Work Pension vs. investing a "Commuted Value"

I am not a financial planner.  I like engines.

But my financial planner is strongly suggesting looking into taking what would be my work pension's "commuted value" and investing it and living off that.  He says I'd very likely be able to retire earlier, plus come away with significantly more in pocket per month, plus I can pass the balance down to the kiddies when I kick the bucket.

Anyone a "money whisperer" who can give me other opinions on the subject?

I'm not a financial planner, but I have opinions...

Unless there is a danger that your current employer's pension isn't that stable, whatever investment your financial planner is going to try and sell you on is going to have a hard time creating more income for the rest of your life than a proper, larger company pension will be able to provide.

A lot of companies are trying to get pension liabilities off their books and offer seemingly generous payouts,  but they're usually not that generous when you have to consider that you (and potentially your surviving spouse) need to live off this money until you start pushing up daisies.

The simple question is - if you take the buyout, how much of your promised pension would a 4% withdrawal rate of the lump sum actually cover?

There's more to this, but it's a tad late here - I'll add bit more tomorrow morning. 

I would be putting pencil to paper and running the various possible scenarios. It definitely isn't a universal answer, but I tend to agree with your financial guy (but keep in mind depending on his fee structure he's likely also looking out for himself here).  

My gut reaction is to say if the expected annual pension benefit divided by .04 is in the same ballpark or less than the cashout value, do it. So if the expected annual pension is $25k, 25000/.04=625,000. So if the cashout value is around $575k or higher, I'd be taking it. But I'd play around with it, .04 is a pretty standard safe withdrawal rate. So go higher and lower, run more than just one equation. 
 

I am assuming you work for a public school. I don't know what it is like in Canada/BC, but coming from Illinois I would want to get my money in my hands so that I'm not at the mercy of politicians deciding to change, delay, or reduce the benefits. 
 

Additionally, they (the folks running the pension fund) are going to have a much different risk profile than I am. They're looking out for thousands of pensioners. I'm looking out for me. I may be able to take on significantly more risk for a better return. It also eases up the uncertainty on if you pass before your wife.

BoxheadTim said:

A lot of companies are trying to get pension liabilities off their books....

For this reason.

My father-in-law worked for General Motors for 30 years and his plant closed or he'd work longer.

He's been getting a pension for 34 years now.  He's also had full insurance benefits all these years for almost no cost.  They offered those guys $100-$125,000 to take a buyout which seemed decent in 1989 but dudes bought trucks and bass boats with some of it.

I guess the whole thing is we need to know when you're planning on dying?

In reply to Datsun240ZGuy :

For comparison here, $100-125k in 1989 money is worth about $250k to $320k today. That would have to be a pretty small pension for me to consider it. 5% withdrawal rate on the upper end of that is only $16k annually. 

In reply to SkinnyG (Forum Supporter) :

Another question: what are the details on the pension? Does it grow annually? Set amount or tied to returns for the fund?

It sounds like you have beneficiaries. It sound like you plan on living quite a while. These are a pro for the buyout and the pension respectively.

I'm typically a fan of buyouts because the ones I've projected out have beaten the pension in the long run. BUT, I've only calculated them for my coworkers at my employer, which has about 6 different pension ratio options. Some companies are really skimpy in their offerings.

The math is really easy - the assumptions that feed the math are what is really hard.

Usually, one can take the pension at 100% or some other fractions for survivorship to support a significant other. If there is not currently a significant other, that makes the math even easier.
As for calculating earnings on investments, I have traditionally taken VTSMX annual earnings and projected them out. I then do it again with a four fund portfolio similar to Bogle and Ramsey.

My free advice is that you become much more educated on your investing so you can be more confident in the decision making process. If you cannot reach a reasonable level of confidence, then stick with the pension as it is considerably harder to screw up.

I worked at a company just barely long enough to qualify for their pension.  Some years after I left that job they sent me a letter saying that I would get $X/month at age 65 or they would send me $Y and call it even.  What I did to decide if  $Y was fair was check how much it cost to buy an annuity that paid me $X/month for life starting at age 65 (I found some company selling annuities that would quote it online).  The annuity turned out to cost approximately $Y, so I decided to take the money and roll it over into an IRA.  I didn't actually buy an annuity for the same reasons that your financial planner is telling you.

So IMHO your planner is probably right so long you don't spend the money on cars or car parts.  Also, again IMHO, if you don't care about investing, just put the money in Vanguard's Total Stock Market fund (VTSAX).  Or the Canadian equivalent; sorry I am ignorant of investing and retirement in Canada.

Pensions are typically calculated on a 4-6% rate of return. An S&P500 index will average 8-10%. Leaving it in the pension is a net loss over time. 
 

When you die, the pension dies with you or maybe your spouse receives some benefits, after that it's typically done. So you lose whatever was not paid out. By taking the roll over or buy out, the money goes to your heirs. 

mtn said:

I would be putting pencil to paper and running the various possible scenarios. It definitely isn't a universal answer, but I tend to agree with your financial guy (but keep in mind depending on his fee structure he's likely also looking out for himself here).  

 

My gut reaction is to say if the expected annual pension benefit divided by .04 is in the same ballpark or less than the cashout value, do it. So if the expected annual pension is $25k, 25000/.04=625,000. So if the cashout value is around $575k or higher, I'd be taking it. But I'd play around with it, .04 is a pretty standard safe withdrawal rate. So go higher and lower, run more than just one equation. 
 

I am assuming you work for a public school. I don't know what it is like in Canada/BC, but coming from Illinois I would want to get my money in my hands so that I'm not at the mercy of politicians deciding to change, delay, or reduce the benefits. 
 

Additionally, they (the folks running the pension fund) are going to have a much different risk profile than I am. They're looking out for thousands of pensioners. I'm looking out for me. I may be able to take on significantly more risk for a better return. It also eases up the uncertainty on if you pass before your wife.

Quoting this to make sure it's done.  The math is the important part.  A good financial planner will run various scenarios to show you that you can do better with one version over the other.

Basically, you need to look at your scheduled pay out as the system giving you both returns and depleting the investment.  And then compare that with the lump sum that you will get with a nominal return- and the 4% that mtn points out is a good, conservative, estimate.  

The other question is when you would need the money.  If you are already 59.5, this is irrelevant.  But if you are younger, the natural thing to do with the pension lump sum is to put it into an IRA, which you can't access without penalty until you are 59.5.  This is different than a 401k that you can access if you get to some full requirement prior to that.

One last thing is IF the healthcare and pension are coupled.  Mine are not- I could take the lump sum and still get healthcare benefits.

Since you are on your own, you also need to make sure you have access to funds to invest in.  Which are generally going to be no load index funds.  It's not that shocking that KISS index funds are as good or better than the active funds.  The part you would need to research is a distribution of funds that meets your requirements going forward.

Just remembered one more thing- how healthy are you?  I don't mean to be morbid, but how long do you expect to live once you start retirement?  And compare that with the no-interest assumption of taking the lump sum and dividing that by the pension benefit.  If you are not in good health, and will probably pass before *that*, you are far better off taking the lump sum so you have more money to use.  

The number of people I know that died quickly after retirement is pretty astonishing.  And by quickly, I mean less than 10 years.

I think much of it comes down to risk tolerance, expected lifespan and survivor benefits. I'd guess that a BC school pension is about as guaranteed as they get these days, but if you're invested in a segment of the market that crashes, you might not be in a poor position. Similarly if one doesn't expect to live long, has no spouse or if the pension has poor survivor benefits for the spouse, then the payout is good to have something left for the family.

Financial planners make money off you investing with them, so they have self interest in convincing you to invest with them. Keep that in mind as they may over estimate returns and gloss over the risks. Not saying that they're trying to scam you, just something to keep in mind, plus be sure to factor in their fees into the calculations.

Lots of excellent advise here, but you need to have your financial advisor quantify the situation.  If you are still working and contributing to the pension plan with some sort of match I would have a hard time saying no regardless of the option numbers.  But you need to ask what will my cash value be either way in 5 years.  What would the minimum distribution for an IRA be either way. Also how would the financial planner recommend doing with the money and how will this affect my taxes this year.

Sorry for being brutally honest but you need to learn for yourself about money management.  You are at an age where you probably have more money than ever and have no idea how to make it grow in the future.  Or maybe what you will need in 10-20 years.  It isn't hard, read some books and take notes on the confusing parts.  Take them to the planner and ask them to explain.  Or your banker.  A good banker will have some advisors on staff who should help even if they don't get your IRA, etc account management.

Maybe not relevant but the wife is close to filing for social security.  She is 65 but the FRA(full retirement age, look it up if you dont know) is in a few months.  I did a spreadsheet showing a total dollars received until she would be 90 if she filed this month or at FRA.  She was surprised how little the difference was, but being a cheapskate still wants to go to FRA.  But now she understands.

Had my pension buyout offer from AutoTrader been anything more than a laughable joke, I would have taken it. I'm gambling that I live a lot longer than the couple grand they threw at me to go away.

RX8driver said:

.....Financial planners make money off you investing with them, so they have self interest in convincing you to invest with them. Keep that in mind as they may over estimate returns and gloss over the risks. Not saying that they're trying to scam you, just something to keep in mind, plus be sure to factor in their fees into the calculations.

Important note here: this ONLY if they are not a fiduciary.  It's generally pretty easy to tell.  If you are not paying them a general fee (say yearly), for their services, then they probably are not.  Fiduciaries do not make money off of stock trades, their purpose is to give financial advice that is completely uncoupled from your gains / looses.

In other words, figure out if this person is a fiduciary (you can just ask).  If they are not, be very suspicious of their motivations. E.g. annuities are not a great idea for most (guaranteed, but lots of overhead costs) but financial advisors (non-fiduciaries) will push them because they make good money selling them.

One other comment about beneficiaries- they don't have to be people if you take the lump sum.  They have to be if it's a pension.  So IF you pass early- the pension holder makes money- even if you have a beneficiary- that's a reduced amount compared to what you get.  If you have the lump sum, you get to decide what happens with the remainder of the funds when you pass.

I'd rather give someone the rest of my money when I pass than let the pension company keep the remainder of the annuity.

In reply to aircooled :

Ken Fisher (founder of Fisher Investments) has a TV commercial where he says "I'd die and go to hell before I'd sell you an annuity".

He goes on to say "there's absolutely nothing an annuity can do that other investment instruments can't do better".

I totally agree with Mr. Fisher...the only way I could possibly justify an annuity would be if my portfolio was far larger than I needed.

In my mind all aspirations can be placed into one of two categories (comfort and safety)...it's possible to be completely comfortable and once you're there, the only logical direction to throw additional resources towards is safety.

For example, a five million dollar retirement portfolio may meet your objectives and you literally couldn't think of what to do with more than a ten million dollar portfolio but you wound up with a fifteen million dollar portfolio...OK, at that point, it makes sense to throw some of that last five million at an annuity since you have no need for it anyway.  

In reply to BoxheadTim :

I believe I know the generalities of Mr Wellwood's pension. As a teacher he's on the Bc Municipal Pension Plan. The plan is defined benefit, fully indexed, and has survivor benefits, there's extended health benefits but there has been a reduction of extended health for survivors.

My father was on the plan and my mother received the pension for 28 years after his passing. My sister is on the same pension now and she has no complaints.

Good discussion up here, and I finally wanted to throw some additional thoughts in there.

First, one concern I have is that you would be going from a defined benefit (the pension) to a defined contribution (the commuted value). This can potentially add risk or mitigate risk. It would be the former if the company is stable and the pension fund is well run, and the latter if one or both of these statements aren't true. If we're talking about a well run, stable pension fund then it's not that likely that you can generate the same return on the money that the pension fund can, for the same risk profile. That's because the pension fund can invest with a longer time horizon and thus accept more risk overall, at least if it's still taking on new members and thus isn't look at a cliff where all the contributions dry up all of a sudden and they're switching into distribution-only mode as the latter requires very conservative investments.

Second, how close are you to retirement age? If you're either very far away or very close, the math changes a bit compared to when you're grinding away in your 40s and 50s. If you're very close to your retirement age, you could theoretically (in the US, not sure what the Canadian equivalent is) check what the monthly payout from an immediate payout annuity would be if you took the whole commuted value and dumped it in there. Not say that you should, but it's an easy way to determine if the expected pension payout is realistically achievable with low risk investments as that's pretty much all an immediate payout annuity can be invested in. As an aside, I would generally avoid any other kind of annuity as they tend to be a good deal for the person and company who is selling it to you.

If you're very early in your career, you can take a much higher risk than later on, so there is a chance you can actually reach the goals your financial advisor has talked about.

In either case, if you are planning to receive the commuted value, check a) if there are any tax implications and b) have a very close look at what products the financial planner is recommending as investment vehicles. Unfortunately at least here in the US, at least some financial planners have been known to peddle products as suitable that I wouldn't let anywhere near our septic tank, let alone our portfolio. If they're trying to sell you on annuities, products with "downside protection" that have limited upside as a result and potentially even managed funds, I'd politely decline. If however they suggest some investments that are in a bunch of low-cost index funds, it's certainly worth a second look.

The last part is psychological. With a pension, you basically don't have to (or shouldn't have to) worry about how it is invested and what the stock market is doing. How nervous do you get if the stock market does market things if you or your financial planner are in control of the investments?

Rons said:

In reply to BoxheadTim :

I believe I know the generalities of Mr Wellwood's pension. As a teacher he's on the Bc Municipal Pension Plan. The plan is defined benefit, fully indexed, and has survivor benefits, there's extended health benefits but there has been a reduction of extended health for survivors.

My father was on the plan and my mother received the pension for 28 years after his passing. My sister is on the same pension now and she has no complaints.

If it's that kind of plan, I personally would stay in there and not futz around with taking the money and trying to have a go myself. And I say this as a pretty dedicated DIY investor.

I'm 61, about to retire, and had this very discussion with my money guy today. He immediately said he didn't recommend it, and did some very quick calculations to back it up. He also said it's really hard to beat the security of guaranteed money and the fact that it continues after your death to your spouse.

I'm good at making money and saving it, but I'm no investor. So I'm very lucky to have this guy only because of an internal connection in the bank. He's not a bank branch investment planner, but a specialist at Nesbitt Burns, that deals only with the wealthy and I trust his judgment

Ask to see the numbers.

I appreciate the comments and input.

I like my financial planner, he's done really well for us.

As mentioned, I certainly am on the BC Teacher's Pension Plan, which has historically done really well.  There is something to be said about the stability of sticking with it.  My "gut feeling" about pulling out is not a good one, and when I don't listen to my gut feelings, I usually regret it.

I'm liking the "set it and forget it" of just leaving it alone; the hydraulic lifters of retirement funding.

Thanks again!