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Dueling Desires

Richard Connor

MANY YEARS AGO, when I first developed an interest in financial planning, I read as much as I could on the subject. I distinctly remember being in a bookstore—remember them?—and looking at the myriad of personal finance books. Two stuck out.

The first book purported to show how to maximize your spending throughout retirement and die with nothing. The second book purported to help with the opposite strategy—leaving millions to your children. The stark dichotomy struck me then and it’s stayed with me ever since.

Indeed, among my family, friends and old colleagues, I’ve noticed the same twin desires at work in their retirement planning. They want to maximize their retirement income, but they also want to leave a legacy to their children. This often manifests itself in their concern about “leaving money on the table” if they die early in retirement. It’s an emotional response, reflecting our well-documented tendency to be loss averse. We spend our adult life working hard to accumulate retirement savings. Once we get there, it’s hard to let those assets go.

This instinct can impact three crucial decisions: whether to take a lump sum rather than guaranteed monthly pension payments, when to claim Social Security and whether to use part of our nest egg to buy income annuities. My contention: The choices many folks make could end up backfiring—leaving them with both less retirement income and a smaller estate.

Pensions. Like me, a number of my friends and former colleagues are eligible for traditional defined benefit pensions. We know we’re part of the lucky few, as those without pensions frequently remind us.

My old employer’s pension plan has an attractive “early retirement subsidy” that allows retirees who meet certain criteria to retire with a full pension at age 60, instead of 65. Retirees are eligible to take their pension as either a monthly annuity or a lump sum. The lump sum calculation, however, doesn’t include the early retirement subsidy. Result: For a 60-year-old retiree, the present value of the subsidized monthly annuity is about 33% larger than the lump sum.

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To me, the choice seemed obvious: Take the higher valued monthly annuity. It’ll provide steady income for my wife and me. But what seemed obvious to me wasn’t obvious to my old colleagues: They expressed the concern that, if they and their spouse die early in retirement, their children will get nothing if they opted for the monthly pension.

Social Security. Folks raise similar concerns about Social Security. Many financial planners believe retirees should delay claiming Social Security to get the largest benefit possible. This is especially true for married couples. By delaying the main breadwinner’s benefit until age 70, the couple will lock in the largest possible payment for both the retiree and the surviving spouse.

Boston College’s Center for Retirement Research has an excellent paper that explains how delaying Social Security is akin to purchasing an income annuity. More recently, the researchers there released another paper attempting to quantify the value of delaying. Both studies clearly show the financial value of claiming Social Security later—and yet many retirees take benefits early, fearful they’ll die young and “leave money on the table.”

Income annuities. Sold by insurance companies, these have the potential to play an important role in our retirement income plans. Last year, HumbleDollar’s James McGlynn published an excellent article describing how he’s integrated annuities into his retirement income plan.

Single premium immediate annuities—so called because you make a single investment in return for a predictable income stream—can be used to generate lifetime income or to cover a specified number of years. I’m considering buying them to provide income from age 65 until I claim Social Security at age 70. I’m also considering buying a qualified longevity annuity contract—a form of deferred income annuity—to provide income later in retirement. Both of these require giving a chunk of our portfolio to an insurance company in return for a guaranteed income stream.

Locking in a hefty amount of guaranteed income, whether from a pension, Social Security or income annuities, can greatly strengthen a retirement plan. On top of that, if you have guaranteed income to cover your regular expenses, you can take more risk with your portfolio by investing a higher percentage in stocks. Over a retirement that might last 20 or 30 years, that should mean better portfolio performance and potentially a far larger inheritance for your children.

In other words, avoiding income annuities, claiming Social Security early and opting for a lump sum payout from a pension plan might seem like the best strategy for leaving a legacy and generating a healthy amount of retirement income. But there’s a good chance that just the opposite will turn out to be true—and that, by locking in a healthy steam of guaranteed retirement income, you’ll end up leaving more money to your kids.

Richard Connor is a semi-retired aerospace engineer with a keen interest in finance. He enjoys a wide variety of other interests, including chasing grandkids, space, sports, travel, winemaking and reading. Follow Rick on Twitter @RConnor609 and check out his earlier articles.

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Rebel_Alliance
Rebel_Alliance
6 months ago

I need to show this to my husband, who is on his glide path to retirement at age 60. His dad is still alive at 93 and he will get a pension from work. At least he hasn’t spoken about taking a lump sum in years but he has mentioned claiming SS at 62, which is ludicrous. I’ve been warned about the specter of RMD’s by a guy pushing the scary annuities ( we didn’t buy them). I get that it is a thing, so maybe spending some qualified assets earlier on (in a reasonable market) until FRA or later might reduce that later bogeyman.
This predicting the future stuff for retirement spending is really hard! Thank you for your posts.

UofODuck
UofODuck
6 months ago

The pension example cited is not one that most people will face. It usually is just a choice between a lifetime annuity, at whatever discount rate assumption their employer is using, and a lump sum distribution that they can roll over into an IRA.

Which option is “best” is seldom simple or even obvious as there are a myriad of variables involved than can affect the final decision: How much money is involved? What other savings and income streams are available? Age? Health? Family health history? Children? etc., etc.

In general terms, I think an annuity stream may be better from someone who has limited other resources or who may less discipline in managing their own resources. However, with enough resources and either the ability to manage their own resources, or the means to hire someone who does, a lump sum distribution may prove better over its expected time horizon (wage earner + spouse + children).

For most people, It may be worth paying someone to help make these decisions as, once you elect which path to take, there is no going back.

R Quinn
R Quinn
7 months ago

I agree. For most people a stream of income is best and reduces the temptation to spend from assets beyond a budget. I had an employee who took a pension as a lump sum, blew it all at Atlantic City over several months and ended up living in his car. A pension should always be an annuity. While a higher SS benefit will be welcome in later years, the reality is it should be taken when it’s needed to live on, perhaps to avoid using other assets.

Guest
Guest
7 months ago
Reply to  R Quinn

What an unfortunate story about the former employee! I do believe that in retirement, it’s probably best to have, of the income stream options, some that are guaranteed and some that aren’t. The “should I start collecting Soc Sec as soon as I can or wait” question will go on forever. I can think of at least half a dozen different reasons folks would want/need to start early. And as far as leaving a $$ legacy, for my wife and me, if we leave our 2 kids nothing except our fully paid for home, it would be far more generous than normal and they’ll be very grateful for it.

Langston Holland
Langston Holland
7 months ago

That last paragraph should be the beginning of every conversation about retirement planning. The numbers don’t lie. Unfortunately politicians do little else and that complicates the social security calculations for those who can afford to wait longer to receive it. The monster in my closet is taxation and even without (likely) changes, waiting until 70 reduces after-tax PV and makes choosing between 62 vs. FRA difficult. On the other hand, those in lower brackets who cannot afford to wait longer before starting benefits can expect a higher PV if they wait!

greglee
greglee
7 months ago

For the decision whether to take a lump sum payment or monthly pension income, in the case of state pensions, I encourage people to take the monthly income, or at least calculate the value of the monthly payments somehow. I’ve had to decide this three times, myself, for my mother back in 1972 in Ohio when my father died, and in 2010 when my wife and I retired with two pensions in Hawaii, The monthly payments were the better deal by far.

CJ
CJ
6 months ago

What about us tail end boomers/gen x folks who will hit SS eligibility right before or around time of the projected cuts in benefits? This is where I get a bit confused as to best path forward.

If you don’t need the funds at 62 or 65, is it still better to wait until 70 – but only get partial benefits because the congressionally-passed cuts will have already taken effect? OR claim SS earlier and at least enjoy a few years at FULL 100% benefits (albeit smaller benefits) before they chop it down? Or is it all just a wash in the end – 6 of one, 1/2 doz of the other?

I stink at math – wondering if there’s a tool to help figure that out.

Handy Randy
Handy Randy
6 months ago

What is missing in discussions of Soc Sec claiming ages is Do you keep working? Keep working and claim Soc Sec means taxes have to be considered in the equations. Stopping work early (living off savings) will not cause Soc Sec to increase as predicted, since your 35 yr history is set. If you didn’t work (pay Soc Sec taxes) for 35 yrs, then 0s will be put in for the missing yrs, which lowers your payment.
Of course, for lower income folk, Soc Sec Admin uses a formula (as secret as the recipe for Coca Cola) that makes up for lower years.

John McHugh
John McHugh
6 months ago

“Locking in a hefty amount of guaranteed income, whether from a pension, Social Security or income annuities, can greatly strengthen a retirement plan.”

Maybe.

If bad inflation returns, all that except inflation-adjusted SS goes out the window, unless the rare pension recipient’s benefits include an even more rare COLA.

SanLouisKid
SanLouisKid
6 months ago

Welcome to the pension casino. If you take the lump sum there is always the chance the investments won’t pan out. If you take the monthly pension there is always the chance the company will go bankrupt and a reduced pension will be paid by the Pension Benefit Guaranty Corporation. I’ve had companies that offered to convert my pension to a lump sum years before I would even withdraw it. I’m sure they had my very best interests at heart. Having said that, I plan to wait until 70 to start social security. I have a pension from a company (and I wouldn’t be surprised if they went bankrupt). My wife has pension from a fairly stable company. But, we could live without pensions or social security. Our core survival does not depend on those sources of income. They are just icing on our retirement cake. Not everyone can pull this off but it does cut out those scary variables from retirement calculations.

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