Pension Scenarios

[Aphalite]

Hi all,

I have a question that I'm hoping you all can help me out with

Background:
I came out of school about 4 years ago and started my career in public accounting. In June of this year I left to take on a more lucrative position. Last night I received the letter detailing my options for the firm's pension program, in which I am 100% vested due to my years of service. I was going through the scenarios and need some advice.

Terms:
Lump sum now of $6,716 or monthly benefit of $838 starting in November 2051 (when I'm 65 - am currently about to turn 28)

My questions:
1) I ran the cash flow analysis assuming that I live to 90 (which may be optimistic? Right now I'm only 28, fit and in good health, but probably too early to tell if there'd be anything big that could spring up), and it seems that if I assume 8% or more annualized return, the lump sum looks to be a better option (I got $735k monthly vs $793k lump sum  using 8% and $636k vs $446k, respectively, using 7% - but please check my math on this), 8% seems to be pretty safe, but it's close enough to make me rethink my decision - a guaranteed single life annuity is always nice. (P.S. it really shocked me that a corporate firm would use such a high rate of return, unless of course my math is wrong)

2) The thing I worry about is that the pension will not be solvent by the time I'm eligible for the payments if I do take the monthly payment. Even though this is a multi-national accounting firm, accounting is an industry at the whims of regulatory agencies and the public trust, and I don't have a crystal ball to tell me whether the firm will continue to fund its pension adequately in the coming years.

3) This is peripheral but I also have the option of 5 year certain/life ($824), 10 year certain/life ($786), and 15 year ($740) where if I perish before those time periods, my beneficiary will continue to receive benefits for the rest of the period - I've currently been very generous in projecting 25 years of life after I turn 65, so I wonder if the 15 year option might be worth it - probably not

Thoughts? Questions? And thank you very much for taking the time to read this question

[MDM]

aphalite, congratulations on having such a problem. ;)

1) Your cash flow analysis looks good.  The options are equal at ~8.18% for annual compounding, and ~7.96% for monthly compounding.

2) Good question.  A lump sum in the hand vs. ??? in the bush. 

3) My $0.02: it's not enough to bother worrying about.  At 3% inflation, $838/mo becomes ~$281/mo in 37 years - not nothing, but likely small in comparison to your eventual portfolio and cash flow.

Aside from the company's viability, perhaps the largest unknown is average inflation over the next 37-52 years.  If it stays below 3%, a guaranteed real 5% return isn't bad at all.  If inflation goes double digit for too many years, however, your real return for the monthly option gets very low.

In short, considering all the above: roll the lump sum into an IRA, stick it in your choice of equity fund(s), and get on with your career.  At least that's what my cloudy crystal ball shows today.

[Heart of Tin]

FYI, the SSA only expects you to live to about 78 if you're male or 82 if you're female. If you'd like to refine your valuation, then you can use their life table here: http://www.ssa.gov/oact/STATS/table4c6.html

I'm with MDM; take the lump sum. If nothing else it will give you the satisfaction of having more control over the investment.

[Aphalite]

Thanks very much guys for the input!

[pom]

2) The thing I worry about is that the pension will not be solvent by the time I'm eligible for the payments if I do take the monthly payment. Even though this is a multi-national accounting firm, accounting is an industry at the whims of regulatory agencies and the public trust, and I don't have a crystal ball to tell me whether the firm will continue to fund its pension adequately in the coming years.

That part you should almost ignore because even if the plan goes down, your pension is insured by the PBGC (for the benefit of other readers, the maximum guaranteed amount is 60k a year for a single life annuity starting at age 65, any amount above that is not guaranteed).

There is a tool to check that your plan is insure on the site http://www.pbgc.gov/

I used "almost" because of course the PBGC could cease to exist but that is unlikely.

[Catbert]

I'd take the lump sum (roll to IRA).  Your or your survivor even remembering that the pension even exists in 35 years is questionable.

[Hvillian]

Some quick thoughts assuming you are in the United States:
- They are not assuming an ~8% rate of return.  They are likely using lower rates which are set law, but are also accounting for the chance that you die.
- I think the lump sum payment is taxable income, unless rolled over into IRA (or similar pre-tax retirement account).
- As someone mentioned, the benefit is covered by the PBGC, so you will receive it even if the company goes belly up tomorrow.
- If you leave the money in the plan, they are required to notify the Department of Labor that you are entitled to the benefit.  So in theory, when you apply for Social Security benefits, the Social Security Administration will notify you that "Hey, remember your brief stint at company XYZ, well our files say that they may still owe you a monthly benefit and you should look into that."  So there is a back-up, if you forget about it and the company can't find you.

I think the essential decision is whether you would pay $6,716 in pre-tax money for a annuity that isn't going to begin payment for 37 years.
PRO:  I think it is likely a much better deal than you could get on the open market for a similar annuity.  It is a guaranteed income amount . . . assuming you make it to that age.
CON:  Why the heck would a 28 year old be purchasing a annuity that does begin payment for 37 years, in an amount that likely won't amount to much at that time?

No wrong decision, and probably easier to take the money now.  I hope you are enjoying the new job.

[Joel]

I know my firm (a big four) guarantees a 5% return (or the 30-year treasury rate, whichever is greater) on my pension balance every year. When I plan to leave, I will be treating it as part of my bond allocation.

[Jellyfish]

I also work at a Big 4 firm.  Mine grows the balance at the 30 year treasury bond rate, currently at 3.3%.  Over the long term you could probably beat that in a well diversified portfolio of your own.  You probably want to check the particulars of your particular pension plan to understand the return on your pension balance between now and when you could begin collecting the benefit.

[MrsPete]

You'd probably collect more dollars by waiting for the pension.
At the same time, the pension carries the highest risk; it could disappear between now and then.

Probably the "roll it into an IRA" option is the best. 
It'll give you control over your money, and it won't disappear. 

The worst option is to take the cash now.