Young w/ pension plan: lump sum or annuity?
I've become fully vested in my company's pension plan, and I intend to quit in the near future to pursue other career options. It seems the pension scheme allows me to decide what to do with the pension when I quit rather than forcing me to wait until retirement. I'll be 28 when I quit.
Based on what I've read, it seems the lump sum is the best choice considering my age. Most annuities (and I think my options are included) don't keep up with inflation in the long run. This is fine for older people anticipating a short run, but it would be a problem for me.
Am I right in thinking the lump sum is the best option for me?
Notes:
I also have k in a 401(k). That's separate from the pension.
With a lump sum I'd shore up my emergency stash and reinvest the rest.
The lump sum is about k; the annuity would be about 0/mo at age 65.
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You can eat your cake and have it too. The 401(k) money (or part of it) can be rolled over into an IRA and can be invested inside the IRA. Whatever you don't roll over and take as a lump sum is taxable income, and most likely subject to a penalty for premature distribution. I believe that 20% withholding is mandatory and so whatever is left can be used to shore up your emergency stash, and/or can be reinvested as you see fit.
Using Excel's IRR function and the following cashflows:
10,000 today (age 28)
-6,000 annually from age 65 to age 85 (life expectancy)
Gives me an IRR of about 5.6% (which means that the 10,000 grows at 5.6% per year for 37 years and needs to continues to grow at that rate to last another 20 years). Which isn't terrible, but with a 40-year investment horizon you can afford to take more risk than that. Plus, since you have a good use for the money today (building an emergency fund) you are probably better off taking the lump sum, building your emergency fund, and putting the rest in a retirement account.
Plus, if you die earlier, you risk getting a lower return (assuming the pension is not inheritable) and your heirs getting nothing at all. An IRA, on the other hand, can be inherited.
You could look at it in terms of break even. The annuity pays for itself in 20 months (after you retire) and everything after that is profit. However, that is over-simplifying things somewhat. We all know that a chunk of money today is worth more than the same amount tomorrow, because of inflation and opportunity cost.
If you were to take the lump sum now and invest it in equities, the general guess given these days is to expect an average growth of 10% annually (before adjusting for inflation). So compounded for 37 years, your initial investment might be worth somewhere in the region of 0,000 by the time you're 65. If you converted it all to low-risk investments at that point, it would then take about 84 years of 0/month withdrawals to deplete the balance.
So, if you expect to live past 149, and you don't need the money now and/or don't have something better to invest it in, the annuity might be considered better value. On the other hand, if you have the lump sum, you're not just getting the retirement security, but you also have the opportunity to use it for something else at any point between now and retirement (at the expense of future financial security of course).
Lastly, if you take the lump sum and die before reaching 65, your estate gets that asset at whatever its present value is. The annuity would immediately become worthless, unless it has some clause that lets a beneficiary inherit it (these versions typically cost more or payout less).
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