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# Pension lump sum paymentOctober 18, 2013 5:45 PM   Subscribe

I have the opportunity to take a retirement plan lump sum …

and I want to know if it would it be better to take the lump sum and invest it or wait for the monthly payment. It is from Honeywell Corporation. I am 52 and in good health. Those life expectancy things on the internet say I'll live to be 80, which sounds about right.The lump sum is \$15,231. The monthly amount would be \$198.33 (for lifetime, no beneficiary) starting on 10/1/2026. I would be 80 in 9/2041, so let's say that's 15 years of monthly payments and then I die. So 15 x 12 x 198.33 = \$44624.55. The lump sum can be tax-deferred and I would add it to my existing Prudential mutual fund. So I think the question is can I turn (in round numbers) \$15k into 44k in 13 years. Is my thinking correct? What else can you tell me?

This is obviously just a small part of a retirement plan, but I would nonetheless like to maximize it.
posted by anonymous to work & money (11 answers total)

Do you have access to a financial planner? Because the first thought that comes to my mind is: can they flake? What if you only get 10K and they go into bankruptcy?
posted by Lyn Never at 6:03 PM on October 18

One thing to note, you have more than 13 years to realize the 44k.

Remember even after 13 years you will just start to draw \$198.33 each month not spend the entire amount, so the remainder will continue to earn interest.

Another way of saying this is that after 13 years you don't need to have 44k to match the pension, to match the pension after 13 years you will actually have less than 44k but enough such that drawing down \$198.33 a month it will not be depleted until age 80...

I could write down the formulas here - but in this case a spreadsheet is your friend. Make each row a month. Pick a reasonable interest rate (not sure what I would use here given the world we currently live in - but pick 3% to be conservative and 12% to be optimistic) and compute the yearly gains starting with \$15,231. After 13 years of this start removing 198.33 a month but continue to accumulate interest on the remainder. Hopefully when you see the numbers it will start to make sense and you can adjust the interest rate to see what you need to achieve to match the pension...

(A1 = 15,231, A2 = A1+(0.02/12)*A1 .... A157 = A156 - 198.33 +(0.02/12)*A156 ... and so on)
posted by NoDef at 6:10 PM on October 18 [1 favorite]

Try this calculator
Use the lump sum as the inital amount with no further contributions, retire at 65 (2013) and draw down for 15 years. Be sure to use an interest rate that it is AFTER expenses for your Prudential fund. You can adjust the interest rates and see how that changes things. Also play with the life expectancy number.

Aside from the financial calculations there are some other considerations:
1. can you trust yourself not to spend the money the next 13 years?
2. how do you feel about the life expectancy? if you live to 90 instead of 80, the annuity looks better. if you get hit by a bus tomorrow, the lump sum will be better for your heirs.
3. how important is it to not run out of money? would you be willing to give up monthly income to know that the payout will last your lifetime? On the other hand, will it annoy you if die young and never get the money or die and have nothing from this particular support to pass on to your heirs?
4. if there is a relatively small part of your retirement plans, how much will it simplify your life to have it folded into your existing funds instead of a separate investment.
posted by metahawk at 6:39 PM on October 18

Is this my Finance professor? Are you trying to trick me into crunching numbers on a "real-life" example of the time-value of money lesson we talked about Wednesday? CHALLENGE ACCEPTED! TGIF! YOLO!

NoDef is definitely right that you don't need to turn \$15k into \$44k, you just need enough to be able to draw out the ~\$200 a month over the course of your life once you start drawing it out (drawing down to zero, since you don't need it once you're gone). The rate of return in your mutual fund is going to be the deciding factor; I did my calculations assuming you're getting about 5.5% annually, now and forever, similar to this Vanguard retirement income fund. That's not perfect since you don't the same return every year, but it's close enough for this exercise.

So, using that rate, I calculated out how much money you would need to create a little annuity that would pay out \$200 a month for 15 years (drawing down to zero), assuming the principal was invested at 5.5%. That total is about \$2000. Then, I calculated how much money you would need now in order to have \$2000 in 13 years, and you'd only need about \$1000 now, if you could invest it at 5.5% annually now.

In short, I think you should take the lump sum, and invest it anywhere but a savings account. You will almost certainly be able to build up the cash to draw out the \$200 a month your pension would have paid, and you might be able to get more.

*If! If! I could be totally wrong. I'm but a lowly student. I hope my numbers check out.
posted by ThePinkSuperhero at 6:45 PM on October 18 [1 favorite]

I do these calcs all the time for clients, and I find that the implicit ROR on a pension for a normal lifespan is 3.5-ish percent. if they can beat that in the market they should take the lump sum. its a funny market: low interest rates (which is what pension beancounters base annuities on), high equity RORs, so lump sums are usually better.

posted by jpe at 7:02 PM on October 18

Mr. Money Mustache's simplified but very useful rule is that if you keep \$X in a normal retirement-type investment account you can safely withdraw 4% of \$X annually forever.

So if you have an annuity with annual payout value \$Y then a lump sum of 25 X \$Y is (in many senses) just as good in the sense that it will also pay out \$Y annually forever, but in two senses actually better than an annuity:

#1. You can allow the amount you withdraw to rise with inflation, thus never losing in buying power--vs most annuities are a fixed monthly amount.

#2. When you're done, the 25 X \$Y lump sum is still there. So for instance you could take out the 4% annually for as long as you live and then pass along the lump sum to your children upon your death.

According to this method, you need \$200 month or \$2400 annually. So your required lump sum is 25 X \$2400 or \$60,000. To get there with your \$15,241 in 13 years you'd need an average 11% annual return (which just might be possible according to some people, though that is thinking more on a 30-40 year horizon, not 13 years).

This approach requires a bit more money up front but it is also better than the annuity for the reasons explained above (you get an **inflation adjusted** \$200/month for life, whether you live to be 80, 90, 100, or 110), and it's definitely much better than the plan to completely draw down your principle by the time you are 80 or any other specified age. What are you going to do if you live 2 or 5 or 10 or 20 extra years beyond that?
posted by flug at 9:34 PM on October 18

Your employer will have used some calculation to arrive at their figure. It will have an interest rate. They've calculated that the \$15,231 will grow at that rate for your expected lifespan, and they've factored in monthly withdrawals of 198.33 starting on 10/1/2026.

Ask your employer what interest rate they used for the calculation, then ask yourself if you can do better. And ask yourself if you believe that the company will continue to be healthy, not go bankrupt, not find a way to get out of pension obligations. I'd take the payout, as I think interest rates are unlikely to stay this low in the long term. If you think you'll be tempted to take it out (paying the penalty and taxes) then leave it in the employer's plan.

You should be able to roll the money over into an investment plan - 401(K), whatever. Invest it in a reliable low-cost mutual fund.
posted by theora55 at 8:32 AM on October 19

I'm showing that a roughly 5% ROR on the lumpsum will permit you to take out 200 / month until 82-ish. At 6% you go out til 92-ish. At 7% it's self-sustaining. At 4% it goes til 78-ish.
posted by jpe at 12:22 PM on October 19

Do you trust the company to honor its pension benefits for 38 years? There aren't many firms for which my answer would be "yes," and as others have said, you can probably do better. I'd take the lump sum.
posted by snickerdoodle at 12:46 PM on October 19

"The lump sum can be tax-deferred"

Who told you this? It is probably not true. An employer-sponsored retirement plan can allow you to move your money to an IRA, where it will be handled under the same rules (no withdrawal without penalty until age 59.5, mandatory withdrawals after age 70.5), and where you can decide where it is invested. But if you take the money out as a lump-sum distribution, without doing a qualified rollover to an IRA, all of it is taxed as ordinary income at whatever your current marginal tax rate is. So the amount you would start with as an amount to invest outside an IRA environment will be reduced. That needs to be factored in.
posted by yclipse at 3:02 PM on October 19

your \$44k is a worst case scenario because you're assuming zero percent interest. you're also assuming you'll live to the expected age, but your actual life time may be longer or shorter. you're probably risk adverse, so this also affects the calculation.

i'm not a financial adviser blah, blah, blah ... the offer you got has implicit assumptions about what interest rate they expect to get in the future and your mortality. they wouldn't offer you the early retirement if they didn't think they'd save money in the long run. your employer is more like an institutional investor than you. as an individual you're unlikely to be able to achieve the same yield as your employer. since taking the early retirement is essentially a bet on how well you can invest vs your employer, it seems to reason that it would be best to not take the deal.

however ...

your personal situation may be special. what would you do if you retire now, and how much would you make if you did not retire? these kinds of things also need to go into your calculation. there is also value in that you likely also hold an "option" in that if you don't retire early, you maybe be able to get them to give you another early retirement when your situation is more favorable to you.

i'd also say we are in a historically low interest rate environment, and if interest rates do rise, you could be locking yourself into a low return if you take the early retirement.
posted by cupcake1337 at 10:23 PM on October 19

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