Q: I have been offered a $318,000 settlement from my ex-employer. The money is from a retirement profit sharing plan that has been frozen. I now receive a monthly check of about $2,300. It was supposed to be for the life of both my wife and me. The surviving spouse would continue to receive the benefit, but nothing could be passed on to heirs. Now I am being offered the $318,000 lump sum. I would be able to roll this into an IRA. We owe about $90,000 on our home at a very low interest rate — 3.32 percent. We have no other debt. I pay off credit cards every month. My wife and I have a combined Social Security income of $3,600 a month. We also have IRAs of $80,000, $65,000 (inherited), $103,000, and a small Roth IRA of $6,000. My wife is 75 and I am 73. We have one son. He will probably need our support as long as we can provide it. So I am wondering, what would Scott do?
A: The best way to evaluate this offer is to find out how much it would cost, today, to buy a life annuity that would provide the same lifetime benefits — that $2,300 a month. If the benefit were a 100 percent joint-and-survivor annuity, as you say it is, that would be fairly unusual for a corporate pension. Most pension plans are pegged to offer a 50 percent or 75 percent benefit to the survivor, though some do offer a 100 percent option.
You can do this comparison by visiting the website immediateannuities.com. Once there, enter your age, your spouse’s age, your state, and the amount of monthly income you are seeking — $2,300 in this case. Press a button, and you’ll get a page of representative life annuity quotes with different terms.
Here’s what I found on a recent visit:
For a joint life income with 100 percent to survivor for people your age, a $2,300 monthly income would require a deposit of $384,000. If you wanted the same income, but just for your life, the cost would be $306,000. Since your company is offering $318,000, it’s pretty clear that they are hoping the cash will be worth enough that you will take a substantial discount to what your pension income is worth based on current interest rates used by insurance companies.
This isn’t an evil plot to cheat you. Your company, by law, must value its offer by an interest rate based on corporate bond yields. That yield is higher than the interest rate insurance companies are using on life annuities. In addition, the marketing costs for a group transaction are lower than the marketing costs for a single transaction. That’s why the company offer will be a smaller amount than you would need to replace the income if you had to buy it on your own, based on interest rates built into insurance company life annuity offers.
But none of that really matters. What’s important to you is very basic: You aren’t being given a good reason to take the lump sum. The stream of income payments is more useful to you than the lump sum payment. So you should stick with what you’ve got. Indeed, most people being offered buyouts will find that they are better off keeping the annuity. The exception? People in poor health.
You should also know that if many of your fellow retired employees opt for the cash payment, the security of your pension would increase. Why? Simple: The funding of your corporate pension plan will improve. The company will have reduced its payment liabilities more than it reduced its assets. That’s what your company is trying to do by making this offer. Funding improvement has been the experience of the many corporations that have been offering pension buyouts in the last six years.
Another advantage of keeping the life annuity is that it increases your guaranteed monthly cash flow. That will put a lot less pressure on you to withdraw money from your $254,000 in savings.
If your son is disabled, the best way to provide some level of future security for him is to explore what can be done, today, to build a workable low-income life support system for him. Meanwhile, use the higher income/higher value of your current income stream to help preserve your other assets for inheritance.
Questions about personal finance and investments may be sent by email to firstname.lastname@example.org. The website www.assetbuilder.com has comments on articles, referenced Web links and discussion of personal finance topics on forums. Questions of general interest will be answered in future columns and on the website.