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Author: RoadScholar5 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 76418  
Subject: Lump Sum vs Pension Annuity Date: 3/21/2011 11:42 AM
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I did 20 years of hard time with my previous employer.

They froze the pension plan in 2006, nevertheless, I am still eligible for a pension based on all my service up to that point.

I am eligible to begin receiving a reduced monthly amount at age 55, or wait and receive the full monthly benefit at age 65.

Additionally, there is an option to receive a partial lump sum in lieu of monthly payments.

I have not yet contacted the company to look into the lump sum option.

What are the calculations and considerations given to taking a lump sum vs. monthly benefit?

Thank you in advance, RS
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Author: Fuskie Big funky green star, 20000 posts Top Favorite Fools Old School Fool Ticker Guide SC1 Red Winner of the 2010 Rule Breakers Challenge Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68667 of 76418
Subject: Re: Lump Sum vs Pension Annuity Date: 3/21/2011 12:33 PM
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This is the same dilemma that Social Security and lottery winners face. Your payments are based on an actuarial prediction of what your lump sum amount would be worth over time. The longer you wait to claim it, the longer the principal has to grow and thus the larger payments.

If you think you could grow the money better on your own, consider the lump sum. You can usually have the money placed into a rollover Traditional IRA so you can avoid income taxes and penalties. On the other hand, if you don't need the money and trust the company to not raid the pension fund for executive bonuses, the full monthly benefit could be a better deal, especially if you are in good health and will live many years past 65.

Fuskie
Who recommends considering your pension options in the overall context of your full retirement portfolio...

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Author: pauleckler Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68669 of 76418
Subject: Re: Lump Sum vs Pension Annuity Date: 3/21/2011 1:39 PM
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A few thoughts--

If offered a payment at an early age, say 55 your first consideration should be, if you wait to age 65, how long must you live to recover all the funds you would have collected between age 55 and 65. Then how is your health and in your family genes? What are the odds you will live that long or say to age 90?

What are the tax implications if you begin collecting at age 55? Will you continue working? Retire? Consider the whole plan.

If you retire early, will you be covered by employer health insurance? And what are the rates?

With a defined benefit pension plan, the lump sum value is calculated based on the pension benefits at age 65. When interest rates are low, the lump sum value is higher than when interest rates are higher. That implies that now is an especially opportune time to take a lump sum.

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Author: JLC Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68672 of 76418
Subject: Re: Lump Sum vs Pension Annuity Date: 3/21/2011 5:38 PM
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I would get the money into my grubby little hands as soon as possible. You need to consider what would happen if the company filed for bankruptcy, folded, or was merged.

I knew too many people that locally that stayed with GM instead of taking the early buyout. What could happen to GM? Great car company. How did that turn out again?

JLC

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Author: RoadScholar5 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68674 of 76418
Subject: Re: Lump Sum vs Pension Annuity Date: 3/21/2011 7:37 PM
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"When interest rates are low, the lump sum value is higher than when interest rates are higher. That implies that now is an especially opportune time to take a lump sum."

I was wondering if you wouldn't mind explaining this a little further?

Why is the lump sum higher when interest rates are low?

The funds are being managed by a third party trustee and not under the control of the company. Still, the point about one in the hand versus two in the bush is well taken.

RS

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Author: pauleckler Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68677 of 76418
Subject: Re: Lump Sum vs Pension Annuity Date: 3/21/2011 9:57 PM
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I was wondering if you wouldn't mind explaining this a little further?

The pension works kind of like a mortgage--designed to make payments of the promised amount for your life expectancy (with the insurance company taking the risk that those who live longer than their life expectancy will be balanced by people who live shorter than expected.)

As with a mortgage, the first payment you receive is almost all interest on that lump sum cash and the last payment (at life expectancy) is almost all principle.

The pension plan defines the monthly amount to be paid. As market interest rates change, the lump sum value changes to compensate.

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Author: pauleckler Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68678 of 76418
Subject: Re: Lump Sum vs Pension Annuity Date: 3/21/2011 10:23 PM
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Pension of $12,000/yr for 7 years							
							
							
Interest rate=		5.00	%				
Lump sum=		69437.00					
							
Year	         1	2	3	4	5	6	7
							
Interest	3471.85	3045.44	2597.71	2127.60	1633.98	1115.68	571.46
Principle	8528.15	8954.56	9402.29	9872.40	10366.02	10884.32	11428.54
							
Total	     12000.00	12000.00	12000.00	12000.00	12000.00	12000.00	12000.00
							
Remainder	60908.85	51954.29	42552.01	32679.61	22313.59	11429.27	0.73
							
							
Interest rate=		4.50	%				
Lump sum=		70713.00					
							
Year	         1	2	3	4	5	6	7
							
Interest	3182.09	2785.28	2370.62	1937.29	1484.47	1011.27	516.78
Principle	8817.92	9214.72	9629.38	10062.71	10515.53	10988.73	11483.22
							
Total	     12000.00	12000.00	12000.00	12000.00	12000.00	12000.00	12000.00
							
Remainder	61895.09	52680.36	43050.98	32988.27	22472.75	11484.02	0.80


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Author: aj485 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68682 of 76418
Subject: Re: Lump Sum vs Pension Annuity Date: 3/22/2011 10:03 AM
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The funds are being managed by a third party trustee and not under the control of the company.

Genereally, pension funds are still considered assets of the corporation, and can be lost in a BK, even if the funds are managed by a third party trustee. ('managed' being the key - rather than 'owned')

On the other hand, the PBGC http://www.pbgc.gov/ will step in and make up some (possibly most/all, depending on the benefits you are owed) pension benefits if a company goes belly up, so not all is necessarily lost in a BK. So you probably need to consider if your benefits would be covered by the PBGC, and how much you trust that the PBGC will be able to continue living up to the guarantees that it is making.

AJ

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Author: RoadScholar5 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68683 of 76418
Subject: Re: Lump Sum vs Pension Annuity Date: 3/22/2011 10:15 AM
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Thank you. I have been looking at this as well:


www.immediateannuities.com for comparison purposes.


RS

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Author: ptheland Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68684 of 76418
Subject: Re: Lump Sum vs Pension Annuity Date: 3/22/2011 1:56 PM
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Genereally, pension funds are still considered assets of the corporation, and can be lost in a BK,

I don't think that has been correct since ERISA was enacted back in the 1970s.

Since then, pension funds are typically held in a separate trust for the benefit of the employees earning pension benefits. Those funds are not normally available to creditors in a bankruptcy.

However, a lot of those pension funds are underfunded - they don't have enough in assets to pay the benefits already earned. Companies can hide this for a while by paying in to the pension fund to keep the funds from running out of money and making some outrageous assumptions about what the fund can earn on its assets. But if the company goes belly up, there isn't enough money in the pension fund to continue paying retirees. So the pension fund becomes a general creditor of the company for the unfunded benefits, which is a death blow to the fund's ability to survive.

That's when the PBGC steps in, takes over the plan, and continues paying retirees - but generally pays them less than they were getting.

--Peter

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Author: BruceCM Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68688 of 76418
Subject: Re: Lump Sum vs Pension Annuity Date: 3/22/2011 8:25 PM
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I did 20 years of hard time with my previous employer.

This wasn't at Shawshank, was it?

They froze the pension plan in 2006, nevertheless, I am still eligible for a pension based on all my service up to that point.

I am eligible to begin receiving a reduced monthly amount at age 55, or wait and receive the full monthly benefit at age 65.


There are two way companies may 'freeze' a plan. A "warm freeze" that allows you to keep accruing benefits even though the plan isn't enrolling any new employees. Then there's a "hard freeze" where the plan stays in place, but you do not accrue any more benefits. I'll assume from your discription, that it is the former.

Additionally, there is an option to receive a partial lump sum in lieu of monthly payments.

I have not yet contacted the company to look into the lump sum option.

What are the calculations and considerations given to taking a lump sum vs. monthly benefit?


The 'lump sum' is what is called the "Present Value" of your future benefits. This is comperable to the 'lump sum' you'd pay an insurance company to provide you with a life annuity. In fact, this is exactly what some employers do with the accrued 'lump sum'. If you'd like, I can explain the calculation used to get to the Present Value, but it won't change what you'll be offered.

You don't mention it, but a significant factor in determining the lump sum is if the plan will increase each year with inflation. This is rare with private employers, but does often occur with government employers, and may significantly increase the present value.

Assuming there is not an annual inflation adjuster, you will need to look at the lump sum value your employer plan would provide you and then find the best life annuity available from an insurer that could annuitize the lump sum amount you'd roll over into your IRA.

Most private employer plans are insured by the PBGC under ERISA although some employer plans are not 'insured' this way (multi-employer plans, plans of service employers with fewer than 25 employees, family owner employers, and a few others) and will be protected from default by the PBGC, as has already been mentioned. If the employer went bankrupt, the plan would be taken over by the PBGC, who, like the FDIC with failed banks, will take over operations of your life annuity. Most or all of your benefit would continue. With a private insurance company, the annuity in your IRA could be lost if the insurer went into default, although most state's "Guaranty Funds" will protect the annuity Present Value up to certain maximums...usually minimum $100,000 up to unlimited. However, private insurer default is rare.

BruceM

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Author: RoadScholar5 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68689 of 76418
Subject: Re: Lump Sum vs Pension Annuity Date: 3/22/2011 9:28 PM
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It was a hard freeze, similar to hard time, lol - and no COLA :(


Thanks, RS

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Author: reallyalldone Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68690 of 76418
Subject: Re: Lump Sum vs Pension Annuity Date: 3/23/2011 8:45 AM
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There has not been much mention of taxes in this thread other than an assumption that the lump sum could be rolled into a traditional IRA. This is true for 401Ks but is it true for lump sum pension payouts ?

One other factor may also be state tax treatment of pensions. In my state some portion of pension income is excluded from state income taxes so taking a lump sum would also include the calculation of foregoing the tax break other than the first year.

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Author: JCMcCarter Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68692 of 76418
Subject: Re: Lump Sum vs Pension Annuity Date: 3/23/2011 11:31 AM
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I'm retired and took a "buy out" so I don't have a lot of interest in reading all that was posted. But glancing over the replies, I didn't see anyone mention one possible advantage to taking a lump sum.

My employer offered a survivor benefit that allows one's spouse to continue to collect a (reduced) "pension" after your death. So I made sure to use the reduced pension into all my calculations.

Taking the lump sum has given me a great sense of financial freedom. I am not dependant on the well-being of my former employer. I also feel somewhat "self-insured" should long term care be a necessity in our future.

The downside is that I am responsible for growing the "buy out" to meet our future needs.

James

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Author: pauleckler Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68694 of 76418
Subject: Re: Lump Sum vs Pension Annuity Date: 3/23/2011 3:22 PM
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There has not been much mention of taxes in this thread other than an assumption that the lump sum could be rolled into a traditional IRA. This is true for 401Ks but is it true for lump sum pension payouts ?

In my case, yes the pension lump sum from a qualified pension plan could be rolled over to an IRA.

So I would say yes (unless the rules have changed since 1989).

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