In the first part of this post, we talked about the role a pension plays, along with your Social Security benefit, as bedrock retirement income flooring for your essential expenses throughout retirement. We also mentioned that for most of us, the chief reason to take a lump sum buyout instead of regular pension payments is if you can buy a bigger pension with the lump sum.
Can You Buy A Bigger Pension?
Here’s a simple way to find out if you can buy a bigger pension. The example spreadsheet below shows a case where someone has been offered a $700,000 buyout for a $50,000 annual pension.
The annuity quotes shown are from the Vanguard website, which offers low-cost single-premium immediate annuity (SIPAs) quotes from a number of highly rated insurance companies through an arrangement with Hueler Investment Services. These low-cost annuities bear roughly the same relationship to more controversial and risky high-cost variable annuities that low-cost term insurance has to costly variable life insurance. SIPA’s are a low-cost, low-risk way to add to your secure retirement income floor.
The chart shows that for a 65 year-old male, a $50,000 annual annuity costs $773,000 and for a 65 year-old female, who statistically will live longer than the male, the cost is $825,000. In other words, in this case the company is offering 10% —$73,000—less than the cost for a male to replace the pension with an annuity.
Yes, $700,000 is a big chunk of change. But in this case, it’s not big enough—it’s at least $73,000 short of being a wash.
If the lump sum is significantly higher than the cost of a comparable annuity, then take the lump sum, and either use it all to buy a bigger annuity than your pension (which is a good thing!) or buy the replacement annuity and bank the rest. And count yourself very lucky—your company is probably not offering such a favorable deal.
If the lump sum and the cost of the annuity are about the same, then the relative business risk of your pension plan vs. the annuity insurance company, and the size of your annual pension relative to PBGC coverage may come into play.
Your company is probably not giving you a bonus, but you should go through this exercise to find out if they are. It will at least help you better understand the value of your pension, especially when someone is waving a big gob of money at you to make it go away.
You can download the spreadsheet here and plug in your pension amount on line 5 and the buyout offer on line 19 and see how it plays out. Keep in mind that the effective interest rate for annuities constantly changes and the 6.5%/6.11% shown now will go up and down and the current rate could be different, so you should get a current quote when you do the comparison if your leaning strongly towards the buyout.
Not The Only Way To Build Secure Retirement Income
There are other kinds of secure income floor besides single-premium immediate income annuities—ladders of Treasury bond STRIPS or TIPS, for example. Or highly-rated muni bonds in taxable accounts. The current low-yield environment favors the immediate annuity, so we’ll stay with that in this discussion for simplicity, but during retirement income planning, various secure income flooring options should be studied.
I’m not an insurance agent and I don’t work for a large asset management firm or bond dealer, so I don’t have any particular ax to grind—I’m not pushing annuity insurance products or selling stocks and bonds. From my fiducial viewpoint as a retirement management analyst, these are all tools that in some combination can be used to create a plan that best aligns with your household financial situation to provide a secure retirement lifestyle for you and your family.
It’s in your best interest to work with someone who is not biased by the products they sell and who is also knowledgeable about lifetime retirement income planning, and not just steeped in risk management with insurance products or building asset value through portfolio management. You need the whole picture.
You can find additional information about lump sum pension buyouts here from the Pension Rights Center.
If you have any questions, don’t hesitate to contact me via email or phone, 201-741-9428.
Michael Lonier, RMA℠ is a lifetime financial planner and retirement income specialist.
Securing our family's lifestyle over a potential 30-year retirement is the largest and most important financial goal we face. It is the lifetime goal of a prudent financial plan, and the focus of my practice.
Lifetime financial planning is a specialty that creates a life-long savings, investment, and risk management plan to meet your lifetime goals and securely fund your retirement.
My planning approach puts you and your family’s lifestyle, not your investment portfolio, at the center of the planning process. I focus on creating secure, reliable outcomes instead of high expectations based on at-risk market strategies.
This approach allows you to begin your retirement income planning at an earlier age when simple steps to secure your retirement income are much cheaper than later on in life.
My services organize and simplify your financial life, and set goals for your savings and investments. My mission is to help you attain the confidence, peace of mind, and resources to reach your goals and live your life more fully.
(The Retirement Management Analyst (RMA℠) designation is based on an innovative retirement income curriculum that is administered by the Retirement Income Industry Association, a non-profit organization dedicated to rigorous research and thought leadership for successful retirement income management.)