so interesting that you say all are equal and should be if they have good actuaries.  I have always thought that about these choices - they know what they are doing when they offer me x or y or z.  From there things change based on my choices but the company is not going to offer x or y or z if one saves them money.

[pom]

As an actuary I can tell you that the choices are not always equal. Depending on the regulation you can tilt a little to get to what your client is trying to achieve.

I suspect that in your case they are trying to "Derisk", i.e. pass on the risk of longevity and interest rate to you.

Considering how longevity has continued to surpass expectations, I would suspect that, for the average person, options 2 or 3 are the better ones. That being said, nobody is the average person. You will know better than I if you are in decent physical shape and if your family has generally lived longer than average.

For the average person, I would recommend that they keep the annuity and consider it as a very safe bond-like investment: lower return but low volatility. It should be worth 70k-90k at age 66.

[MayDay]

Did you work for 3M?  I used to work for them, and just got a similar offer. 

My numbers are something like:

7000$ now lump sum
45$ a month starting now
$150 a month starting when I am 55.

I am going to pick either 1 or 2, but I haven't run the numbers yet.  My family has some nasty health stuff like cancer that seems to kill us all off early, so I figure I will be better off getting it sooner rather than counting on living until a ripe old age.