Are monthly pension payments better than a partial lump sum amount?
Posted by MarkJul 2
Retiring in early 50′s with a public pension that has a Partial Lump Sum Option Payment (POLP). The plan provides a pension of ,600 per month with a cost of living increase each year of a little less than 2%. Pension with a PLOP of 0,000, rolled into an IRA, would be about ,000 per month with a similar COLA and health care.
A portfolio could provide additional income if needed and consulting work that generates about ,000 to ,000 annually is done and there are no debts.
The pension fund provides about a 7.1% return as the base rate for the funds that are removed as lump sum. If I can generate an average return in excess of that on the PLOP money, and hold off on tapping the PLOP money from the IRA until age 60, I would have a significant amount in excess of the original PLOP. Main reason for taking the PLOP is to offset future inflation.
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Seems like the choice is, fundamentally, whether or not to trade $600/month increasing 2% per year for life or take a $100,000 check right now.
These look to be about actuarially equivalent and the $100,000 appears to include the value of the 2% COLA.
As a result, you should not be concerned with whether or not this is a "fair" deal. Instead consider the other risk issues that could be important to you:
1. Outliving income: the lump sum is based on average life expectancies; Are you healthier or sicker than average. If healthier you’ll want to maximize the life income, lean toward the annuity. If sicker you’ll want the cash as fast as possible, lean toward the lump sum.
2. Spouse’s health/investment knowledge: How important is it to have an income for your spouse after you pass. Will he or she be more comfortable with a monthly income or a large IRA account balance?
3. Risk tolerance in retirement: Are you going to be fully invested in stocks at retirement. Or are you going to set up a balanced portfolio (some stocks/some bonds)? Need to set you return expectations accordingly. 8-10% returns may be right for an all stock portfolio but can you stand a -10% return year for this money? If you blend in bonds, how does that dilute your return?
4. Are there dreams you want to fulfill in the early years of retirement? Lump sum could be helpful funding those: a boat?, a trip around the world?
You seem to have answered your own question. If you are confident that you can manage the money and return more than 7.1%, then you win. A realistic long-term goal is 8-10% return, so you should be able to do it.
If you look back 100 years, the average return for the stock market is about 7% a year. So it’s a toss up whether you would come out ahead if you took the partial lump sum. You’re talking about tapping into the lump sum after 6-8 years. That’s a relatively short time for the stock market. The stock market’s had plenty of times when it went nowhere for 7 years, like 1929-1936 and 1973-1980. In fact, if you look at the time period 2000-2007, the stock market was negative and only broke even and went positive just a couple of months ago. So for 7 years, the stock market’s net gain was negative or zero. In fact, adjusted for inflation, the stock market is still lower today than it was in 2000.
But there is another reason to take the partial lump sum. Some medical and related expenses aren’t covered by health insurance. These would include things like assisted living facilities and some home health care. While you may be a long time away from a permanent stay in assisted living, some people end up there for shorter periods of time, to recover from illnesses or accidents. Having a lump sum of cash you could tap into might be very useful, if you don’t have other significant savings. Assisted living and home health care can be very expensive.
If you’re concerned with investment gains only, I can’t say that taking the lump sum is necessarily a good idea. If you want some cash for major expenses, the lump sum might be worthwhile even if it isn’t an investment winner.
2 factors come into play…1. you need to generate an overall investment return of 9.2% to keep up with the 600 per month need and the 2% COLA…can you?
2. the question becomes what does the 4600 give your beneficiaries? If no one gets any money when you die, THEN being able to leave them 100,000 makes GOOD SENSE.