Lump sum pension vs future annuity

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Lump sum pension vs future annuity

Post by nycguy83 »


My employer has recently ended their pension plan and is giving employees grandfathered in the choice to either taking a lump-sum distribution now (and roll into IRA) OR keep the monthly benefit that begins once I turn 65. I am currently 31 years old.

The lump sum distribution payout is $33,000.

The monthly benefit would be $1112 and I would receive that starting at age 65 (34 years from now) until my death. Using an estimated life expectancy of 82.2 years, it appears they've used an avg discount rate of approximately 4.7%.

I have a very well funded 401k and Roth IRA (approximately $230 401k and $80k Roth IRA) and no other future annuities. Is a 4.7% guaranteed return a good hedge? Should I take the lump sum or the future annuity? It seems like when I leave the company I will get presented with the same question. The pension will be managed by the Pension Benefit Guaranty Corporation going forward.

Thanks for any advice.
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Re: Lump sum pension vs future annuity

Post by cricket49 »

I assume you received these figures from your employer.

If your employer is no longer offering the pension plan I assume they are no longer contributing to it?
Your monthly benefit amount seems very high for a lump sum of only 33,000. You might have a
very rich pension plan. However, a lump sum of 33,000 does not seem very enticing since you can
earn that much in 30 months.

I would ask your employer if you quit will your monthly benefit be the same or will the
amount drop?

If your company is financially healthy in the future, I would take the monthly benefit.

I just went through this last year and I was offered a lump sum of 58,000.00 or 400.00 monthly. I took
the lump sum because I wanted to convert it into an IRA and invest it. My ex employer is not
financially healthy and the future of the company is uncertain.

You also need to know that some major employers offered lump sum payments years ago and when all
the employees did not take the lump sum, they sold the pensions to an insurance company. They were
converted to annuities and the retirees and current employees were not happy. Once this happens you
are not insured under the PBGC.

Good luck in what you decide to do.
Expect the best. Prepare for the worst.
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Re: Lump sum pension vs future annuity

Post by lthenderson »

It doesn't seem like a good deal to me either but at age 31, how do you feel about your company still being around 34 years from now? I retired way early and when given the chance to cash out my pension, I took it rather than wait another 25 years to see what happens. However, my payback period was closer to 180 months and the way the company was being run and the reason I decided to retire early, led me to believe that the chances were high that I might not get a pension at all in 25 years.
Bill M
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Re: Lump sum pension vs future annuity

Post by Bill M »

What is the present value, at age 31, of an annual annuity of $1 starting at age 65? My actuarial spreadsheet says $5.047, based on the 2008 GAAT mortality table and 3% interest rate. So for your $1112/mo that comes to $67,355.

Alternatively, what would an insurance company charge to provide such a monthly payment? Using Vanguards annuity marketplace (through Hueler) is a bit of a problem, since they only give quotes for ages 35&up. But for age 35, the quote is $77,265. (My actuarial spreadsheet says that should be 12.8% higher, so adjusting for age 31 would give $68,534).

So you are being offered $33000 for something that would cost you $68000 to buy.
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Brian 2016
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Re: Lump sum pension vs future annuity

Post by Brian 2016 »

Another suggestion is to apply different annual returns for the 34 years on the $33,000 lump sum....try 8% per year for example and the lump sum should double every 9 years. Then plug that number into an immediate fixed annuity when you are 65 years old.

Early Retirement May 2016
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Frugal Al
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Re: Lump sum pension vs future annuity

Post by Frugal Al »

Are you married or will you be married? Is the $1112 per month 100% survivorship? If not, what is the 100% survivorship payout?
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Re: Lump sum pension vs future annuity

Post by Valuethinker »

Difficult. Actuarially it is a no brainer to stay with the pension, or so it would appear. 4.8% guaranteed for 34 years is better than you can do with any safe bond investment.

If there's a survivor benefit that is even more the case (you don't have to be married now, AFAIK, so for future plans even if you have none now).

Balanced against that 34 years is a long time. And you have (AFAIK) no inflation protection in there.

If you do take it, adjust your bond weighting accordingly - this is a bond investment equal to the cost of an SPIA paying this much at 65 discounted by, say, number of years at 2.5% (ie somewhat higher than current US long Treasury bond).

A part of me would gamble take the money into an IRA, put it into a global equity fund, and figure that in 33 years, I would probably wind up with more than 4.8% pa return. But the math, and the normal logic that you should never dump a defined benefit pension (because it is highly diversifying against the rest of your portfolio) would argue against me.
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Re: Lump sum pension vs future annuity

Post by nycguy83 »

As always - thanks for such great advice. As Bill notes, I'd have to pay twice what they were offering to get the same future annuity on the open market.

This is a great way to diversify my retirement portfolio. Thus I am definitely keeping the pension.
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