pension options - lump sum vs monthly payout
this is just a question, not an issue with the application. Nonetheless I would like to hear your option. I have a 10 year certain and life pension option. Bascically I can take $6800/month for 10 years or my lifetime, whichever is longer. The other option is a lump sum of $898,000. This looks like the monthly payout is a "no brainer", paying out $2.8 million if I were to live until 95. I understand the inflation factor, but taking the lump and putting it into a Roth IRA does not come close to what the lifetime monthly payout would be. Do you understand why there would be such a discrepency in options available from my employer ? The pension plan is fully funded by my employer.
RSS
I just ran the most simple case study for a single person born in 1949.
With the annual payment of 81,600 this person would have a living standard of 41,019. If this person took the lump sum, the living standard is just 21,393 annually.
So, I agree, the annuity is much better.
I guess I don't know enough about how pensions work to have an opinion, but my wife has small pension from the state of KS, and, like you, the lump sum they would offer her is a pittance compared to the annual premium. I think I figured once that we'd burn through the lump sum in about 5 or 6 years.
Maybe someone else knows why the structure them this way. They seem to penalize those that take the lump sum.
yes this seems pretty odd to me. Of course the downside to the monthly payout is future inflation. Our annuity is NOT adjusted for inflation. From the employers perspective I guess since they are paying out future dollars that are worth less than todays dollars they feel like the trade off vs a lump sum is adventageous. I still don't quite get it. I just hope I am not missing something major here. Would be great to hear from some others that are either already retired or are actively comparing similar options.
If you are healthy, take this annuity! Your conclusion is correct even considering inflation. Remember, the purchasing power of the lump sum cash flow is subject to inflation as well. If you were to take no more than $6,800/month from the lump sum cash flow, breakeven is just slightly beyond the 10-year certain payout. If you live another 10 years (20 years of annuity benefit), you'd have to earn 6.7% on the lump sum annually before your money ran out. Should you live longer, and earn less (or experience losses early in retirement) with your lump sum, the money will be GONE!
Remember, the annuity is insurance that some cash flow will always be there. This creates less spending anxiety in early retirement - and less temptation to spend a larger portion of the lump sum in the early years, because it seems like such a large nest egg.
I happened to just speak with Kotlikoff on the phone and I asked him about this. He said that it's a way for employers to pay less to their employees. They seem to know that people will take lump sums and, although there may be some sort of actuarial equivalence, they win big time when people take lump sums. Even though it's obvious to you and me, people will still take the lump sum. I think often planners talk people into this--oh, I can earn you more with my secret trading skills.
Remember, when you put this into ESPlanner and compare options, you leave the index to inflation set at zero.
The lump sum is ignoring the insurance against longevity piece of this. They have you dying at the "average" age--which is probably 79 or so. But because you are not an insurance broker, you don't want to take that gamble--you want the insurance against a long life that the annual payment provides.
You might take a look at this case study:
http://www.esplanner.com/case-should-i-take-my-pension-lump-sum
The point in this simple case is that annual payment is better--unless inflation immediately takes off to 10%. You can read the study.
The lesson here is that you should model your options with inflation going up at some point. That said, I think you are still going to find the annual payment a much better offer. But that's why we run different cases . . . compare.