The recent news that GM and Ford employees – at least the non-union ones – have been offered a buyout of their pensions (instead of getting income for life, they can take a lump sum right now, and do what they want with it) has put me to work.
I won't describe the work, which would be tedious, but the concept applies to a lot of us who are retired or thinking about it. A whole lot of people unaffiliated with an auto manufacturer have a similar choice to make.
Many pension plans offer a lump sum payout at retirement as a regular option. In addition, after the GM and Ford announcements, the buzz in the pension business has been that other employers will also make such offers.
And, even more intriguing, people who retire with a 401(k) or IRA or other similar plan that does not offer a guaranteed monthly benefit but does allow you to withdraw your money when you retire, actually offers a very similar choice, because you can buy an individual annuity that is practically just like a pension. Or you can buy an annuity with money you have in the bank or in the stock market, converting it to guaranteed lifetime income.
So the reality is, a lot of us face this kind choice when we retire, and often after we retire: Big Money Now, or Small Money Forever. Which should it be?
Almost always, when it comes to retirement, the correct answer is: it depends. In this case it depends on how much other guaranteed income you already have, how much else you have in liquid assets, what your current and future expenses are likely to be, what your health and life expectancy are, whether you have a spouse or other people who continue to need support from you (or will need it later), and also on your capacity and tolerance for financial risk, and on your discipline and knowledge in managing money (or willingness to pay someone else to do it for you). It also depends on the financial value of the lump sum vs. the guaranteed income (not all such choices are created equal). And it depends on who is guaranteeing the income: the government, an insurance company, an employer?
But not to cop out, I would also say that in normal times, I'd recommend that most people not give up a guaranteed pension for a lump sum, but in today’s environment, it may well be best if they do.
In normal times, the choice between taking a fairly priced lump sum or a fairly priced lifetime income tilts toward the guaranteed income, for most people at risk of running out of money if they live into their 90s or beyond. A lump sum is not likely to last that long, while a guaranteed income is good no matter how long you live. Of course, you "lose" if you die ahead of your normal life expectancy, but in that case your real loss is that you died – compared to that, your finances don't matter so much. So unless you need to provide for others after you're gone (and often even if you do), the guaranteed income is usually the prudent bet.
All the more so when you consider that having a big pot of money in a bank or investment account can be too big a temptation for spending (or for family members to ask for "loans" which will probably never be repaid). Or you might lose some of it in unfortunate investments.
So what's different today? You might have a chance to have your cake, and eat it, too. That's because interest rates are mostly now at or very near their all-time lows. When rates are high, guarantors of future income can lock them in, which means that a larger portion of your future income derives from the interest rather than the principal. And in turn, that means that the lump sum equivalent is lower. Conversely, when interest rates are low, the lump sum equivalent has to be higher. So now, when rates are so low, it's a great time to "buy" a lump sum.
Although nothing is certain, it is highly likely that sometime in the next several years, and maybe in the next two or three years if the economy starts picking up at a better pace, interest rates will return to normal levels again. At that point, you can keep the lump sum, if you feel that it's working for you, or if you then have health issues and your life expectancy is short. Or you can "sell" the lump sum and “buy” a guaranteed income at a better price by purchasing a lifetime income (i.e., an annuity) from an insurance company.
Even if you spent part of the lump sum to cover the guaranteed income you gave up, you would probably come out well ahead – that is, with a higher guaranteed income after you buy the annuity than you had (or were being offered) before. That's partly the effect of a rebound in interest rates, and partly the effect of being older then than you are now. The older you are when you buy an annuity, the shorter time you are expected to live afterwards, and so the higher the monthly income that the insurer will pay.
Even so, the right answer remains: it depends. This is all just an idea, not a recommendation. Take it for what it's worth.
Chuck Yanikoski is a part-time retirement adviser who lives and works in Harvard. For more about him, or to contact him directly, visit www.ChuckYRetirement.com.