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I’m 58. I’m in good health. My time with my (aerospace) employer is ending soon. That’s ok; I need to work another ten years (have a 12 year old), and there are jobs out there. My question is this-

I have a small pension coming, from the time before they ended pensions. I can receive $1,600 monthly for life (I can reasonably expect 25 more years) or so can take a $200k lump sum. 
Honestly, if I take the monthly check, I’ll spend it. If I take the lump sum, I’d roll it into my self directed IRA, to invest. 
More disclosure- I have decent retirement savings. This is not money to “save” me, but rather to optimize. 

I know how to do a NPV calculation. What should I use as the interest rate?

Thoughts? Suggestions?

Edited by statsman
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Yeah, usually my company’s lump sum doesn’t look like a great deal (compared to the purchase price of a lifetime annuity on the open market for the monthly pension amount). However, higher inflation may change things (assuming it is invested to beat inflation). 
Should the NPV model run for 25 years, using a discount rate of 6% for inflation? I could show the lump sum growing a few percent more for ten years, and then a withdrawal from it for the remaining 15 years of 4.5% of principal?

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15 minutes ago, statsman said:

Life works out the way it works out, and not the way you plan for it to work out. After miscarriages and struggles with adoption, I wouldn’t change a thing. 

That's awesome.

Still get to give you shit, Grandpa.

FWIW, I appreciate the thread as I have some similar financial considerations coming down the 'pike.

Edited by slorch
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The math on the lump sum doesn't really make sense here, even with our atypical inflation. But, if there is any potential concern about the employer being around in 20 years, I'd take the lump sum. 
 

It should be covered by the PBGC if the company goes tits up, and the annuity is under the maximum, so you wouldn't take a hit monthly. Worth researching.
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I'd check the T's & C's of the pension to see what happens to it if you were to die tomorrow... I have an old one that I had forgotten about from early in my career and that one won't go to wife or kids when I'm gone so doing a transfer to an IRA (or elsewhere) is a must or the money goes away...

Edited by Grimas
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22 hours ago, Grimas said:

I'd check the T's & C's of the pension to see what happens to it if you were to die tomorrow... I have an old one that I had forgotten about from early in my career and that one won't go to wife or kids when I'm gone so doing a transfer to an IRA (or elsewhere) is a must or the money goes away...

The above is the starting point.  Most pensions will provide multiple options......Single life, joint life, etc.  You need to know the monthly income paid if it is based just on your life, and also the different (will be lesser) amount paid if you elect the payment option with a spousal benefit if you die first.  That becomes increasingly important the younger you are, if there are significant age difference between spouses, or if there are health issues affecting expected mortality for either spouse.

You also need to make damn sure you know what ( if any ) COLA provisions there are.  Pension plans don't follow a universal formula like Social Security, so there is no right answer until you have gathered more information.

You would be able to roll the lump sum into an IRA without taxation at this point.  Whether or not your current 401(k) allows for outside rollovers will be plan dependent - ask your HRD or plan sponsor.  Either way, the effect would be similar in that your qualified savings would be increased.

If you've got decent retirement savings in qualified plans already, that brings up an interesting question / option. 

Should you add to your qualified holdings which will be subject to an RMD at some point (by doing a lump sum rollover), or do you invest the monthly income by taking the payment stream and create a bucket of non-qualified funds which can help with tax planning and diversifying income streams?

Were it me, I'd do a lot more digging and planning than just a NPV calculation.

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I understand that NPV isn’t everything, but I know who to do one, so I did. 
 
Parameters and stuff: I already max in 401k contribution ($26k with catch-up contribution), so the pension would either be spent or invested in an after tax account. Probably spent. 
SS: learned from my FIL’s experience (he drew SS as soon as he could, worked full time until his mid 70s, lived until early 90s, and my MIL’s survivor SS benefit is a huge chunk of her income. It would be a lot easier for her if he had waited until he was older to draw it, as she would probably get over 50% more per month if he had) to not draw SS as long as you are still working. 
 
Situation 1: draw pension for 25 years, starting this year, and then it ends. Tax at 30%. 
Situation 2: Roll lump sum into 401k and let it grow for ten years untouched. Assume investment growth 2% higher than inflation (is that reasonable?). Start drawing 4.5% of grown amount annually, and tax it at 30%. Fifteen years later, stop drawing, but count the grown amount from year 10 (I’m dead, assume wife is too, but daughter inherits principal). 
The discount rate for the NOV comparison was 6%. 
This model shows the lump sum as the better option, primarily because I let it grow for ten years first, and there is a chunk left over at the end, for my survivors. 
What do you think?

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One wrinkle to throw at you.......the fact that you can start taking then pension today provides a lot of different options.

If you can start to draw the pension immediately (per your Situation #1) -  Direct deposited into a taxable investment account - the future value of a stream of monthly $1600 investments made for 10 years and earning 8% would be  around $290,000. - Use whatever return you want.....

So.......at the end of 10 years and when you retire, you have $290,000 in an after tax account plus a continuing monthly pension income.  That continuing pension income could help you delay taking SS by filling in some of that gap.

Then, withdrawing 4.5% of $290,000 gives you around $1050 per month (plus you still have the $1600 per month pension) so now you are at $2650 per month, and based on the current tax code, the taxation would be more favorable because at least some of the money coming out of the taxable account would be presumably at cap gains rates so your blended effective tax rate would be reduced.

Question - Is the pension actually a period certain benefit - Ends in 25 years, or are you just using that 25 years as an assumed mortality?

There are innumerable "right ways to do it", but personal finance is about 90% personal, and just 10% finance - so knowing your own self-discipline, risk tolerance, and emotional goals will be the most important factor in which "right" decision you choose.

Finance looks great on paper and passes the math test until life punches the person in the mouth and they either have to stick with the plan or abandon it.

 

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12 hours ago, statsman said:


This model shows the lump sum as the better option, primarily because I let it grow for ten years first, and there is a chunk left over at the end, for my survivors. 
What do you think?

I joke with my wife that we almost certainly need to take the lump sum because I'm gonna be one of those folks who keels over 1 year into retirement.

Her financial wellbeing is of the utmost importance to me, regardless. I know, i know, she's scheduling a hit now... but yeah, she would have already had me knocked off years ago, if she was so inclined.

If anything, yours and Reagan1K's  last 3 posts have emphasized the need to get a  financial expert's counsel.  I flat out don't understand the proper/ optimal utilization of some of the options I will have.

Edited by slorch
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Not that you will post it here, but I don't think it's as easy as saying what do I do with the pension options. Your other retirement funds and income needs are part of the equation.

I know some who only recommend historic/stable returns and to push as much money as possible into those funds but there is something to be said about guaranteed income that is effectively independent of the market.

I will have a similar situation from a short stint with Big Oil that will give me $150,000 lump sum or a monthly amount. The monthly amount is currently estimated at ~$800 but it wouldn't be set until I start to receive it. It's depends on the prevailing interest rates.

Edit: if you can get $1600 for a $200k fund, that’s a good monthly payout.  If you wanted to withdrawal $1600/mo from a 401k, the rule of thumb is that the fund would need to be about 500k for a safe 4% withdrawal rate. I would double check the amounts and I assume that the payment is only for your lifetime and not your younger spouse. Tie it to her lifetime and I bet you see the amount drastically drop.

Edited by Nice Guy Eddie
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Look at it from another angle- this is a pension from an old aerospace company. The monthly payment was the baseline it was structured around and the lump sum was an option added later. At first glance, the lump sum isn’t a good deal. How much does it cost a healthy 58 year old male to buy a lifetime annuity paying $1,600 per month? It costs more than $200k (simple calculators indicate $300k or so), meaning if everyone took the lump sum, the pension fund would come out ahead. (Also, the withdrawal rate you describe has a goal of preserving capital. In a pension, the monthly payment of $1,600 gets cut in half for my widow, if I die first. When both are dead, that’s it). 

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