Lump Sum vs Pension - what is right for you? (Bloomberg)

You've Been Offered a Ton of Money. Should You Take It?

If a former employer tempts you with a lump sum for your pension, consider these four points before you jump.
 Suzanne Woolley
 WealthWatch
October 22, 2015 — 7:00 AM EDT

It's like the famous marshmallow tests done at Stanford University decades ago, when researchers gave some kids marshmallows and told them if they waited 15 minutes to eat them they'd get a second one.  The kids who delayed gratification went on to have better lives, judged by a variety of measures, than the kids who didn't.  
When it comes to your pension, you are the kid. The marshmallow is a big chunk of money.
The test: Within 30 to 90 days, choose to take your pension all at once, as a lump sum based on the present value of your future pension benefit, or wait and have the money trickle in on a monthly basis over the course of your retirement.
If you're lucky enough to have been in a traditional, defined-benefit pension plan at some point, it's a choice you may have to make in the next couple of months.
Before 2012, when legislative changes  made offering lump sums more attractive to companies, the offers weren't common. Activity revved up in 2013 and 2014, and there's been a dramatic uptick this year, said Matt McDaniel, who leads Mercer’s U.S. defined-benefits risk practice. The end of the year tends to be particularly busy, he said, with offers going out on Nov. 1 or Dec. 1.

Employers have a big financial motivation to offer lump sums. Pension costs are rising as workers live longer, and companies would love to get those long-term liabilities off their balance sheets. They'd also like to stop paying rising amounts to the Pension Benefit Guaranty Corp. (PBGC), a federal agency that functions as a backstop for pensions at insolvent companies. Since 2007, the PBGC's per-person flat premiums for single-employer pension plans have risen from $31 to $57. In 2016, they'll be $64.

The argument for accepting a lump sum offer is much, much weaker. As the General Accounting Office put it in a report issued in January, "participants potentially face a reduction in their retirement assets when they accept a lump sum offer." Yet about 40 to 60 percent of those offered lump sums take them, said McDaniel.

That may be because they don't have enough information to make a good decision. The GAO report notes that the 11 information packets from plan sponsors to plan participants it reviewed "consistently lacked key information needed to make an informed decision or were otherwise unclear."
Should you accept a lump sum offer? It depends on:

Your health 
If your close relatives tend to live into their hundreds, the lifetime annuity that a defined benefit pension plan provides is extremely valuable. If you have significant health problems, smoke, and close relatives died or had serious health problems fairly young, the benefit may not be as valuable. Statistically. To be frank.
The Social Security Administration's life expectancy calculator provides a longevity benchmark. It shows a life span of 84.4 for a man who is 65 today; for women it's 86.7. For a more nuanced estimate, David Littell, director of the retirement income planning program at the nonprofit American College of Financial Services, likes www.livingto100.com. (Helpful hint: Have your cholesterol numbers handy.)
Your alternatives
If you're tempted to take the lump sum and buy an annuity on your own, think twice. For starters, you won't get the lower institutional pricing your plan gets. And if you're a woman, you'll pay a higher price, because in your defined-benefit plan annuity pricing must be gender-neutral; outside of the plans, women pay more for annuities, because they live longer. (That same logic means women pay less for life insurance.) Then there's the task of vetting an annuity provider.
The best way to determine the value of a lump sum offer is to compare it with a commercially available product. You'll probably find that the lump sum isn't enough to buy an annuity outside of the pension plan that provides the same monthly benefit,  Littell said, particularly if your plan offers cost-of-living increases.
Littell went to immediateannuities.com, a consumer website that provides annuity quotes from major insurers, and looked for the lowest price on a deferred single-life annuity (with no death benefit) with a benefit of $500 a month and payments to start at age 65. The result: At age 50, it would take $51,000 for a woman to buy that annuity, compared with $47,500 for a man. A couple would pay $60,000.
If the woman is offered a lump sum of, say, $50,000, it might seem a wash. But if her company subsidizes early retirements and her plan includes features such as a cost-of-living adjustment, or if her lump sum offer is $40,000, that argues for staying in the plan.
Your investing expertise
If you've had long-term success in investing your own money, taking a lump sum may make sense. To earn a decent return, you'll probably have to leave the pension in equities for a few decades, which means coping with market swings.
"In times of volatility, like we had this summer, there's something to be said about that guaranteed check you know will show up in your mailbox every 30 days," said Matthew Sommer, director of retirement strategy for Janus Capital Group.
Also, an annuity's guaranteed income simplifies financial management, which is especially valuable later in life, when people are less likely to be capable of managing money.
Your cash needs
When the offer is between $10,000 and $50,000, the majority of people accepting it just cash it out, said McDaniel.3 That means paying income tax, and a 10 percent penalty if you cash out before age 59 1/2.
Cashing out early is a cardinal sin of personal finance. Tax-deferred investment vehicles let the earnings on money compound, year after year. Also, income from cashing out could push you into a higher tax bracket. 
Littell, who isn't a fan of the lump sum, points out that one good use of it would be to defer tapping Social Security until you're old enough to get the maximum benefit. And when the cash is in your investment account, you can leave it to children, other heirs, or charity.

Straight Facts about Retirement in the USA (Morningstar)

Improving Your Finances

25 Shocking but True Statistics About RetirementBy Christine Benz | 07-28-11 | 06:00 AM |

It's summer. Much of the country has been coping with scorching heat. But you still might not welcome this bucket of cold water: a passel of statistics about how many retirees are woefully underprepared for the financial challenges of retirement.


The goal of aggregating these numbers isn't to send you lurching to your closest bar cabinet. After all, you personally might be in much better financial shape during retirement than the following averages suggest. And even if you're not, you still might have time to make some adjustments to your plan so that you can avoid coming up short.


Herewith, 25 shocking but true statistics about the state of retirement in the United States.


19: Percentage of U.S. workers participating in a defined-contribution plan, such as a 401(k), in 1980.


52: Percentage of workers participating in a defined-contribution plan in 2004.


$71,500: Average balance of Fidelity 401(k) account holders at the end of 2010, based on 11 million accounts.


$740,000: The amount of assets needed to deliver an annual income of $50,000 per year for 25 years, assuming a 5% rate of return and no inflation.


$1 million: The amount of assets needed to deliver an annual income of $50,000 per year for 25 years, assuming a 5% rate of return and a 3% inflation rate.


$1.25 million: The amount of assets needed to deliver an annual income of $50,000 per year for 25 years, assuming a 5% rate of return and a 5% inflation rate.


45: Percentage of retirees who don't factor inflation into their retirement planning.


13: Percentage of retirees who look at least 20 or more years into the future when planning for retirement.


21 and 17: Average number of years, respectively, that women and men in the U.S. will be retired.


25: Percentage of 401(k) participants ages 56-65 who had more than 90% of their accounts in equities at year-end 2007.


42: Percentage of the target equity weighting for those retiring in 2010 according to Morningstar's Lifetime Allocation Indexes.


$1,000: Monthly Social Security benefit a retiree would receive if he begins collecting benefits this year, at age 62, assuming an annual income of $50,000.


$1,951: Monthly Social Security benefit if same retiree delays receipt of Social Security benefits until age 70.


72: Percentage of Social Security recipients who begin collecting benefits at age 62.


34: Percentage of retirees who rely on Social Security for 90% or more of their income needs during retirement.


40: Percentage of average wage earners' income that Social Security replaces.


80: Percentage rule of thumb for how much of one's pre-retirement income will be needed during retirement.


$230,000: Amount that a 65-year-old couple retiring in 2011 will need to pay for medical care throughout retirement.


40: Estimate of the average percentage increase in 2011 premiums on long-term care insurance policies issued by John Hancock.


45: Percentage of Americans ages 40-64 who believe the government will pick up the tab for their long-term-care needs.


$2,000: Amount of countable assets to be eligible for Medicaid to cover long-term-care costs in most states.


70: Percentage of Americans over age 65 who will need some form of long-term-care services during their lifetimes.


$162,000: Average annual costs for private-room nursing home care in Manhattan in 2011.


$60,000: Average annual costs for private-room nursing home care in St. Louis in 2011.


2.4 years: Average length of stay in a long-term care facility.

Why You Should Wait: Fixed Annuity Rates are Still Too Low (Morningstar)

The Error-Proof Portfolio:

For Annuities, Timing Is Key

By Christine Benz | 04-12-10

Many investors' hackles go up when you say the word "annuity." They immediately think of variable annuities, many of which are pricey and often sold, not bought. (When the TV program Dateline is using hidden cameras to catch salespeople in the act of peddling inappropriate products to unwitting seniors, it's fair to say that an industry has an image problem.)


But plain-vanilla single-premium immediate annuities deserve more respect. The concept is as simple as it can be: You give the insurance company a slice of your retirement portfolio, and the insurer, in turn, sends you back a stream of income for the rest of your life. You can layer on additional bells and whistles--such as survivor benefits in case you die early in the life of the contract--but they will dramatically decrease the payout you'll receive.


The Value Proposition
The idea of using annuities as a slice of retiree portfolios has been gaining traction in the financial-planning community and among mainstream investors during the last few years. Against the backdrop of a rocky stock market and a shrinking number of defined-benefit plans, annuities' promise of a certain payout holds a lot of appeal. And with bond yields still exceptionally low right now, annuities are also attractive in that they generally deliver a higher payout than what a retiree would receive via a traditional high-quality fixed-income investment.


Annuities also help address the more basic problem that--regardless of the market environment--we're all planning for an unknowable time horizon. None of us knows how long we'll live. And increasing life spans increase the risk that a portfolio of stocks and bonds (that is, one without an annuity) might not last throughout a retiree's lifetime, thereby burnishing annuities' appeal.


Problematic Timing
For all of these reasons, it's become conventional wisdom that SPIAs should be part of retirees' toolkits. Unfortunately, fixed annuities are catching on at what could, in hindsight, be the worst possible time. That's because the payout you receive from an annuity is based on two key factors: 1) the expected life spans of other annuityholders and the likelihood that some of them will die before actuarial tables would suggest; and 2) the interest rate that the insurance company can expect to earn on your money.


The first factor--in essence, the fact that some unlucky people in the annuity pool will die before their time--is why annuities can provide a higher payout than fixed-rate investments. In a pool of hundreds of people, the statisticians know that at least some of the folks who should live into their 80s and 90s will expire in their 60s and 70s instead. Those early decedents will have paid more into the annuity than they've gotten out. Other annuitants, meanwhile, will live well beyond what the actuarial tables would suggest, enabling them to receive more than they've put into their retirement.


The wrinkle is that people are living longer, and insurance companies are having to spread the money in the annuity pool over more and more very long lives, so increasing longevity will have the side effect of shrinking the payouts for everyone. (As a side note, an interesting body of research indicates that annuity pools include significant adverse selection--that is, the people who are most likely to buy an annuity are also likely to live much longer than actuarial tables would suggest. That may be because those most attracted to annuities may have longevity in their families, or perhaps there's a correlation with wealth and better health care.)


That trend will provide a long-term headwind for annuities, but it shouldn't have a significant impact on the timing of when you buy an annuity. The other component of annuity payouts--the interest rate the insurance company can expect to earn on your money--is more problematic. If you buy an annuity today, the currently ultra-low interest-rate environment will depress the payout you receive. (It's not a perfect analogy, but it's somewhat akin to buying a long-term bond with a very low coupon. Rates may go up in the future, but you'll be stuck with your low payout.) The average fixed annuity rate plunged from 5.55% to 3.94% between December 2008 and December 2009, according to National Underwriter.

What to Do?
For those who like the concept of an annuity but are concerned about the effect of low interest rates on payouts, one possibility is to ladder your investments, essentially dollar-cost averaging in to mitigate the risk of buying an annuity when interest rates are at a secular low. If, for example, you were planning to put $100,000 into an annuity overall, you could invest $20,000 into five annuities during the next five years. Such a program, while not particularly simple or streamlined, would also have a beneficial side effect in that it would give you the opportunity to diversify your investments across different insurance companies, thereby offsetting the risk that an insurance company would have difficulty meeting its obligations.


Alternatively, a prospective annuity purchaser could simply wait until fixed-income interest rates head back up toward historical norms. While fixed-income yields have recently begun to climb, they're still extremely low relative to historic norms.