Here’s a question similar to the one about pension options but with different numbers, options, etc.
A reader writes in:
Similar to another reader I was offered a pension buyout.
I retired a couple of years ago.
My wife is retiring in February 2019.
Lump sum pension buyout is $458,000 (roll over to an IRA so not to be taxed at 50% rate with penalty) or pre-tax payment for life for me is $26,000/yr (I’m 55) beginning 1/1/2018 or pre-tax payment for life $54,000 at age 65.
My wife is 55 and will get full pension at age 60 at $101,000/year.
We are both healthy and expect to claim social security at age 70 for maximum payout of $80k/year combined. College for children are fully funded in 529s.
Our other financial details are:
— $6.8 million in tax deferred accounts: $4.9 million in my rollover IRA, $1.7 million in her 401k, $180k in non-deductible IRAs
— $45k in Roth IRAs. Could not fund anymore due to our income.
— $300k in a taxable brokerage account
— $2.1 million in 2 homes
— No real estate investment properties
— $1.2 million in mortgages (3% and 4% rates)
— $200k cash
— She will be eligible to join her company retiree health plan until age 65, then Medicare kicks in.
1) Should I get the $458k payout even though it represents only 6% of our total tax deferred account? Or should I take the annuity now versus at age 65?
2) Should I withdraw some money from the tax deferred account and pay down the mortgages, or try to get a pre-tax 8% return on investments (basically leaving the money in an S&P500 fund)?
What’s your advice for him?
Razorback 14 says
Question 1. Roll the total amount over and add to your IRA.
Question 2. I would not pull money out of a tax deferred account.
I would consult a cpa paid by the hour. All of the options need to be explored in depth also might check bob brinker moneytalk site.
Also current liabilities and associated i rates should be evaluated. New GOP tax law has a 1 time 25% withdrawl at 10% tax rate for mortgage reductions or investment (if it gets passed). Too much to consider and evaluate here.
Take the lump sum. I base my advice on the primary fact that you don’t need the money. So, there’s no reason to risk the pension going to Pension Guarantee, especially since there’s always a chance that -if that happened – you may not get the full amount of the annual payout. Additionally, we’re getting closer and closer to means testing with social security and I would imagine the Pension Guarantee would follow along shortly thereafter.
If you take the annual payout, I would claim it as early as possible, not waiting until 65. Again, for the same reasons.
Thank you Jay. The company pension fund is very well funded, about 95%. I found out that the new pension accounting kicks in 2018 incorporating longer longevity rates. In addition, the discount rate used for the lump sum is 1.8% for the first 5 years, 3.8% for the next 5 years and 4.8% after that. Congress changed the rules a few years ago allowing companies to do it. It seemed high compared to the 30-year treasury bond at 2.8%.
[email protected] says
We should check with @actuaryonfire to see if he’d be willing to run the numbers. I’ll tweet this out and tag him.
My two cents is that your question shows how you have been so successful to accumulate what you have. Your assets are impressive. Still, you want to make sure you make an optimized choice with the pension. That’s exactly how I define “Winning Personal Finance!” It’s inspiring.
Thanks Jason. I’ve been fortunate to max out my 401k contributions early on my career plus getting a very generous 15% company match over a 23-year career. But my retirement account really took off once I rolled over to an IRA and invested myself on great technology stocks. God Bless America!
1. Wait to 65 and take the pretax 54,000. That equates to 1,350,000 invested with a 4% withdrawal rate. I don’t think taking the lump sum and investing now will give you that type of income.
2. I keep the mortgages and keep the investments in an asset allocation that produces 5-6% minimum. Paying off the mortgages with pretax money will cost you the tax deduction on the interest and the additional income tax of pulling pretax money.
Thank you Danno. I am contemplating waiting to age 65 to get the full pension (well funded) which guarantees a 6% annual increase versus getting it now. This is the first time in 20 years that the buyout is being offered to a population of 8,200 former eligible employees. My believe is that they will do it again in 5 years (with substantially higher buyout), but despite that I may not accept. If everything goes well I’ll probably live until 85, and my wife has longevity in her family and achieving age 100 is very reasonable. As a result, I think I should opt to a lower pension at age 65 but getting 100% spousal benefit. Basically milking my pension for 40 years! Boy, the company would hate that!
Paper Tiger (aka MI 27) says
You are getting some good advice from others on the pension so I won’t add much value to that. However, I would suggest you might want to sit down with a good CPA and retirement planner and discuss your situation regarding how much money you have in deferred accounts and the impending tax implications. This is an exercise I am going through right now and it has opened my eyes to some things I had not previously considered.
As you approach retirement, minimizing risk and dealing with more certainty rather than uncertainty becomes important. There is a rationale to consider moving some of your deferred money into a Roth IRA and paying the taxes now so you and your heirs have more tax-free money later. The reason for this is fairly simple. Taxes are probably as low now, and potentially a little lower still, than they will ever be. We have a huge and growing deficit that is going to have to be dealt with at some point. We have broken politics and a political system that is failing us. Congress is not going to deal with the deficit and will continue to kick the can down the road until we reach a point where we have no choice but to address it. At some point, China is going to stop buying our debt and that will probably be a key trigger.
The result will most likely be higher taxes and less deductions and all of that deferred money will be impacted as you ultimately pay the income taxes and capital gains back to the government on that money at higher rates. At this point in your life it is a good idea to deal with what you know and not risk what you can’t control in the future.
You have plenty of money so putting some of your nest egg into Roth IRAs and paying the taxes on that money now with some of your non-qualifed money will set you up very nicely for the future and put you in a better position where you don’t have to worry about what the politicians in Washington ultimately do to us. You also will lessen the tax burden of any money you plan to leave to your heirs and give them the added benefit of letting that money continue to roll, tax-free, for as long as they desire. All of YOUR future gains will be tax-free as well which is nice to know and a great benefit to have. I don’t know if your legacy is to create multi-generational wealth but these are some of the tricks that help facilitate that process and assure more money in the future goes to those you love, rather than to Uncle Sam.
Again, lots of options given your great planning and financial results so don’t go it alone. Take your time and find some good folks to guide you if this sounds like something you want to consider. You are in a very enviable position and, as I said, many options at your disposable to make it even better for you and those you love. Good luck!
Thank you for your insightful advice.
Great advice here already but I will add my two cents. I am in a similar situation, so I have thought a lot about both of these questions.
I would wait to 65 on the pension. A 6% return on a very safe asset seems like a good deal to me. Sounds like the pension is well funded but you would still need to consider the risk of the company too. That is the nice thing of the lump sum payout, you get to control all of the risk, but if it is a solid company in a moderate to low risk industry, I wouldn’t be concerned at all.
On the mortgage, that is a tough one, and one I am still struggling with myself. I will give you my solution but it may not be applicable. With my kids gone now, I am looking to down size and possibly relocate to a cheaper area to eliminate my mortgage which is about 40% of my total equity ~similar to you. However, I don’t have the assets that you have and maybe that isn’t something you want to do (or your wife :). Back to your question -on the one hand, I have had a philosophy of not paying off my mortgage and investing in stocks instead, and it has paid off handsomely over the last 30 yrs. On the other hand, now that I am retired and much more risk averse, it is really hard to find safe money at 3-4 percent. So, it would seem silly to have 1 million in safe money in your IRA getting 1-2 percent and paying 3-4 on your 1 million mortgage and maybe that is why you are asking. Taxes would be a big part of this decision, also current stock market valuations make me nervous and I’ve been at this for decades. I wouldn’t take a tax penalty to do it for sure. One other option might be a 72t distribution from your IRA and pay it off over 5 years or so, but now I’m getting really complicated. Anyway, food for thought. Congrats on building those huge assets, well done..
Thank you for your insightful advice.
I plan to withdraw from my wife’s 401k to meet expenses until I turn 59.5. First step is to take a $50k loan from her 401k before she separates to take advantage of this opportunity. If you separate from your employer in the year you turn 55, you won’t be subject to the 10% penalty in a 401k account per IRS rules. However, I will be subject to the 10% penalty if withdrawing from my Rollover IRA.
I’m also in a similar situation although not with the same degree of financial success that you have. I agree with Paper Tiger, that a question of equal or greater importance is developing a strategy for Roth converting your significant tax sheltered savings while you still have a reasonable number of years to fill up on the 25% bracket in the new Republican tax plan. You don’t want to be facing the tax man when you hit 70 with huge RMDs with who know what tax rate at that time.
In my case, I’ve done tax-based modeling in Excel and Maxifi Planner for my lump sum vs annuity DB pension and a couple of Non-Qual plans. My plan also involves moving out of CA to a tax-free state (Go Texas). My DB annuity is also a better deal (IRR wise) than the lump sum. Even though my employer’s plan is also well funded, you never know what companies look strong today but will be in the cross hairs of an Amazon or Google tomorrow (remember Lehman Bros, Bear Sterns, etc.). I’ve looked at the PBGC guarantees, particularly for the 50% contingent option and it won’t come close to covering what you and I are being offered. I also agree with Jay’s concern about the potential for means-testing in the future for the PBGC guarantee.
Did you say the lump sum was calculated using the new 2018 longevity tables or that your company was making the offer prior to having to use those more favorable terms (some companies are petitioning for a 1 year hardship exception to the new tables)? Lump sum payout values are most sensitive to interest rates. Given that interest rates are unlikely to be as low as they are today, your lump sum today will probably be higher than what they might offer you in 5 years.
In my case, the lump sum pension is worse financially than the pension, but it’s how I’m leaning. I don’t need the pension to live on and my focus is on estate planning through the Roth conversions in the 15 years between retirement and SS at age 70.
I would say take the lump sum. They have all kinds of wonderful assets and this will only add to that. If one of them passes suddenly they, of course, will be fine, but that money will be gone. No matter what they have done fantastically well and should be applauded for their efforts.
Well done on preparing for the next phase of your lives. As you move from success to significance (Bob Bullard – Halftime) my counsel is to have a detailed functional budget of the first 2 to 3 years of your post-working life. Looks like you have 500K in “cash or equivalents”. How long can you’ve on that before you have to start dipping into the IRA money which is “off- limits” until 59-1/2.
I repurposed my life 2-1/2 years ago. Coming to grips with not having a steady paycheck was the biggest stress during the transition (still is some days).
To address your specific question about taking the lump sum – Answer a few questions 1) do you need the cash now and after your wife no longer works to fund your budget? 2) Your said the retirement plan is well funded – great, but if it did default how would the impact you? 3) When the stock market drops 10 – 20 -30 % (and it will) how is that going to effect you emotionally? Would you rather be making 6% and receiving the 26 or 54 / yr or have it in the market?
As you know, your retirement income will come from many streams of income, some will be making market returns and some will be making less (or more).
Good Luck on the decision. This part of your life can be the most fun or the most stressful.
Feisty Fire says
Take the lump sum, buy 30 Bitcoins and distribute them to your kids… They’ll thank you twenty years later when they can buy a house of that 🙂
Congratulations on your success! How did you accumulate your net worth?
This guy doesn’t need any help. C’mon son!
Take the lump sum. You shift longevity risk to yourself, but you can afford to self-insure for that risk.
One big detail missing is your average annual expenses – if you’d like to be spending >$500k/yr in perpetuity, keeping some guaranteed income may be preferable.
Personally, I would pay down mortgages with taxable investment accounts, but to each his own.
I don’t think I saw your age mentioned in the article. That might be important, considering your retirement assets. Honestly, you’ve done really well, so I don’t even know if any of us are qualified to advise you.
When you die does the pension continue to pay your wife? This math assumes your wife will continue to receive the payments.
Wife’s Age= 55 Wife Dies= 100 Number of years left=45
Reader’s Age=55 Reader Dies= 85 Number of years left=30
Lump Sum vs Payment @55 vs Payment @65
Present Value of each option (Interest Rate 6%)
Lump Sum= $458k
Payment @55 = $402k (Number of years = 100-55)
Payment @65 = $437k (Number of years = CF ten years=0 CF 35 years=54k)
Based on this analysis, the best value is the lump sum followed by the payment at age 65.
You pay 3-4% on your mortgage.
You potentially receive a tax advantage = (1-Tc)*Interest Paid.
You stated you can receive 8% yield on invested assets (which means I should use 8% return for question 1 above)
You would not want to pay down the mortgages given the economic opportunity cost and total returns.
1. Take the lump sum
2. Pay off both mortgages completely
3. Invest everything in simple index funds – Equity and Bond at a ratio you are comfy with. No individual stocks
4. Spend the rest of your life not thinking about money optimization anymore.
You have $7.3M liquid. That is a $300K annual income @ 4% SWR. Add in pensions and SS and this gets to a silly retirement income quickly. Obviously you have been quite successful with your investments and money optimization (And market performance has surely helped). And tech stocks.
Fortunes can turn quickly, and many will in the upcoming decade as markets mean revert. You are no longer in a position to need to play the game, as ESI posted about recently. So stop playing. Completely.
Seriously. An extra $1M will not make a difference in your life, so get out, remove the risk, be debt free and eliminate the leverage and mental effort that leverage requires, and move on to the Forrest Gump chapter where “You don’t have to worry about money no more”
If your wife would work for free, then I would continue with the retire in Feb 2019 plan for her as she must love her work for more than the money. If not, I would have her retire tomorrow regardless of the pension implications at 60. I would take SS at 62 for each of you because age 78 breakeven is far from guaranteed (and you don;t need it anyway). I would then maximize your unique combination of money and youth and have the best 2018 possible. IT sounds like your kids are still at home since you say college 529 is fully funded. I would spend all the time I could with them while they were still there.
15 years from now when you are 70 and your portfolio has grown, you won’t care about more money, but you will treasure the time you had together as a family if you choose my advice path.