Pension Decision - Lump Sum or Annuity?

This is pretty cool . I can take it and invest in whatever I want and , if God forbid , something happened to me tomorrow , my heirs inherit all of this money . Now , with the annuity , it also feels nice because you go well , I get this guaranteed income for the rest of my life and there's different options there .

Does your spouse get a hundred percent If something happens to you ? Do they get 50% ? Is it worth the trade off of that ? I'm going to help walk you through how to think through a pension decision and I'm going to actually show you one . I did with a client . So welcome back to the Early Retirement Podcast . I am your host , ari Taublieb .

I am a certified financial planner . I am the host of the Early Retirement Podcast that you're listening to right now , and I'm the vice president here at Root Financial Partners . So , with that being said , a few quick announcements financial partners . So , with that being said , a few quick announcements .

The first is that I am going to be showing you today , right now , an internal rate of return analysis . Some of you have never heard of this before . And the same way , I went to my doctor and they told me to take a pill I had never heard of before . So it's not something that I'll go over often with clients .

But I actually want to go on more of the technical side today , just so that you know , if you are trying to make that decision for your pension , you make the right one , because it has a lot of different factors and it can really dictate what a successful retirement might look like for you .

If you do not have a pension , you might still find this episode interesting . But you can apply a similar analysis to if you have an annuity right now and you're wondering , hey , should I get out of that annuity ? It's guaranteed with all this stuff , but I don't know if the fees are worth it and what about the surrender charges ?

So this is really an analysis to determine okay , should I take lump sum or annuity ? But it can go deeper if you have another product that you're wondering how to think through that .

So I'm going to hop right in after I go over the review of the week , and this review comes from cool 0867 , who says anyone who's considering an early retirement it's a must listen . Ari creates great content for his audience and truly cares about helping people achieve their dream of an early retirement . So thank you for that comment .

That is a comment from the podcast app . Now , for a lot of you , what I imagine you're wrestling with and I could be wrong , but you're going look , right now I have got a decision to make . If I take the lump sum , first of all , I just don't even know where would I put that money ? How would I invest that money ? It would be a lot all at once .

So it kind of feels odd and I like the idea of guaranteed income . So I want to take it , but I just want to make sure I'm doing the right thing and I'm not like missing one giant thing . So a few things .

Number one there is a flow chart that is in my academy that's going to help you think through Should you take the lump sum , should you take the annuity , in conjunction with what I'm going to show you right now .

So I'm going to distill all of this for you , but some of you I'd say a large portion of you are actually listening on the podcast app , which is awesome . That's why I do this , so I'm going to continue to do that . But what I'm going to be showing today is also going to be on YouTube .

So if you're going , hey , I want to be able to follow along with what numbers you're showing , because there are going to be a lot of numbers . You can go to YouTube and you can see exactly what I'm going to be showing .

I'm going to explain it so you don't need to be on YouTube , but just want to give you guys that option , so I'm going to hop right in . This is a pension analysis that I just did for a client . So what you're going to see on my screen right now is this person who has the option . They have the option Now .

This person's single , so they're not worrying about their heirs , but I'm going to pretend , what if they did in a second ? This person's single and they don't have any children , and so they're wondering what do I do ? Should I take this pension that's going to guarantee me $1,081 every month for the rest of my life ? There's no cost of living adjustment .

So it's just $1,081 every month for the next 50 years if they live 50 years , or $179,000 immediately . And by the way , big confusion here for a lot of people If you take that lump sum amount , that does not . You do not want to take that money and put it into your bank account because you'd have to pay taxes , a lot of taxes .

All of that would be taxed . So what you do is you move that money to an IRA , an IRA pre-tax account . So you would have that option . So just to be clear , don't move it to a brokerage account or take it as cash . I've only seen that once where someone did it on accident and they paid 40% taxes on that $179,000 . Except theirs wasn't $179,000 .

It was $800,000 . You don't want to do that . So only saw it once and we were able to amend it due to paperwork stuff . So if you know who you are and you're listening to this , they're laughing back going oh my gosh , I can't believe that would have been a big mistake . So I know a lot of my clients are still listening to the episodes here .

So here's what's called an internal rate of return analysis . So option one on the column C here , and I'm going to explain it if you're just listening to the podcast is $179,000 . That's their option of just taking it all at once , or $12,972 every single year , forever . So what you're going to see on the right is what's called the internal rate of return .

This is saying what is the return you received each year . So let's assume after one year you pass away . So you just say I'm going to take the annuity , but then you pass away . Your internal rate of return is negative , 92.75% . Why , well , what happened is you received the $12,972 and that's it . You passed away .

Now , in their case , they don't have a spouse . So most of you guys , if you have a spouse or and it can't be children it can only be a spouse .

Your spouse can be eligible for oftentimes a hundred percent , for it's going to be a smaller amount , or for 50% or 75% , where it would be a larger amount for you , until you pass away , and then it's 75% of that for the rest of their life .

So more often than not , I will elect if we are doing the annuity option and it's based on how good a pension is , by the way , that's how you make this decision is I will do the 100% spouse option , so it's called 100% joint and survivor . If someone has a spouse and they're debating , what do I do ? But let me show you the analysis so you can hear .

If they passed away after one year they would have received a negative 92% , because if they take the 179,000 , that could have grown . And if after one year they passed away , it could have gone to heirs , it could have gone to charities , it could do whatever they want . That is their money tomorrow for the rest of their life .

So the way to think about this is if we continue going down the line here , at what point does it start to make sense ? At what point is it a positive return by taking the annuity option ? And you can see here year 15 is where the annuity option would be positive . You can see about 1% . So not a good return , but positive .

Now , if we continue to go out here , the longer you live , the more attractive the annuity option is is because they're paying you out more and more and more . So what you can see here is , after 35 years their return would be about six and a half percent .

So the question is if this person was 50 years old and they knew , now they're not 50 , they're 60 . So if this person's 60 , I'll use them as an example and they live till 95 , they would have gotten a return of 6.43% . So I will ask them I'll go do you think that's a good return ? And some people go , yeah , it's a great return .

I can guarantee if I live for 35 years I will get a 6.43% return . Like that's pretty awesome and I'll say it is . But yours is not accounting for inflation , so that 1,081 a month . That is not rising with inflation . So really , even though this says 6.43% , it's really not six and a half percent . Let's call it .

It's really more like three and a half percent , because inflation is also going and growing and let's assume it's growing at three percent . Well , if six and a half percent is your return on paper and inflation is three percent , we have to subtract that . So 6.5% minus the 3% . So now you're working with 3.5% as your real return , your inflation-adjusted return .

So this is not an example where I would say let's take the annuity option , especially because that lump sum of $179,000 , well , I just know , if we're looking at markets historically , you can do a whole lot better than 6.5% average over 35 years .

So on the next page that I'm going to show you guys and once again explaining it , in case you're just listening , which is totally cool .

What I want to now understand is what would be what's called the cumulative annuity that you would have brought in over time , meaning , how many dollars would you bring in if you were to add up receiving $12,972 every single year for 35 years , you would have , as a total , brought in $454,000 over 35 years . So that's pretty cool .

Over 35 years , if you said I want to take the guaranteed annuity option , you get $12,000 every single year . You add that up , you've got $454,000 . Now what we want to understand is that lump sum . How much income could that create for us while we're alive ? So I'm taking just a sustainable withdrawal rate amount and I'm applying that logic to the lump sum .

So if your lump sum is $179,000 , if we were to take just starting out , let's just say , five and a half percent , which can be on the high end for some and low end for others , but I just want to take this just as a conservative figure here for a second . This is not similar to the 4% rule .

This is a different analysis , where , if you're taking from the pension , $179,000 is not similar to the 4% rule . This is a different analysis where , if you're taking from the pension , $179,000 is your lump sum balance . If you took five and a half percent of that in the first year , that would be $9,800 .

So with the annuity you could guarantee about $13,000 in a year and with the lump sum you can guarantee about $10,000 . So it's $3,000 less with my lump sum recommendation . Now why would anyone do this ? Well , it starts out as 9,800 bucks , or let's call it 10,000 .

And then what happens is it continues to grow because that $179,000 is growing every single year . So what happens is at the beginning it's only throwing off $10,000 a year , but as it grows , by year 11 , it's now beat the annuity and now it's bringing in $13,000 a year versus $12,000 .

So some of you are like well , I get that it's bringing in $13,000 , but is it ? You know , I would have had a guaranteed $12,000 every year . The one difference here and this is an important piece of the analysis is if after 10 years , you passed away and you took the annuity option , you brought in $130,000 and that's it .

So $130,000 came in and then it was done . So Versus , if you did the same analysis after 10 years with the lump sum , you would have brought in $112,000 total , meaning just income it generated . You can see here , guys , that was you're hearing that in live time .

That was the outro of the episode starting to play immediately , so trying to interrupt my pension analysis . Okay , so sorry about that . Back to this , so that $112,000 , that's the income your $179,000 would have generated in total . Meaning you take $9,000 the first year , then $10,000 , then $10,500 , then $11,000 and so on for a total of $112,000 .

But if after 10 years you pass away , so on for a total of 112 . But if after 10 years you pass away , it wasn't just 112 and that's it . That 112,000 goes on to your heirs and it could go wherever you want . So what we want to always understand is what's going to put the most money in our pockets at the end of the day .

And at the end of the day , the lump sum would have brought in a total after 35 years of $600,000 . And if you pass away in year 30 , where there's 460,000 of value , that 460,000 goes to whoever you want . So there's a lot of value in that . Once again , in total , $460,000 , that's what you created in income over the last 30 years .

But then , whatever is the value of the account left , you also get to give to your heirs , versus with the annuity option . It doesn't work that way . Whatever you're inheriting , whatever income's coming in , that is great . But then when you pass away , it goes away , unless you have a spouse .

So if you have a spouse , the difference to the analysis is you want to shift the numbers , so I'm going to do it on my screen here , in case you're on YouTube . So , instead of this saying 12,972 , what if we switch this to 11,000 ?

Because more than likely , if you're going to take that joint and survivor option , the company that's giving you that choice they're going to say , hey , if we're going to have to pay your spouse after this , we're not going to give you as much money , because that just wouldn't benefit us .

So now , if you look at the return , instead of six and a half percent being the return after 35 years , it's only five percent , it's only 5% .

So what you always want to do is run the numbers on your pension , because I see some pensions that all in , are guaranteeing about 10 to 12% and if I see those numbers , that's going to beat any strategy that you can conservatively look at if you're trying to invest the right way .

But if you're looking at anywhere in the range of three to 6% , that's where I tend to say , hey , that lump sum might make more sense .

Now some of you guys a few considerations to think of are going look , I get that , but I'm just going to sleep better knowing I've guaranteed income and , yes , I know it doesn't have an inflation adjustment , but I'm just going to sleep better . Well then , great , you can do that . Others of you are going to go .

No , I'm comfortable investing , and because of that of you are going to go . No , I'm comfortable investing , and because of that , I think this lump sum option makes more sense .

The other option and the reason I like going through this type of example with a pension once your pension gets turned on and social security is turned on and required distributions are turned on , you might have a lot of income coming in .

So if you're thinking about doing Roth conversions , you more than likely want to select the lump sum option , because once this pension gets turned on , it cannot get turned off and what happens is that's sending you more income , which is good so you can live , but it's also filling up your tax brackets .

So now , if you want to do Roth conversions , you might be having to pay taxes at the next tax bracket , which makes it less optimal for you .

So whether you should collect your pension lump sum or annuity is dependent on your current pre-tax balance , your comfortable , really , your flexibility with investing and comfort surrounding the subject , as well as what that means for the rest of your family . So lump sum versus pension this is just a sample as to how I would look through it .

Hopefully a quick episode and gives you the insight you want on thinking through pensions . So that's it for today's episode . If this was helpful , please do like , please do share . If you want a copy of this type of analysis , it is in my academy . So in the early retirement academy you will see there's an option to create your own analysis .

I've already put the code in here that I use so you do not have to worry about going hey , if I'm not like an Excel whiz , how am I going to be able to do this myself ? So don't worry about that , it's just already in there . So this is how to think through it . Hopefully this is helpful for you guys and I will see you guys next time .

Thank you for listening to another episode of the Early Retirement Show . If you have a question that you want answered in a future episode , you can always go to my website , earlyretirementpodcastcom . That's earlyretirementpodcastcom , and you can go ahead and submit a question that I'll look to answer in a future episode . Thank you all for listening .

Please do rate it , review it and share it with someone who you think would benefit from this information . If there's anyone out there that you know , I certainly appreciate it and I will see you all each week . Hey guys , it's me again . Please be smart about this . Nothing in this podcast should be construed as financial , tax or legal advice .

Consult with your tax preparer or financial advisor before taking any action . This podcast is for informational purposes only .