Reader Question: My former employer has offered a $73K + lump sum payment by Dec., 2014. Otherwise I could elect monthly payments of $530 @ age 65, or $460 to begin Dec, 2014. I am 63 years old in good health. Also how would you suggest investing the lump sum amount?
Answer: First, let’s tackle the choice between taking a lump sum versus taking lifetime payments. My associate Foster Hyde, CFP®, who is also a candidate for the Chartered Financial Analyst designation, had these observations: “Comparing the two fixed payment options, if you can afford to delay the income for a year, consider choosing the $530/month option. That is a guaranteed 15% increase in monthly benefit just for waiting one year. According to the Social Security actuarial table, your life expectancy is age 84. The $530/month payment would be roughly equivalent to a 5.8% internal rate of return on the $73,000. For every year longer that you live, this return increases. If you were to take the lump sum and invest in a portfolio of 60% stocks and 40% bonds, we believe that a 4% withdrawal rate would be considered a safe amount to withdraw from the portfolio each year. However, that would only be $243/month, but projected to grow with inflation.”
A lot of people eventually face a decision like this gentleman. At first glance, it appears taking the monthly income is the best choice since it produces the most monthly cash flow. But there are a number of related issues you must consider:
- Life expectancy. If you are in excellent health and have a family history of longevity, this tends to favor choosing lifetime payments. Less than excellent health or a poor family health history will favor taking a lump sum.
- Spousal situation. If you are married, be sure to consider the needs of your spouse should he or she survive you. In many cases, your best choice is to choose a ‘joint life’ payment plan. For example, you choose a lower monthly benefit but it lasts as long as either you or your wife lives. Again, current health and family health history of both spouses should be considered. For example, say your health is poor but your spouse’s health is excellent, a good choice might be joint life payments because one or both of you are likely to live beyond life expectancy.
- Money for heirs. If you choose lifetime monthly payments, at death, there will be nothing left for your heirs. We have found a lot of people want to leave money to their children and would rather take a smaller monthly income in the hope of preserving principal for heirs.
- Emergencies. If you take a lifetime income and have a need for access to capital, say for health reasons, this money will not be available.
- Return risks. Lifetime income means just that…an income that will last as long as you do. Choosing a lifetime income means that you are transferring market risks to the insurance company. On the other hand, had you taken the lump sum and invested well, your nest egg could grow into something much bigger.
- Inflation risks. Most lifetime payment options are not adjusted for inflation so that ten or twenty years from now the purchasing power of the monthly income you are receiving will have diminished…perhaps by a lot.
- Other resources. You don’t want to make this decision in a vacuum. Consider all of your other financial resources. For example, if Social Security payments cover your basic monthly expenses you may want to choose lump sum so that you have a source of capital for emergencies and money for heirs.
This decision is very important and has long-term consequences so you’ll want to get it right. I strongly recommend that you meet with an experienced Certified Financial Planner practitioner to help you thoroughly weigh all the personal factors in your case. This is the type of analysis that planners do on a regular basis.