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Learning, Sharing, and Teaching => Ask a Mustachian => Topic started by: mrsggrowsveg on September 07, 2014, 02:14:14 PM

My mom is ready to retire and wanted me to ask you all the best way to take her retirement money. She has two options: a lump sum of $470,000 or $2820 per month. She is 62 and is still planning on working at a different hospital job until 65. My dad has no retirement, started a small winery and their spending is fairly high. She also has $512,000 in a 401k and $45,000 in mutual funds. Which retirement option would best?

I'd probably take the pension. Maybe. Probably.
A 4% withdrawal rate on the lump sum would be $1566. That argues for the pension. But the lump sum would still be there is your Mom died early.
Another way to look at it is that it would take about 14 years of the month payments to use up the lump sum (with no interest accrued.)
Things to consider:
is there a cost of living rider on the pension? (definite plus to the pension)
Is there a survivor option on the pension? At what cost?
What would your Dad do if your Mom and her pension died first?
What's longevity like in your Mom's family? Lump sums are generally/often calculated on the annuitant dying in early/mid80s. Would she likely beat those odds?

mary w has some good questions. Sometimes you can select between various monthly payments that provide various levels of survivor payouts. For example, it might be $2820 for just your Mom, or $2500 for your mom and $1250 for your Dad after she dies, or maybe $1700 until they both die. I made those numbers up, but you get the idea. You should find out if these options or others are available.
Here's my take:
Using Social Security's actuarial tables, she has a life expectancy of 22.65 years, and assuming a 6% real return, the present value (http://en.wikipedia.org/wiki/Present_value) of the monthly payments is $413304, a good bit less than the lump sum payment.
That 6% is the "discount rate," or the amount you'd expect to get if you invested the monthly payments. It accounts for the fact that choosing the monthly payments means that you miss out on the investment gains you'd have if you took the lump sum instead.
A more conservative estimate of the discount rate might be appropriate given that she'd almost certainly be focused on income generation with a relatively lowrisk portfolio at her age and current market conditions. Here's the present value at a few other discount rates:
6%: 452658
5%: 498011
4%: 550508
They usually do a pretty good job of matching present value of monthly payments to the lump sum, but it's never perfect because we're just guessing about future returns.
Most importantly, this is assuming that there is no inflation/COL rider on the monthly payments. If there is, then the monthly payments are almost certainly the better choice.
Other things to think about: How much are your parents expecting from Social Security? If they have a hefty amount of fixed income coming from SS, then they may be willing to take on more risk in their portfolio, which potentially increases their discount rate and tilts the choice towards the lump sum payment. On the other hand, if they have trouble controlling their spending then a fixed monthly payment is a good way to keep that under control and make sure that they can't spend it all.
Given that they have even more money available in the 401(k) and brokerage account, they'll probably be fine either way.

You mention that their spending is high. I guess I would also consider whether their spending is likely to change if they get the lump sum (i.e., do you think they would blow it on vacations or dubious winery "investments", etc), and how capable are they of cutting back their spending if they take the lump sum, invest it, and have their investment go sour. If they are high spenders but capable of selfcontrol/good judgement with money, the lump sum starts to make more sense. If you think there's a good chance the lump sum will be gone in another 5 years, they should take the pension, regardless of whether or not it's really the better dealit's probably a better deal for THEM.

garrettld has done a good job covering various whatif? options, and others have put forth good things to consider as well. I get slightly different numbers for present value using Excel's PV function, but within the accuracy of predicting investment returns and longevity they are close enough.
See table below. Columns are headed by "years to live after retiring", and rows lead by "expected investment return of the lump sum if taken. The numbers within the table are the cumulative values of the monthly payments. The easy part is comparing numbers within the table to $470,000. If the table value is higher than $470K, take the monthly payments. If the table value is less than $470K, take the lump sum. The hard part is picking which table entry to use.
The longer your mom expects to live, and the lower the expected return on the lump sum, the more likely the monthly option is better  and vice versa.
One other potential whatif?: can your mother defer taking the pension until age 65, and how much would the lump sum and monthly options be then? She might want to do this if the "different hospital job" will pay the bills in the next three years, and if the current employer will provide higher amounts if she delays taking them.
4.7309097%  rate, /yr       
22 2/3  length, yr       
2820  pmt, /mo       
$470,000.00  PV       


 5  10  15  20  22 2/3  25  30 
8%  $139,078  $232,429  $295,086  $337,143  $353,588  $365,372  $384,319 
7%  $142,416  $242,876  $313,742  $363,731  $384,059  $398,993  $423,867 
6%  $145,866  $254,007  $334,180  $393,618  $418,752  $437,683  $470,352 
5%  $149,434  $265,873  $356,604  $427,301  $458,385  $482,389  $525,314 
4%  $153,123  $278,532  $381,242  $465,362  $503,812  $534,256  $590,681 
3%  $156,940  $292,044  $408,351  $508,477  $556,051  $594,672  $668,874 
2%  $160,888  $306,477  $438,223  $557,441  $616,318  $665,323  $762,947 
1%  $164,973  $321,903  $471,182  $613,184  $686,066  $748,264  $876,758 
0%  $169,200  $338,400  $507,600  $676,800  $767,040  $846,000  $1,015,200 

Thank you for all of the great information. Apparently if she takes a 20% reduction to her monthly pension, then my dad will get 50% of the pension if something happens to her. Longevity is something that does run in her family so she is planning to live until around 100.