Help a Reader: Dealing with a Pension

Here's an email I recently received from a reader:

I was hoping to get some help from your readers in determining my best option.

I received an offer from a former employer with whom I am entitled to receive a pension when I turn 65.  I am currently 51.

I have 3 options:

    1. Do nothing.  When I turn 65 I would receive $187 a month for life with a 100% survivor payment for my wife.

    2. Take a lump sum payout now of $13,705 which I could take as cash, rollover to an IRA or Roth IRA.

    3. Take an immediate annuity that pays $67 a month for life with a 100% survivor payment for my wife.

What's your advice for him?

Comments

[AndrewB]

Your former pension plan is giving you this option to remove its responsibility to you later on - it is acting in its best interest, not yours.
My wife encountered the same situation one year ago, and we decided to do nothing (your option 1), as we did not need the money now, and we did not think it was in OUR best interest to do so. I do believe exercising option 2 or 3 would make the income taxable, which will be taxed higher if you are in a higher tax bracket while still working.
Consider your personal situation - do you need the money now? Do you think you will survive to 65 to benefit from the pension?
Do you think inflation would make the future value worth less than it is now?
Do you think you can invest the money to generate a better return than the $187 when you turn 65?

[AdAm]

All options are fair representations of your money. It all boils down to your financial discipline.

To me, it boils down to control. Taking the lump sum now, putting it in a Traditional IRA (which would "not" be a taxable event) and investing the money in a no-load S&P Index fund would likely net you more money in the long run. That way I could control my money and not fall victim to any corporate collapse. Pensions are not always guaranteed.

However, if you have impulse problems and are not disciplined enough to control your own money and keep it for retirment purposes only, then option 1 is your best bet.

[M19]

YOUR PENSION:

$187/month x 12 months is = $2244/year. This is guaranteed safe money payable for your life and your wife's life.

Can you INVEST THE $13,705 Lump Sum & DUPLICATE the PENSION ON YOUR OWN?:

In order to SAFELY generate $2244 annually you would need ***$74,800*** in the bank earning 3% INTEREST.

THE OFFER YOU HAVE:--

They are offering you a lump sum of ONLY $13,705--- much less than the $74K you need to duplicate the pension. This sum @ 3% will generate only $411 PER YEAR (and $34.26/mo).

ANSWER: Keep the Pension

[M9]

My thought is to take the immediate annuity of $67/month ($804/year). This is a risk-free return of 5.87% beginning now. Delaying to age 65 makes the 'breakeven' on the immediate annuity age 72.

The other solutions presented by posters above are all accurate, and make sense. This is my reasoning, and my 'nem di gelt' (© Henny Youngman) mentality (Yiddish for 'get the money!').

[BradM]

To expand on what M19 is saying, you would need to have an annual return of 12.9% on your $13,705 over the next 14 years to have a lump sum of $74,800 when you are 65, which you could then earn 3% on and take out the $187/month.

Doubtful you could generate 12.9% over the next 14 years, so I'd keep the pension as is - although if I were in this position, I would carefully consider the risk that this company goes under and the pension evaporates.

[JohnnyB]

I'm of the mindset of taking the payout. Especially if your life expectancy is shortened by heritage.

$187 x 12 x 25= $56,100 (monthly income x months/year x 25 years of draw (which puts you at 90)

That $13,705 invested in an IRA and returning an average of 8%, which a Dow index will make, will net $40,255 by the time you are 65.

The 2244 a year you would draw off to equal your pension would be a 5.5% withdrawal rate, leaving a 2.5% continued growth rate. Calculated over the 25 years to make it to 90 would total $74,630.

This also has a 100% survivor benefit. I'd take the lump sum. Are you a savvy enough investor to get 8+% annual return?
(I didn't do the math to see what rate of return you'd need, I just picked a low number and went with that. Don't believe that 8% is high either, my two year rolling aver is over 35% and my 5 year average is in the 20s.)

[M20]

We must all be economists because each of us has a different opinion!

'Nem di gelt' for me would be to take the lump sum and roll it into a traditional or Roth IRA, whichever makes more sense to you. I want to have control of the money and don't want the risk of the pension fund going belly up. In fact, a couple years ago I had the same scenario and did precisely what I'm recommending.

I don’t know a lot about lifetime annuities, but it seems to me that you could buy your own lifetime annuity at age 65 after growing the money yourself. Using a calculator on the web I found that you’d need to grow your $13.7K to ~$34K in order to get your $187/mo. I think that that works out to be ~6% annualized return. I’m pretty confident that you achieve that over a 14y period just by putting it into a broad market index fund. The beauty is that you have control over the money. If the annuity doesn’t make sense for you at 65, then you can do something else.

[Sarah]

I would be concerned about the stability of your present employer. Offering pension buyouts is not a good look. If you have reason to think the company may not be around until your old age, that's a reason to take the rollover now.

Also, it's quite difficult to discount the cash flow that far ahead. Hard to say what the discount rate should be over the remainder of your lifespan, and, thus, how much you need to be paid later to equal the amount you could get paid now.

[Old Limey]

Without hesitation I would take the lump sum payout.

I received a lump sum incentive payout of 32 weeks pay myself when I retired because the aerospace company I worked for wanted to reduce its headcount after the end of the Cold War. I used the money to become completely debt free heading into retirement. It's a great feeling and cause for celebration when you receive your loan documents with the stamp "Paid in Full" on them.

I would have also taken the lump sum payout because I am extremely disciplined where money is concerned and would have invested it wisely. Since the start of 1993 my investment portfolio has grown at an annual rate of 16.41% even though I moved totally into the slow lane with a bond portfolio in 2007.

[Money Beagle]

I'd probably take the lump sum payout simply because once you have it, the money is yours and there's no risk of you being affected by something negative happening with your employer that could jeopardize the funds being there with either of the monthly payout options.

[jim]

Take option #1, do nothing. Please.

Keep the pension. Its a good deal. It will give you guaranteed income for the rest of your lives starting at age 65. Thats what retirement money is for.

To buy a $187 joint life annuity at age 65 would cost you $39,600. If you took that lump sum and invested it then you'd have to grow your money 7.8% between age 51 and 65 in order to get that.
This pension is giving you an effective 7.8% guaranteed growth over the next 14 years. You *might* be able to beat that in the stock market but theres NO way you can guarantee >7% growth in 14 year period. The pension rate is guaranteed.

Keep the pension. Its guaranteed 7.8% growth. Thats a good deal.

Other people have talked about something happening to the employer. Your pension is guaranteed and if your employer goes bankrupt you'll still get the money. Company pensions are backed by federal law and the PBGC backs pensions when companies go bankrupt. Now if your pension is with a government entity not covered by PBGC there is some risk of default, but its remote. Heck... Detroit hasn't even defaulted on their pensions.

Why is the company offering you a lump sum? To save money at your expense.

There is a good reason companies all ditched pensions for 401ks. Pensions are a better deal and cost MORE. If its a better deal and costs more then its better for you as the employee to keep the pension. The reason the company wants to offer you a lump sum is that they want to save themselves money. If it saves them money then its not a good deal for you.

[Mark]

@Jim.....The PBGC does NOT GUARANTEE PENSION BENEFITS 100%. I think it only guarantees 40-60% of the benefit if the company goes bust. That is something to think about. You can go to pbgc.gov to find out if your pension is covered (apparently, not all are) and what the benefit would be if the pension went bust.

[Matt]

I align with what sort of company is it from. If it is a small company that is questionable take the lump sum and invest it as you see fit. Companies want to shed this burden from there books and eliminate pension obligations. Who knows they might want to package up the company to sell and merge with another. If it is a stable type company that would be around a while than I would consider doing nothing.

What are your other investments like would also impact a decision. Do you have a 401k or other savings?

[jim]

Mark, NO thats not right. PBGC guarantees pensiosn up to a limit. The limit is about $55k a year for a 65 year old persion. This writers pension is well below the limit. 100% of the amount below the maximum is covered. The PBGC does NOT cut everyones pensions. It just caps the amount and the people with higher pension values get less than they would.

[jim]

PBGC maximum monthly benefits :

http://www.pbgc.gov/wr/benefits/guaranteed-benefits/maximum-guarantee.html

Nothing on the PBGC site says they' cut everyones benefit to 40-60%. They don't do that.

[Sarah]

The PBGC is under a lot of stress lately. Check on p. 1 of this report on its insurance of multi-employer plans:

http://www.pbgc.gov/documents/pbgc-five-year-report-on-multiemployer-pension-plans.pdf

And I know the story below is about public-sector workers, but you don't want to end up like these people, even if it's "only for a couple years while things get sorted out." Not if those are a couple of your most vulnerable years.

http://www.nytimes.com/2010/12/23/business/23prichard.html?pagewanted=all

Detroit may not have "defaulted" on its pensions, but its workers are getting a haircut on their benefits, for sure. So I think some consideration of the apparent welfare of the company is worth undertaking before making the decision.

[jim]

The PBGC is not going to "go under" as its a government backed program and if the government lets it default then the government is in default. The PBGC is not going away any more than the FDIC is going away.

I understand all the worry and everything but this is really not something to worry about.

Pensions are safe.

Seriously the chances that you'll lose 90% of your money while investing it yourself are about 10 times as high. Yet people fear losing a pension because of the ifs and mights and could and possible scenarios and then manage it themselves and end up losing half of it when the stock market crashes in the year 2023.

[Debtfreemormon]

If it were me I would probably take the lump sum. Personally I like to have the control of my money and I think you could put it in a good investment or add it to the IRA/ROTH. Everyone has made some really compelling points about the other options, but you never know how long you will live, although it's likely it will be many years. But if it's me I take the lump sum, invest it, pay off some debts, and hopefully grow it into part of my retirement.

[JW]

Great comments - thank you all very much. The pension is from CSX corporation.

[Sarah]

Um, PBGC guarantees are *not* backed by the full faith and credit of the U.S. Which means the agency can default without the U.S. defaulting. An extreme scenario, to be sure, but I wouldn't just gaily wave it way.

[jim]

Yes technically the PBGC (a federal agency) could default and the US as a whole wouldn't default. But thats not going to happen and the fed. government wouldn't let it happen. I know theres people who are paranoid and think the worst of the govt. but no politician (right or left) will let the govt. default on its guarantee of pension benefits. Its a outright failure of the entire govt. and would be a PR disaster for the nation and our economy.
Its not going to happen.

[YoungLimey]

Lump sum for me, but I'm willing to accept risk.

$13,705*1.098^14 = $50,735. (based on stock market historical average since 1900)

This is in addition to the fact that you actually get to keep your captial $13,705.

The $187 a month would be only require $22,898 at the same rate of return.

For me a no brainer - an approx $40K gain by taking the lump sum.

[M20]

Furthermore, not only is the historical average 9.8% (from @YoungLimey above) but the best and worst 15y returns for the S&P 500 are 20% and 5% respectively. There's almost no way that you wouldn't be ahead of the game in 14y by just putting the money in an index fund in an IRA right now, even if the market tended toward the worst case. As I commented earlier, you have control of the funds the entire time (and it potentially can be passed on to your heirs).

[jim]

Annualized returns for the S&P500 from August 1999 to August 2014 are 4.5%.

http://dqydj.net/sp-500-return-calculator/

I checked previous 15 year periods ending in August 2009-2013 and you have to go back 5 years to find a period over 7% annual return. And thats with dividends reinvested too.

[Big-D]

I would take the payout. People are talking about PBGC and I look at my father and how he got screwed by GM going bust I would never, ever, rely on a company (or a government) to pay me for retirement. The company can go bust, they can change the rules, anything. Again - All I can point at is GM, and that was an utter fiasco what happened to him.

Plus this is such a piddly amount, take the money and run.

[jim]

How did your father get screwed? As far as I"m aware the union pensions were not cut and white collar workers were offered a lump sum buyout.

As long as a retiree already has a vested pension then companies can NOT legally take away that benefit. At least not since ERISA was passed 50 years ago. If you're a current employee a company can freeze or phase out its pension but that only impacts the benefit you earn AFTER the change. Thats common. But they can not take away existing earned benefits.

[Deserat]

As per about 75% of the commenters, I would take the lump sum and put it in either an IRA (roll it into one you already have), or perhaps into a Roth depending on what your current asset allocation is. " A bird in the hand is worth two in the bus." Based on the behavior I've generally seen of companies and governments with regard to pension money, I feel I am better able to protect my interest than they are.

If you are not disciplined with your money, then you've got another problem which won't necessarily be solved by a pension.

[Big-D]

@Jim - That is not what happened to him. GM paid its benefits to the union pension, as well as the white collar workers pensions (ie. the pensions were fully funded). The Union balked at paying their portion (half) the union employees pension (thus it was underfunded). My dad was an executive with GM (white collar) and retired with the following pension guarantees:

* Free healthcare until the age of 65 when he is forced by law to go on medicare

* 85% the his final salary until the age of 65, when he goes to 50%.

* An annuity payment which he paid each paycheck for the rest of his life. He contributed $250k over his lifetime with the company.

When GM went bust, and the government stepped in, this is what happened.

* He lost his heath care, which he had to get on the open market at $2k a month. You try to insure a 60 year old with pre existing conditions.

* The "white collar" pension fund was used to pay the UAW shortcomings in their pension payout, so it was basically bust. He received 25% his final salary for the rest of his life.

* The annuity that he put over a quarter million dollars was taken from him to add to the UAW pension underpayment.

So how was this all legal? It wasn't according to any laws in the USA. The government just did it. Again - this is why I say take the money and run. I have seen too many things that the government does when it is in dire financial straits and just "changes the rules" to suit them.

I bet in the next decade we are going to see changes in Roth's and other retirement accounts so more taxes come out of those. I bet we are going to see insurance not be "estate tax" exempt. All of this just makes me say, while the company is solvent, while you have options, take the money and run.

[jim]

BigD,

Executives have NON-qualified benefits. nonqualified benefits are not handled the same as normal pensions. Highly compensated employees are treated differently under the law. The fact that its non-qualified would be documented in their plans. Yes if you're a highly compensated employee with a non-qualified retirement benefit then you don't get the same rules as qualified benefits from pension plans for normal workers.

Also retiree healthcare is NOT guaranteed legally like pensions are. Healthcare isn't a pension. So yes that CAN be taken away at least in some cases and the PBGC doesn't back that.