Author Topic: Employer Transferring Pension: What to do?  (Read 4915 times)

stachestash

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Employer Transferring Pension: What to do?
« on: April 23, 2015, 06:55:16 PM »
Hello Mustuchians,

My employer has ended our company's pension and offering options for my accrued benefit.  I'm not entirely sure how to evaluate my options so any help would be greatly appreciated.  Although there are a number of options, these are the two best:

Option #1
Transfer Lump Sum of $94,525 now to a traditional IRA

Option #2
Transfer benefit to an insurance annuity where, payable at age 65, I would have a lifetime benefit of $2,055 per month.

I'm a 41 year-old in good health and although nobody every knows for sure, I expect to live into my 80's and beyond.  At first glance, it seems like #1 is the better option but have since spoken to co-workers and getting a wide range of opinions.  If I went with option #1, I would invest in low fee index funds.  Can anybody calculate what my average ROI needs to be for the lump sum in order to make Option #1 a worthwhile choice?

Thanks in advance.
S t a c h e S t a s h

« Last Edit: April 23, 2015, 06:59:07 PM by stachestash »

MDM

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Re: Employer Transferring Pension: What to do?
« Reply #1 on: April 23, 2015, 07:17:14 PM »

stachestash

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Re: Employer Transferring Pension: What to do?
« Reply #2 on: April 23, 2015, 07:46:21 PM »
Thanks MDM!  That is a very relevant thread and found something I never thought of.  That I can think of the annuity payment option as a diversification option similar to a long-term bond. 

As for the formula in your link, any idea how to solve it?  I have adjusted the numbers to fit my scenario.  What does ^ mean? 

[$94,525 * (1 + i/12)^(24*12)] * i/12 = $2,055 for i 

How would I solve for i?
« Last Edit: April 23, 2015, 07:55:31 PM by stachestash »

Heckler

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Re: Employer Transferring Pension: What to do?
« Reply #3 on: April 23, 2015, 07:55:49 PM »
http://www.moneychimp.com/calculator/compound_interest_calculator.htm


$94,525 at safe 4% annual increase for 24 years is $242,296.

if you have:

40% of that ($96,918) in bonds (1167 BND @ $83), assuming $0.15 monthly distribution is $186/month distribution
60% of that ($145,377) in stocks (1333 VTI @ $109), assuming $0.45 quarterly distribution is $600/quarter or $200/month

Total estimated monthly distribution: $386/month after 24 years.


$2055/month sounds pretty good.  Where have I gone wrong fellow investor?  (I'm learning here...)

MDM

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Re: Employer Transferring Pension: What to do?
« Reply #4 on: April 23, 2015, 07:57:19 PM »
As for the formula in your link, any idea how to solve it?  I have adjusted the numbers to fit my scenario.  What does ^ mean? 

[$94,525 * (1 + i/12)^(24*12)] * i/12 = $2,055 for i

^ is exponentiation.  E.g., 2^3 = 2*2*2 = 8.

For solving, do you have access to Excel?  If so, google   Excel goal seek   for the version you have.  In short, you put the formula into Excel using some cell for i, then let Excel adjust i until it gets 2055.

MDM

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Re: Employer Transferring Pension: What to do?
« Reply #5 on: April 23, 2015, 08:04:08 PM »
As for the formula in your link, any idea how to solve it?  I have adjusted the numbers to fit my scenario.  What does ^ mean? 

[$94,525 * (1 + i/12)^(24*12)] * i/12 = $2,055 for i 
I get 6.08% for i.

stachestash

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Re: Employer Transferring Pension: What to do?
« Reply #6 on: April 23, 2015, 08:29:33 PM »
Thanks MDM - Ah, never did exponents in Excel before.  With the formula, I get 6.08%. 

That's the average return I would need to get the $2,055 per month in 24 years.  The drawback with the annuity option is that it's a constant payout so in 35 years, the payout will still be $2,055.

If I calculate for 35 years from now, I would only need average returns of 4.83%.  At age 70.5, I would have to begin mandatory my minimum withdrawal though which makes it more complicated. 

((94524.83*(1+i/12)^(35*12))*i/12)

Trying to wrap my head around that factor.  Any thoughts on this?
« Last Edit: April 23, 2015, 08:31:34 PM by stachestash »

Cathy

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Re: Employer Transferring Pension: What to do?
« Reply #7 on: April 23, 2015, 08:34:49 PM »
[$94,525 * (1 + i/12)^(24*12)] * i/12 = $2,055 for i 

How would I solve for i?

As MDM says, you can solve this equation to arbitrary precision using Newton's method or any other root finding algorithm, such as whatever Excel implements.

But how do you solve this equation using algebra? That is to say, how can you express "i" in terms of a finite list of algebraic operations such as additional, multiplication, and root extraction ("radicals")? If you were given the equation "x + a = 3", you could trivially solve for x with "x = 3 - a". How do you do the same for the more complicated algebraic equation above?

The main observation to make is that the equation is a polynomial equation. It contains 290 terms: one term consisting of i to the power of 289, and then one term with i being raised to each lesser integer power, and finally a constant term. Each term has a rational coefficient.

For a polynominal of degree 5 of higher (a quintic equation), there has been proved to be no general algebraic solution. This is called the Abel–Ruffini theorem. However, specific higher degree equations can still have individualised algebraic solutions, so the one under examination might still be solvable algebraically.

Determining whether the specific equation under examination is solvable algebraically turns out to be nontrivial. There are known algorithms, but they are mostly of theoretical interest and are hard to use practically because they involve iterating over huge spaces that are too large for current computers to deal with except for low-degree polynominals (and ours is not low-degree). The paper "Techniques for the Computation of Galois Groups" gives a list of some techniques that work in specific cases without being computationally infeasible.

I won't actually see if I can find the answer here, because it's too much work, but the paper is still interesting.
« Last Edit: April 23, 2015, 08:39:37 PM by Cathy »

MDM

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Re: Employer Transferring Pension: What to do?
« Reply #8 on: April 23, 2015, 08:48:29 PM »
That's the average return I would need to get the $2,055 per month in 24 years.  The drawback with the annuity option is that it's a constant payout so in 35 years, the payout will still be $2,055.
That $2,055/mo is also what the lump sum option will be paying in 35 years, assuming you start withdrawing that amount in 24 years and the same 6.08% return continues.

Quote
If I calculate for 35 years from now, I would only need average returns of 4.83%.  At age 70.5, I would have to begin mandatory my minimum withdrawal though which makes it more complicated.
But that's still for $2,055/mo - will the pension option pay you more if you delay taking it until age 76?  And would you even want to do so?

One large unknown is what inflation will do.  If it stays low, that guaranteed 6% return is decent and well worth considering.  If inflation goes high, that same 6% won't look nearly as good.

stachestash

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Re: Employer Transferring Pension: What to do?
« Reply #9 on: April 23, 2015, 09:30:38 PM »
MDM - Yes, inflation is a certainly something I didn't factor in.  It's quite probable that sometime in the next 25 years, there will be a burst of inflation.  You've given me such great information.  Thanks for all the quick responses. With the option to change withdrawal amounts and the ability to leave the money for inheritance, it seems like option #1 is best.

Heckler - I started trying to figure out what my traditional IRA would be worth if I chose option #1, the Lump Sum, and invested in 100% stock index funds through Vanguard or Betterment. At age 65 in 24 years and an average return of 5%, the lump sum becomes ~$305k.  At an average return of 7%, ~$480k.  It seems like option #1 is better here as well.  At age 75, Option #2 annuity payment would pay out a total of $271k.  See attached spreadsheet for my calculations.

Cathy - I thought the solution is not straightforward and you're saying it's beyond that.  Thanks for the links. It does seem interesting.
« Last Edit: April 23, 2015, 10:25:44 PM by stachestash »

MDM

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Re: Employer Transferring Pension: What to do?
« Reply #10 on: April 23, 2015, 10:50:36 PM »
I started trying to figure out what my traditional IRA would be worth if I chose option #1, the Lump Sum, and invested in 100% stock index funds through Vanguard or Betterment.
...
See attached spreadsheet for my calculations.
stachestash, appears you are doing just fine w/ Excel - nice!

One oh-by-the-way in that spreadsheet: if you want to predict the value of the IRA itself, you'll have to subtract those RMDs each year.  If you are planning to invest (not spend) the RMDs and get the same after-tax return as the IRA, then the "IRA value" column remains accurate as the sum of the IRA + taxable accounts.

Capsu78

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Re: Employer Transferring Pension: What to do?
« Reply #11 on: April 24, 2015, 08:31:30 AM »
Steering clear of the maths, DW and I decided to keep the pension annuities purchased for us by a previous employer exiting their pension on the basis that they provide a 3rd leg to our retirement stool- (non cola) pensions, (cola) SS and then our investments- either by choice or forced through RMD's.  The lump sum offered just wasn't a big enough number to add to our retirement funds on a percentage basis to rock our world.  Talked to others "previously considered smart" from our prior corporate life who took the lump- I placing our bets on living longer than our parents.
As they say, less than 25% of future retirees will have a pension component and we like our future income projections including the pension.  I know the maths might say something different but I psychologically view the pension as part of my bond portfolio.

mikesinWV

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Re: Employer Transferring Pension: What to do?
« Reply #12 on: April 24, 2015, 08:52:02 AM »
I tend to go with the annuity in this scenario.  No surprise that the math puts them as pretty comparable--it's an actuarial equivalent. 

One of the issues/problems with the 401k/DC plan is how to draw it down--3.5%, 4%.  Annuities make it easier and the risk is transferred to the insurance company rather than to you.  Yes, I know there is still some risk, folks.  This is going to give you a nice third leg on your stool when you retire.  Not huge but nice.


stachestash

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Re: Employer Transferring Pension: What to do?
« Reply #13 on: April 24, 2015, 01:15:05 PM »

Quote
One oh-by-the-way in that spreadsheet: if you want to predict the value of the IRA itself, you'll have to subtract those RMDs each year.  If you are planning to invest (not spend) the RMDs and get the same after-tax return as the IRA, then the "IRA value" column remains accurate as the sum of the IRA + taxable accounts.

MDM - In Column D of the spreadsheet, I subtracted the RMDs (named Required withdrawal) starting at age 70.  I thought it would be a fair enough comparison with the annuity to leave reinvesting out of this spreadsheet since I could invest the annuity payments also.

Doulos

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Re: Employer Transferring Pension: What to do?
« Reply #14 on: April 24, 2015, 01:36:49 PM »
Another way to frame all this is to look at the monthly payment relative to stash size.
Just like you can look at a $100 a month cell phone bill as $30,000.
$2k a month, if you assume your 4% is equivalent to 2x12x25= $600k. stash. for income purposes.  You never get that 600k though.
- this number would change based on what SWR you like best.

You could also look at it from the "how many people are working for me?" point of view.  at the estimated 1700 hour year your little green soldiers are making you $14.50 an hour.  that is almost 2 minimum wage workers working for you full time.

Here is the easy math version using a calculator.
http://www.moneychimp.com/calculator/compound_interest_calculator.htm
24 years with $94,525 capital @ a reasonable 6% is $397,532.35.
if you assume that same 6% off of that each year to compare to your $2055, you are looking at $1985.
- But that is an inflation adjusted $1985, in today's dollars.

If you redo that calculation with the 'real' (not inflation adjusted) numbers it looks more like this.  (since you said that 2055 is not inflation adjusted right?)
- that is roughly 10%, but I am going a little lower with 9%
24 years with $94,525 capital @ a reasonable 9% is $813,059.77.
9% a year off that is $6098; which would also still inflate.
Now how does that compare to the $2055?

Inflation is a big deal.

MDM

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Re: Employer Transferring Pension: What to do?
« Reply #15 on: April 24, 2015, 01:59:08 PM »
MDM - In Column D of the spreadsheet, I subtracted the RMDs (named Required withdrawal) starting at age 70.  I thought it would be a fair enough comparison with the annuity to leave reinvesting out of this spreadsheet since I could invest the annuity payments also.
Maybe we're looking at different spreadsheets?  I see the RMDs in column E, but those values are not being subtracted from the "IRA value" in column B...?

MDM

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Re: Employer Transferring Pension: What to do?
« Reply #16 on: April 24, 2015, 02:05:52 PM »
Here is the easy math version using a calculator.
http://www.moneychimp.com/calculator/compound_interest_calculator.htm
24 years with $94,525 capital @ a reasonable 6% is $397,532.35.
if you assume that same 6% off of that each year to compare to your $2055, you are looking at $1985.
- But that is an inflation adjusted $1985, in today's dollars.

If you redo that calculation with the 'real' (not inflation adjusted) numbers it looks more like this.  (since you said that 2055 is not inflation adjusted right?)
- that is roughly 10%, but I am going a little lower with 9%
24 years with $94,525 capital @ a reasonable 9% is $813,059.77.
9% a year off that is $6098; which would also still inflate.
Now how does that compare to the $2055?
The first example is the correct one: use 6.0824% and you'll get the $2055 that is the alternative to the lump sum.

Doulos

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Re: Employer Transferring Pension: What to do?
« Reply #17 on: April 24, 2015, 02:20:32 PM »
So you are saying that 2055 is an inflation adjusted number?
Because the OP said it is a constant.

...That's the average return I would need to get the $2,055 per month in 24 years.  The drawback with the annuity option is that it's a constant payout so in 35 years, the payout will still be $2,055....

That is why I did the second set of figured.
It did seem crazy to me that a pension would give you a non inflation adjusted number.

MDM

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Re: Employer Transferring Pension: What to do?
« Reply #18 on: April 24, 2015, 02:32:46 PM »
So you are saying that 2055 is an inflation adjusted number?
Because the OP said it is a constant.

...That's the average return I would need to get the $2,055 per month in 24 years.  The drawback with the annuity option is that it's a constant payout so in 35 years, the payout will still be $2,055....

That is why I did the second set of figured.
It did seem crazy to me that a pension would give you a non inflation adjusted number.
Depends what one means by "inflation adjusted."

The OP will, if the pension option is chosen, receive $2,055 each month starting at age 65.  How much groceries, electricity, etc. that $2,055 will buy is a different question.

Doulos

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Re: Employer Transferring Pension: What to do?
« Reply #19 on: April 24, 2015, 03:01:24 PM »
And the average accepted number for that is 10%.  I used 9%.
The 6-7% numbers are for inflation adjusted calculations.

Sure, anything can happen.  but to assume for your calculations that we are going to see zero inflation for the next 24 years is not realistic.

A lump sum, assuming average future performance compared to past performance, which is the best we can do.  And then being cautious on top of that.
Would in theory go up at roughly 9% over the long haul when you do not subtract out inflation.

If you are expecting that constant $2055 per month 24 years from now.  $2055 is not going to be worth the same 24 years from now.  You have to use inflation figures to compare to that.

There is a big difference between saying, well high inflation vs low inflation, and running the numbers assuming Zero inflation.

MDM

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Re: Employer Transferring Pension: What to do?
« Reply #20 on: April 24, 2015, 03:25:59 PM »
Sure, anything can happen.  but to assume for your calculations that we are going to see zero inflation for the next 24 years is not realistic.

A lump sum, assuming average future performance compared to past performance, which is the best we can do.  And then being cautious on top of that.
Would in theory go up at roughly 9% over the long haul when you do not subtract out inflation.
We may not be in much disagreement.

There was no assumption of zero inflation in any calculation.

The ~6% is simply the mathematical answer to the question of what return the lump sum investment needs to generate in order to provide $2055/mo starting in 24 years.

One can then project whether one will do better or worse than 6% with that lump sum.  Now inflation should be considered, because the investment return will be approximately "inflation + real return."  Take your best guess and act accordingly.

TomTX

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Re: Employer Transferring Pension: What to do?
« Reply #21 on: April 24, 2015, 09:23:01 PM »
Another way to frame all this is to look at the monthly payment relative to stash size.
Just like you can look at a $100 a month cell phone bill as $30,000.
$2k a month, if you assume your 4% is equivalent to 2x12x25= $600k. stash. for income purposes.  You never get that 600k though.
- this number would change based on what SWR you like best.

Here's the problem with that comparison. A 4% SWR presumes a rising withdrawal on the order of 2-3% per year. Every year, you draw out more.

The pension is fixed. No adjustment upward.

If the pension were going to be COLA adjusted after starting the draw, it would be reasonable to make the comparison.  As it stands: Apples and oranges.

Indexer

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Re: Employer Transferring Pension: What to do?
« Reply #22 on: April 24, 2015, 10:15:57 PM »
I'm a 41 year-old in good health and although nobody every knows for sure, I expect to live into my 80's and beyond.  At first glance, it seems like #1 is the better option but have since spoken to co-workers and getting a wide range of opinions.  If I went with option #1, I would invest in low fee index funds.  Can anybody calculate what my average ROI needs to be for the lump sum in order to make Option #1 a worthwhile choice?

My estimate:  6.86% before inflation.

The math.  Step 1.  solving for a cash flow of $2055 for 35 years.  This would take you out to age 100 which is the age most financial planners use.  The only variable I had to estimate was the rate of growth over this period.  I used 4% since that is a rate of return even a conservative portfolio in retirement should be able to average.  This gives us a value at age 65 of $464,118.62.

Step 2.  Figure out what rate of return you would need over 24 years to turn $94,525 into $464,118.62.  Result 6.8551%. 

Disclaimer:  The only variable that can't be controlled is the rate of return to estimate in retirement.  Using 3% or 5% would give you different numbers.  If its only 3% in retirement then the rate needed until retirement would be 7.48%.  At 5% in retirement then the rate needed until retirement would be 6.27%.
« Last Edit: April 24, 2015, 10:22:41 PM by Indexer »