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# Semi-hypothetical pension question

Dear financial gurus,
If one were faced with the choice of taking a regular single life annuity pension payout or a lump sum amount what is the proper way to evaluate it?
Here are the numbers (dollar amounts not real, but same ratios) Single life annuity: \$12,000/year Lump sum amount: \$170,000 The SLA has a 3%/year compounded built-in increase. Ages: late 50's
I lean towards the SLA as it begins at 7% of the lump sum amount and it will increase over time. The lump sum is approximately 20% of current net worth, but there are no kids so no inheritance issues.
Thanks for any input.
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Dean

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I believe the standard starting point is to get the PV of the payout stream over estimated lifetime. I haven't done the math to account for the increases you mention. Use an estimated rate of return on your alternate investments for the PV calc.
As I understand annuities, these are hybrid investment funds. The funds collected are maintained in an investment portfolio, expenses are deducted, and the balance is distributed per policy. Actuarial tables are part of it. Some annuities have an insurance policy feature to raise the probability of continued payouts worked into the expenses (and the insurer is also backed by investments). In basic form, you're comparing estimated rates of return over your lifetime..With 20%, it sounds - offhand - like a solid diversification relatively worry-free, but the rate of return is the number to look at.
Those of us who rely on number crunching to make choices have to be good guessers.
For example, you didn't say how long you would live or what major expenses were in your future - children/family problems, your out-of-pocket medical and long-term care, and so forth. We need those numbers to avoid looking foolish in 20 years.
Seriously, we don't know what your future is. What we do know is that by retirement most of us are pretty adept at living on a monthly paycheck and budgeting accordingly. That's what has gotten you to this point, and my experience tells me that is what will get you to the finish line.
Semi-hypothetically, my vote is for the monthly check.
From
I see a man, age 59 can get \$11,520/yr from the \$170K. But fixed, no inflation/ 3%.
So, your offer exceeds the number I'd call "break even." Of course, the hypothetical one has data the insurance company issuing the Annuity doesn't - their own potential longevity compared to averages. This shouldn't be ignored.
"HW \"Skip\" Weldon" writes:
Nevertheless, the numbers are a good starting point.
As JoeTaxpayer noted, the annuity that was offered was quite attractive compared to the current market alternatives (since it includes the inflation adjust - that's very valuable!).
Comparing on a straight PV basis - it's easy to take the numbers Dean's given us and generate a series of cashflows (\$12,000 this year, \$12,360 next year, etc ) and then pop that series of cash payments into a financial calculator to come up with a rate of return which could be compared to other instruments, the thing that's impossible to value easily against most other instruments (ie. a ladder of bonds or something) is life expectancy. You might well be able to get a higher rate of return over a fixed period compared to the annuity - but here's the big difference - you won't outlive that annuity. That's *huge*.
The downside, of course, is that if you die a year after you start, your heirs get nothing, but you need to decide how important it is to have a chance, if you die early, of leaving a financial legacy. Or if you have other financial resources which you'll pass on so this won't be as important.
Yeah - nobody ever tells me exactly how long they are going to live...
Without knowing much about the OP's situation, I'm inclinced to agree with wise and experienced Skip here. But before making a strong recommendation, I'd want to know a *lot* more about the OP's situation. What other resourses does he have, what's his cost of living, is he collecting SS, does he provide support for anyone else (who may need ongoing support after his death), etc.
That all said, the annuity looks like a pretty decent deal.
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You didn't mention...was yours a job where you didn't earn Social Security benefits? Meaning, is this pension in addition to Social Security, or in place of it? Does your spouse qualify for Social Security?
And is this pension enough to live on each year? (you said these were representative amounts, not the actual ones)
It seems to me the chance of investing the lump sum to earn more than 7% year after year is rather small. I am inclined to say that it is extremely small. And at your age it is quite possible that you have many, many years ahead. If it were me and the other 80% of net worth were in something stable, like a paid-for home, for example, I would take the SLA in an instant.
Thats only true of some annuities, such as the "Single Life Income with No Payments to Beneficiaries". You can get other types, such as "Single Life Income with Installment Refund Paid to Beneficiaries" which returns the remaining funds to your heirs/beneficiaries.
Many such types of annuities are described at

Skip,
We're planning on living forever. ;-} Though I doubt that will happen. :-( We're in good health. Realistically we should expect 30-some years.
No kids, no debts. Good net worth. I'll have a pension and SS, she'll have the pension, but no SS. I understand she gets no SS (not even spousal benefits) as she is a state of Illinois employee and has not paid into the SS fund.
She has this choice to make between a lump sum and a monthly check.
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Dean in Peoria

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Dapperdobbs,
Thanks for the feedback. I stated "annuity", but it is just a regular pension payout. Isn't the proper term an "annuity" for a monthly payout?
SWMBO works for the State of Illinois so who knows what is backing the retirement pension fund these days. :-( She can take the pension as a monthly stream or the lump sum payment. Given the state of the State, I have to wonder if the lump sum isn't the better bet. The annual payout would be 7% of the lump sum (along with the 3% compounded annual increase) which sounds pretty good.
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Dean in Peoria

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Thanks for all of the analysis. I'll have to chew on it a bit to fully grasp it. I'm an engineer, not a financial wizard.
I've stated else-thread, no kids, no debts, good health, late 50's. The lump sum is around 20% of current net worth. I'll have a pension now, plus SS in 7+ years. SWMBO works for the State of Ill, so she has this pension (or the lump sum). The 2 pensions combined would cover our reasonable projected expenses in the near term (5-10 years?).
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Dean in Peoria

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Thanks. I've stated else-thread that I'll have a pension plus SS when I come of age. She'll have this pension and no SS. This annuity/lump sum debate is about my wife's pension.
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Dean in Peoria

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Prior I wrote - From
I see a man, age 59 can get \$11,520/yr from the \$170K. But fixed, no inflation/ 3%.
Note - now that you've disclosed you have a semi-hypothetical SWMBO I can fine-tune the analysis. You see, women live loner and therefore, the (immediate) annuity for women pays out less. The number drops to \$10,884. 6.4%, no inflation increase.
If you have any thoughts or questions as to the nature of the lump sum vs annuity choice, or why the immediate annuity is the product I choose to compare it to, just ask. The 6-7% we are discussing gives up principal completely, so it's not to be compared to the 'interest' you get on CDs for example. Think of it as your principal being returned a bit each year. I found the same love of numbers that prompted me to get a BSEE came in handy when analyzing money questions, time value of money, etc.
I read the whole thread, and may have missed - is there an option for survivor benefit? The annuity site gives quotes for this, and your wife's plan may allow a lower payout should she predecease you. This should be considered even if you quickly dismiss it.
One of the main objections to this type of payout is the lack of money to leave heirs. 'No kids' is good to know.
guaranteed return = SS + pension + annuity
other variable investments to pay for luxuries, like travel, and inflation
Joe, Similarly I earned a BSME years ago. Though I never took any finance or accounting classes in school. At one time I could have derived the equations for structural finite element analysis--alas no more. All this present value, future value, time value of money, etc. is challenging, but certainly not impossible. Over the weekend I did some reading up on information found in Wikipedia (and MS Excel). Hopefully the info there is correct. I am coming to understand the concepts. Now I need to get a feel for what the numbers mean and reasonable values to use as input.
I too have an affinity for numbers and analysis and all that and certainly understand things like compound interest. The present value analysis is a new concept--we have real financial people to do that stuff at work.
Both of our pensions do offer survivor options, and that is another decision that needs to be made soon. I just figured it was too much for this forum.
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