Lump Sum or Leave in the Pension system

[apricity22]

I have been reading various online articles including posts on the MMM forum about whether to take a lump sum payment or leave it in a pension system. I'm really having difficulty applying it to my own situation especially since I'm not close to retirement eligibility in the pension system meaning it's not a matter of starting annuity payments today vs. taking a lump sum payment today. I'm hoping someone can help me make sense of my own situation which involves a pension from an old employer that I don't know what to do with. Most online calculators tend to say it is about even or that I should stick with the guaranteed payments but it seems like $225k invested in an index fund could do better for me in the long run but I'm not sure if I'm doing the calculations correctly or if I am missing something.

I can roll over a lump sum of $225k to an IRA today or leave it in as long as I want earning 2.5% interest. At age 62, I can collect a monthly benefit of $2,200.  The pension system does not have any COL adjustments; however it is stable and protected by state constitution so I am not really worried about the benefit disappearing. I am currently 39 and my soon to be wife is the same age. The monthly benefit is reduced to $2,000 if we choose the survivorship option. I am comfortable investing in Vanguard index funds on my own. The rest of my portfolio consists of $125k in a 457, $6k in a Roth IRA, $35k in a Traditional IRA and $125k in a taxable brokerage account. What should I do with the pension? If I left out any detail that is pertinent please let me know.

[Laura Ingalls]

Please don't reveal the state if you don't want to, the risk of the state changing the rules (in a significant negative way) or going bankrupt depends greatly on the state.  There is some information around that shows the percentage of obligations that are funded. 

I would be inclined to keep it and think of it as the fixed income portion of your assets.

[JSMustachian]

The Houston Fire department thought their pension was safe too and protected by the state constitution. Politicians changed that and now many retirees are having to deal with benefit cuts. While people that follow MMM won't rely on a pension, nothing is guaranteed. 

I am in a similar situation where I have a pension from a private healthcare company and my wife has a pension from the state. I haven't decided if I'm going to roll it into an IRA or keep the annuity.

[mxt0133]

I have been reading various online articles including posts on the MMM forum about whether to take a lump sum payment or leave it in a pension system. I'm really having difficulty applying it to my own situation especially since I'm not close to retirement eligibility in the pension system meaning it's not a matter of starting annuity payments today vs. taking a lump sum payment today. I'm hoping someone can help me make sense of my own situation which involves a pension from an old employer that I don't know what to do with. Most online calculators tend to say it is about even or that I should stick with the guaranteed payments but it seems like $225k invested in an index fund could do better for me in the long run but I'm not sure if I'm doing the calculations correctly or if I am missing something.

I can roll over a lump sum of $225k to an IRA today or leave it in as long as I want earning 2.5% interest. At age 62, I can collect a monthly benefit of $2,200.  The pension system does not have any COL adjustments; however it is stable and protected by state constitution so I am not really worried about the benefit disappearing. I am currently 39 and my soon to be wife is the same age. The monthly benefit is reduced to $2,000 if we choose the survivorship option. I am comfortable investing in Vanguard index funds on my own. The rest of my portfolio consists of $125k in a 457, $6k in a Roth IRA, $35k in a Traditional IRA and $125k in a taxable brokerage account. What should I do with the pension? If I left out any detail that is pertinent please let me know.

If you think you will get returns of 6% compounding over 23 years, by the time you are 62 then that 225K should be 860K which if you apply the 4% rule can generate 34,377 a year or 2,864 a month*.

You can play around with the expected return to compare what would financially optimal for your situation. 

I conducted the same analysis I did when I had the option to take a lump sum from a previous employer.  I choose the lump sum primarily because I expected the amount invested would generate higher income when I need it vs the pension payout.  Plus I get to leave any principal left when I pass to my beneficiaries.  But it was also a much smaller amount and I am counting on Social Security to serve to diversify my income during the later stages of my retirement.

For your situation since it could potentially be a significant portion of your retirement income and depending on your risk tolerance then you might find a case for not taking the lump sum.


*With all the standard assumption of the 4% rule

[apricity22]

Thank you for the replies. I am leaning towards keeping the annuity but will probably debate with myself further.

Assuming I keep the annuity, how do I determine how much I need to FIRE? It's more complicated since I can't simply use the 4% rule against my stash. I should be able to more aggressively draw from the rest of my stash knowing that I will have that annuity when I'm 62. The question becomes what is the safe withdrawal rate and therefore how large does the other part of my stash need to get so I can FIRE?

[sokoloff]

I didn't go all the way through the process, but just looking over the UI, it sure looks like cFIREsim can help you model out/scenario plan that.

http://www.cfiresim.com/

[PapaBear]

In case you have not yet finalized your decision, I would like to throw some math in the ring.

I just calculated the NPV @ 2,5% discount rate for different lifespans after the start of retirement and discounted the results for another 23 years (39 - 62 years) @ 2.5%.
The result shows that starting with ~20 years, today's NPV is higher than the 225k they are offering (not factoring in inflation or taxes):

- 10 years of lifespan after 62: 131k
- 20 years: 233k
- 30 years: 313k
- 40 years: 375k

Average life expectancy for a 62 year old today is about 20-23 years, if I can trust the source (http://life-span.healthgrove.com/l/63/62). If the trend of the last 20 years continues, you can count on another 2-3 years of additional life expectancy at the time you hit the 62.

I would keep the pension and adjust the bond part of the asset allocation in the rest of the portfolio. Comparing the pension with stock investments is not a fair comparison, since the pension has a completely different risk and volatility profile. Additionally, the pension works quite well as an insurance for the case you exceed the average life expectancy significantly.

[DarkandStormy]

Maybe I'm missing something, but you said you can "leave it" and it will earn 2.5% interest.  If it truly is a $225K balance, that leaves you short of $400K by the time you are 62 - again, assuming it's a $225K balance now and earns 2.5% annually.

OR you can take $225K and invest it - even if it's just 7% over the next 23 years you'll have $1 MILLION.  Even if you go conservatively and use 6% average ROI, you'd end up with ~$860K by the time you are 62.

The annual benefit at 62, if you leave it in the pension, is $26,400.  If it really is a $225K balance right now and you start drawing down at age 62 while it continues to earn 2.5%, they project you to die/stop withdrawing around age 82 (just plugging in the math there and when you'd go negative).

Now let's jump back to the IRA that you've conservatively invested and received 6% ROI annually for 23 years.  You're sitting at $860K there at age 62 and that's not even counting your other investments.  You can withdraw almost $35K/year and assuming a 4% ROI you'd never run out of your stash in that IRA.

I think you should definitely go with rolling it into an IRA.  Even conservatively at 6% ROI the next 23 years, you'll definitely be able to beat out the $2,200 monthly pension.  Some other factors are in play - what would you like your survivorship plans to be, do you have genetic or other health factors that would significantly reduce your expected life, etc.

Assuming I keep the annuity, how do I determine how much I need to FIRE?

Depends on your expenses.  If you do keep it in the pension and ignore my advice above, you'll have an annual benefit of $26,400 - but only starting at age 62.  The rest of your stash is ~$290K, nearly all taxable.  If you move all that into an AA that yields 4% annually, you can withdraw ~$20K/year and it will run out when you turn 62.

If you combine the $225K and the $290K, you're looking at 4% being just north of $20K annually...and a stash that should last you the rest of your life if your annual expenses are $20K.

So a lot of factors - are you planning on continuing to work somewhere else in the near future?  Side gig? Etc.  Any major factors that would indicate you won't live past 80-85?  Do you want to leave a stash for any mini-mustaches, etc.?

[apricity22]

Maybe I'm missing something, but you said you can "leave it" and it will earn 2.5% interest.  If it truly is a $225K balance, that leaves you short of $400K by the time you are 62 - again, assuming it's a $225K balance now and earns 2.5% annually.

OR you can take $225K and invest it - even if it's just 7% over the next 23 years you'll have $1 MILLION.  Even if you go conservatively and use 6% average ROI, you'd end up with ~$860K by the time you are 62.

The annual benefit at 62, if you leave it in the pension, is $26,400.  If it really is a $225K balance right now and you start drawing down at age 62 while it continues to earn 2.5%, they project you to die/stop withdrawing around age 82 (just plugging in the math there and when you'd go negative).

Now let's jump back to the IRA that you've conservatively invested and received 6% ROI annually for 23 years.  You're sitting at $860K there at age 62 and that's not even counting your other investments.  You can withdraw almost $35K/year and assuming a 4% ROI you'd never run out of your stash in that IRA.

These are exactly the kind of calculations that I did but they seem to contradict many of the other replies to this post as well as other general information I have found on bogleheads and the MMM forums.

I should also mention that the pension accrues interest at 8% and pays out as a lump sum to my heirs assuming that I die prior to 62 so it's almost like I have a free life insurance policy built in as well.

Assuming I keep the annuity, how do I determine how much I need to FIRE?

Depends on your expenses.  If you do keep it in the pension and ignore my advice above, you'll have an annual benefit of $26,400 - but only starting at age 62.  The rest of your stash is ~$290K, nearly all taxable.  If you move all that into an AA that yields 4% annually, you can withdraw ~$20K/year and it will run out when you turn 62.

If you combine the $225K and the $290K, you're looking at 4% being just north of $20K annually...and a stash that should last you the rest of your life if your annual expenses are $20K.

So a lot of factors - are you planning on continuing to work somewhere else in the near future?  Side gig? Etc.  Any major factors that would indicate you won't live past 80-85?  Do you want to leave a stash for any mini-mustaches, etc.?

Our current expenses are $46k per year but we are making some lifestyle changes that should make that number $41k for the year by 2018. This includes housing expenses which for us are fairly significant at $20k per year and probably can't get much better until we relocate somewhere less expensive. The amount we put into our stash over 2017 will be about $96k and may be higher in 2018 due to increased income and the expense reduction I mentioned.

We are planning to work in our high paying careers for at least another 4 years. Ideally we would like to be financially independent in the next 4 to 8 years. We don't mind returning to work in something lower paying, less stress, maybe part time, for health benefits, fun money etc. if needed.

My fiancee's family seems to have about average life expectancy. My family seems to be on the higher end of the scale. I'm pushing 40 but all four of my grandparents are still alive in their 90's. My mom did pass away last year to cancer at age 62. Leaving an inheritance doesn't matter to us either.

[Zamboni]

Based upon what I am reading here, I think you should keep it as a pension and not take the lump sum payout.

[Bicycle_B]

Another consideration is whether an unexpected circumstance could lead you to work for that employer again.  If so, a few more years of service at a higher wage (due to inflation, plus any future job title improvements) would cause a big jump in pension payments.

In my case, I have pensions due in future from two employers whose systems each qualify as years of service in the other system for purposes of qualifying for the pension.  I may work a few more years in one of them, accelerating the payout dates and increasing the base pay rate. These are govt employers and there 9 govts in our state that have these reciprocal arrangements, so that's 9 possible employers for those last few juicy years if I do it. Does your pension provider have any reciprocal arrangements like that?

I have been figuring that I have more to gain than lose by keeping the vested pensions alive even though the currently expected payouts are low.  Good luck deciding. 

[apricity22]

In my case, I have pensions due in future from two employers whose systems each qualify as years of service in the other system for purposes of qualifying for the pension.  I may work a few more years in one of them, accelerating the payout dates and increasing the base pay rate. These are govt employers and there 9 govts in our state that have these reciprocal arrangements, so that's 9 possible employers for those last few juicy years if I do it. Does your pension provider have any reciprocal arrangements like that?

The system I am in serves about 60 governmental agencies so there is always the potential that I would return later. I am in the process of relocating out of this state which reduces those odds substantially but you never know. Also, following the 2008 situation, they changed the rules to be a lot less favorable to members but the rules that were in place when you started employment stay with you unless you leave and take the lump sum. Another good reason to keep it there.

At this point I feel more comfortable leaving it there and being more aggressive in my other investments. I just didn't want to do something completely stupid but it doesn't sound like that is the case.

[stashing_it]

I should also mention that the pension accrues interest at 8% and pays out as a lump sum to my heirs assuming that I die prior to 62 so it's almost like I have a free life insurance policy built in as well.

I'll start by saying I didn't understand everything that has been posted so far, but the way I read this is that you can take a lump sum of 225k today, and if you don't then that 225k value accrues 8% interest a year.  Compounded over 20 years that would be over 1 million dollars.

If that is true, it is a powerful incentive to keep it in the pension.  I don't know of any guaranteed 8% returns that exist.  (You do run the risk of it going bankrupt)

[chasesfish]

I think thats a decision you make when you're closer to retirement.   I have a nice private sector pension in a stable industry, but we don't have a lump sum option.

The municipal pensions are most at risk - Google Dallas Police & Fire Pension, they're trying to claw back lump sum payments.   The pension system averaged 1-3% returns for the last 10 years while paying management fees of over 2% due to poor board governance and corruption, now the taxpayers and pensioners are jointly on the hook.

Unfortunately the fund is still 30% private equity investments with outrageous fees for under performance and even the state legislature didn't address that underlying issue.

[Heroes821]

I should also mention that the pension accrues interest at 8% and pays out as a lump sum to my heirs assuming that I die prior to 62 so it's almost like I have a free life insurance policy built in as well.

Just want to add that my father had me as the heir to his pension and he died at 55. The PBGC managed his pension from Delphi Packard Electric (basically the same as General Motors) and I was told by them, good luck you're not a spouse bye. I never went into getting a lawyer or doing more than about 3 or 4 phone calls that took forever, but I would just make sure things are very clear in the pension document that your heirs can collect the lump sum.

[chasesfish]

It was an 8% accrual they are clawing back on the Dallas Police and Fire Pension Fund, just an FYi

[Bicycle_B]

Also, following the 2008 situation, they changed the rules to be a lot less favorable to members but the rules that were in place when you started employment stay with you unless you leave and take the lump sum. Another good reason to keep it there.

Agreed

At this point I feel more comfortable leaving it there and being more aggressive in my other investments. I just didn't want to do something completely stupid but it doesn't sound like that is the case.

Agreed

Fwiw, one tweak I have thought of is to use a real estate mortgage as a hedge against inflation eroding the value of the pension payouts.

For example, 2% inflation reduces the buying power of a $10k/year pension by $200/year.  But if my mortgage is $10k/year, the effort of paying the mortgage drops by the $200/year.  If I return and get an increased pension payout, my plan is to buy just enough rental property that the mortgage(s) offset the payment increase. 

[DarkandStormy]

Our current expenses are $46k per year but we are making some lifestyle changes that should make that number $41k for the year by 2018. This includes housing expenses which for us are fairly significant at $20k per year and probably can't get much better until we relocate somewhere less expensive. The amount we put into our stash over 2017 will be about $96k and may be higher in 2018 due to increased income and the expense reduction I mentioned.

We are planning to work in our high paying careers for at least another 4 years. Ideally we would like to be financially independent in the next 4 to 8 years. We don't mind returning to work in something lower paying, less stress, maybe part time, for health benefits, fun money etc. if needed.

My fiancee's family seems to have about average life expectancy. My family seems to be on the higher end of the scale. I'm pushing 40 but all four of my grandparents are still alive in their 90's. My mom did pass away last year to cancer at age 62. Leaving an inheritance doesn't matter to us either.

I'm sure you could run a calc and see how it plays out if you wait for the $26,400 annual benefit at 62 but if you take it now, add $96K this year and $100K for the next 5 years, you'll end up with $1.4 million when you turn 45 if you average 6% ROI over the next 6 years.  That's enough to FIRE if you keep your expenses under $56K annually.  If you keep them to ~$40K you could FIRE around age 43.  Both of those scenarios assume you'd have an AA that yields 4% annually in perpetuity.  So you're set up very well to retire before age 45/46.

I know a lot of people are suggesting leaving the pension, but I'd personally take it.  I left a job with a small pension this year (~$7k) so it made no sense to leave it. 

EDIT - Alright, so I ran a similar scenario as above, except kept the $225K lump sum out of it.  You'd reach ~$1m around age 45 - I'm using 6% as a conservative estimate since you're coming up on FIRE and may have a more conservative AA.  I added $96K in contributions this year and then $100K going forward.  So you could FIRE at age 45 with $40K in expenses plus get $26,400 annually at 62...essentially for fun.

Now, let's say you retire at age 43 in this scenario.  Your non-pension stash earns ~4% annually and you draw down $45K/year (just as an example - maybe you start traveling more or keep doing home upgrades).  You'd end up with ~$500K in your non-pension stash at age 62.  But by then, you're getting $26,400 annually.  So you could safely withdraw $20K from your non-pension stash and still be safe to cover ~$45-46K expenses annually.

Running the two scenarios, I think you will be fine if you maintain ~$40K in annual expenses and probably even ~$45K in expenses.  The difference in those two is maybe a year or two of additional work.

[Hotstreak]

OP one thing which has not been discussed is your risk of significantly over saving.  If your 2018 expenses are 41k with 20k being housing, is it fair to say your retirement expenses will be somewhere around 30k/year? 


With a 24k per year pension you need another 6k/year, or $150k principal using the 4% rule.  Okay, so that's not too bad.  But what happens when we include social security for you and your wife, plus any pension your wife may have?  I imagine you are very quickly looking at annual retirement income which exceeds your needs.  If social security + pension payments is > annual expenses * safety margin, then all excess annual income + all other principal saved = over savings.


If you end up with perhaps $50k total Pension + SS Income and $30K expenses, you would have been better off cashing out the Pension and using the $225k to live on in the years between retirement and social security.

[apricity22]

 

OP one thing which has not been discussed is your risk of significantly over saving.  If your 2018 expenses are 41k with 20k being housing, is it fair to say your retirement expenses will be somewhere around 30k/year? 

It's fair to say that our expenses probably will be reduced as will likely relocate to a LCOL area in retirement; however, it is also possible that our travel expenses may increase.

Our goal is more FI rather than RE. I started to feel handcuffed to my pension when I realized I didn't necessarily want to work at the same place for the rest of my working days. It was really scary leaving that employment and the pension behind (and I'm still working through that). It looks like both of us may have some high earning years ahead and we did not want to trade handcuffs to a pension system for handcuffs to a high paying job. Some days I regret leaving the comfort of the pension system but that discomfort led us to discovering this world of managing our own investments, minimalism, FIRE etc.

[MDM]

One way to evaluate "pension now"  vs. "pension later"

Compare pension payment promised at the later time to either

- the "Interest generated by Future Value (FV) of the lump sum" (FV principal is not touched), or

- the "Constant withdrawal of FV over time L" (principal goes to zero), or

- "Trinity-style withdrawal of FV over time L" (annually inflated spending; principal -> zero)

Lump sum now	PV	$225000
Payment starting now	Pmt_now	0	$/payment
Interest rate	i	3.655%	/yr
number of years	n	23	yr
number of payments/year	freq	12	/yr
When payments are made for each n	type	0	0 = at end, 1 = at start
Future Value	FV	$520902
Interest generated by Future Value	FV(i,n,P) * i	1587	$/payment
Longevity of future pension	L	35	yr
Constant withdrawal of FV over time L	Pmt_future	2200	$/payment
Spending growth rate (e.g., CPI)	g	2.0%	/yr
First year (of 35) Trinity-style withdrawal	W(FV,L,i,g)	19643	$/yr
		1637	$/payment

In other words, if you can do better than ~3.7% (including inflation) on your investment returns, and expect to live no longer than 62 + 35 = age 97, it would be better to take the lump sum now.  Otherwise, wait for the pension.

You can enter your own numbers in rows 70-90 of the 'Misc. calcs' tab in the case study spreadsheet.