I RETIRED FROM MY other job in 2022, so I could return to our family farm. Upon leaving, one of the first decisions I had to make was whether to take my pension as a lump sum or as monthly annuity payments.
The pension plan based the lump sum on length of service, salary and age, plus the interest rate as of the prior December. The lower the interest rate at the time of retirement, the higher the lump sum benefit. I made my decision in April 2022, using the interest rate set in December 2021.
The decision about how to take pension benefits is a difficult one. If you aren’t comfortable handling a large sum of money, an income annuity is the obvious choice. If all of your ancestors shuffled off this mortal coil before their hair turned gray or their joints began to ache, and you aren’t feeling so good yourself, then perhaps the lump sum might be the wiser option. Ditto if your idea of a fun day during retirement includes the consumption of illegal drugs interspersed with skydiving.
In my case, my parents are both still living and in their late 80s. Three of my grandparents lived well into their 80s. In fact, my paternal grandfather fell just short of living in three centuries. He was born in 1900 and died in 1999. With those antecedents, a lifetime annuity might seem like a good bet.
But to make a considered decision, it’s important to have some idea of the interest rate assumption used to value the annuity payments. After all, if that rate is higher than your personal long-term investment returns, or close enough so that the longevity insurance provided by the annuity plus the imputed return seem like an attractive deal, then you should choose the annuity.
In my case, the imputed interest rate was 2.5%. That made sense, given the low interest rates available at the time of my retirement, but less than I expect to make from my investments. And that’s why I chose to take the lump sum. Because of our family business, I’m comfortable handling large sums and knowing that those sums must last for a long period during which no income is likely.
That’s the nature of agriculture and particularly the greenhouse business, where our yearly income comes in a three-week period. Moreover, I have other sources of income and didn’t immediately need regular pension payments. An added bonus: Interest rates in December 2021 were at historic lows. The value of the lump sum payment would never be higher, and I was aware that the timing of my decision was fortuitous.
Now, given the lofty valuation of the stock market, even after the recent unpleasantness, maybe 2.5% or 3% is what we should expect for future investment returns. Gosh knows, my 2022 results fell short of that benchmark. But if I can average 5% or 6% over the next few years without touching the principal, my lifetime expected returns will be much larger than I could have received from the annuity.
While Social Security promises an increase in monthly payments for delaying the start of benefits, there was no advantage to postponing my pension, so the only logical choice was to take it as soon as I was eligible. Rolling the lump sum into my IRA allows the principal to grow tax-deferred, which will save me taxes over the next few years, when I expect I’ll still be receiving income from the family business.
Does all that sound well-reasoned and rational? It does to me. But truth be told, that’s not really the reason I decided to do what I did.
Among the biases identified by psychologists, one of the most persistent is our overconfidence in our abilities. I’m not immune to such bias when it comes to evaluating myself as an investor. Of course, I ignore this and other biases every day—otherwise they wouldn’t be biases.
I love to invest, spending hours each week studying the market and thinking about my portfolio. The thought of investing that lump sum over the next few years is, to me, like a fly fisherman discovering a new stream, a golfer seeing Pebble Beach for the first time, my wife finding a new flower to plant… well, you get the idea. I took the money all at once because it would be fun to invest it. If that’s a bad decision, it’s not likely to affect our retirement, but rather the size of our estate. Sorry kids, but the old man has an expensive hobby.
Blake Hurst farms and grows flowers with his family in northwest Missouri. He and his wife Julie have three children. Their oldest daughter and both sons-in-law are involved in the family business, growing corn and soybeans, and shipping flowers to four states. Their middle daughter is the chief operating officer for a small hospital. Their youngest, a son, is a lawyer for the Department of Justice. Blake and Julie have six grandchildren. Blake is the former president of the Missouri Farm Bureau and a freelance writer. His previous article was When to Quit.
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My self-managed portfolio is of significant size. I’ve done well but such results are not guaranteed. Taking a lump would be more of the same. I’m opting for the security of a monthly pension. It balances out my retirement income sources.
S&P 500 on a rolling basis with dividends reinvested has been positive for every 20-year period (rolling)—99.70% for 15-year, and 94.55% for 10-year. This is 1926-2022.
An annuity is fine as long as you realize your purchasing power is eroded by inflation
Turing age 62 this year you were born in 1961 when the index closed out at 72–last year it closed at close to 3,900.
Lump sum? One takes 35% or so for the annuity and considers the best way to beat inflation for 30-years.
What are the 7 most important words for a retiree? Every year everything I buy costs more. The objective is to stay ahead of the rising costs. The volatility will give you brown underwear, but if you can hang in there you have a fighting chance.
Like you, I opted for a lump sum from my pension plan when I retired. I had spent 42 years in the investment business and figured I could do at least as good of a job with my own money as I did for clients and save a ton in fees. My theory has largely proven correct, but what I also discovered was that investing your own money is very different from investing a client’s money. Its great when you make money, but there’s absolutely no one to blame but yourself when you make a mistake.
Almost 10 years into my retirement, our investment pot has grown, even with a generous spending plan. Unless something goes drastically wrong, having enough money for the rest of our lives should not be one of our worries.
I appreciate, however, that not everyone is able or prepared to manage their own assets and would never criticize someone opting for a lifetime annuity, rather than a lump sum payout. Each option comes with its own advantages and disadvantages, depending on your personal circumstances.
Say you had $200,000–you took $70,000 and invested in an annuity with a top ranked insurance company–now you have SS (one annuity) and your 2nd annuity with an insurance co.
Now I ran a hypothetical with a very fine fund that has a long history and invested $130,000–all fees included–began on 01/01/1937 (year markets imploded fearing another depression)–took the usual 4% initial and increased payout by 3% annually.
Did 30-year rolling periods through 12/31/2022 as at age 62 one could easily live until 92. Total withdrawn for every 30-year period $246,371. Money left after 30-years? Best was 1967-1997 $5.7 million+—-worst 1937-1967 $485,798—- median $2.2 million+.
Long term, equities are tough to beat, but most folks can’t sit still long enough to be successful–the enemy is volatility and if you can overcome that you have a good chance of withdrawal success.
I don’t doubt your numbers. But investing in stocks is, of course, considerably more risky than a guaranteed income stream. For those who understand and can tolerate that risk, your suggestion may work out fine. But I worry that others, who are less savvy, may view taking the lump sum as a slam-dunk and not realize the potential downside.
I’ll have this decision coming up in a couple of years. I’ve thought about taking the lump sum, though I don’t in the slightest think investing is “fun.” If I did so, I’d definitely put the money in the hands of a professional. The thing that stops me from seriously considering it is my survivor (spouse). He’s the one with longevity in his family tree (his grandfather lived to be 102), and he prefers the annuity so that he doesn’t have to worry about managing it. We already get his pension from 20 years in state service before he moved to private sector work in 2016. Both his pension and mine will include COLAs.
Anyway, because it may end up affecting him longer than it does me, I feel like he gets a say. (I have a bad family history of heart disease. I’m healthy now, but…)
Your pension must be a contributory pension in order to roll it over to an IRA. Since the market is down now, it is a good time to take lump some and invest, especially if you have other resources and do not need the money immediately.
Not that I had the option of a lump sum, but I discovered today that the portion of my pension which included a COLA is actually limited to a maximum increase of 3% annually. Given the current inflation rate, Given this information, I probably would have taken the lump sum given the opportunity.
Forget all the calculations, the interest rates, etc.
As someone who designed and managed pension plans for many years, my view is that a pension is intended to be a life (or joint life) annuity, not a lump sum then managed or in some cases mismanaged by the former employee who then carry’s all the risk.
I guess if a pension or the lump sum is just fun to invest and not needed, that’s one thing but more average people should not take that risk in my opinion. It would be no fun to lose their main source of retirement income
But Humble Dollar readers are not average people
More average than the Not-So-Humble Dollar readers…
Or is it More Humble than the average reader.
Blake, good article and your final point regarding the strong emotional component of our investment decisions is so true. But, unlike many, you recognize it even as you’re heeding its pull.
I was unexpectedly offered this choice over twenty years ago, as my megacorp started getting out of the pension business. I was aiming to take early retirement in a couple of years, at 53, and would start living on the pension or the lump sum immediately. I looked at the annuity I could buy with the lump sum, and it was very much smaller than the pension. I also had a fair sized 401k, invested in index mutual funds, and no interest whatsoever in actively managing money.
I took the pension, and left the 401k to grow – I will finally start spending some of it this year. Although the pension has no COLA, always a source of concern, it is now supplemented by Social Security and I have not regretted my choice.
This is very much an individual decision. There is, sadly, no one right answer, and no way to know how your choice will look in twenty years. The right answer for couples may well be different than that for singles. Those planning to actively manage their money should consider the possibility of mental or physical decline as they age, for both themselves and a potential surviving spouse.
I have a small pension that is no longer funded. I just turned 50 and will have to make the same decision you made, lump sum or annuity. Thank you for the article as it explains your decision well.
One thing I’ve noticed over the years from the small amount of retirees I’ve asked from the plant is if folks use a financial advisor, they almost always choose the lump sum. The incentive for the advisor seems too much to me like a conflict of interest. They always claim they can get a better return. I always think, well you also want that commission you’re going to get also.
Juan – Lump sum pension options for the last half dozen years have been high during the period of extremely low interest rates – most folks in my company elected the lump sum option independent of whether an advisor was involved. With the recent rise in interest rates, lump sum pension payouts have been declining which makes annuity options look more attractive. Of course, anyone that elected the lump sum option in recent years can now invest in an annuity or fixed income options at higher rates than their lump sum was based on.
Richard Connor covered this in his recent HD article here:
Important point here…
“Of course, anyone that elected the lump sum option in recent years can now invest in an annuity or fixed income options at higher rates than their lump sum was based on.”
The problem with the statement above is that at least when I was making the pension vs lump sum is that the annuity payout from insurance companies were significantly smaller than what was offered through my employer. Perhaps due to the company pension not paying a commission. R Quinn can you clarify?
Both Blake and Michael are referring to the unusual situation for those who took the lump sum in 2022: