Every day people that are soon to retire must tell their employer if they want to receive a lump sum for all their years of service or a lifetime annuity. This is a complex decision and one that once made can't be reversed. They often enlist the services of advisors to help them make this decision and it comes as no surprise to me that these advisors which have an ulterior motive advise the soon to be retired that a lump sum distribution is the favorable route. In fact according to the Society of Actuaries almost 90% of people when faced with this choice choose the lump sum. I have not found this to be the case for people that I have advised. I often find that people should not take the lump sum.
Let's look at some numbers and use some common sense. What people want to know is can they generate the same level of income for the rest of their lives from their lump sum as they can from a monthly pension. The answer lies in how long will you live and how good are you as an investor. If you are in poor health and longevity is not on your horizon you of course take the lump sum. If you are a good investor you also take the lump sum because in all likelihood you have saved and invested enough money outside of your company pension plan to recognize yourself as a good investor. In this case the lump sum is just the icing on the cake. The question is now more refined. The question then becomes, should I take a lump sum or a monthly income if I am in good health, I expect to live a long life and I am not a good investor. In this case I invariably advise that the person take the monthly income option.
Why don't I go through the elaborate financial calculations that match up a person's expected chance to live to age 70, 75, 80, 85, 90, 95 etc. with the projected rates of return from portfolios that have different levels of risk? I don't do it because it's just numbers. The numbers are a technique to disguise the advisors desire to generate income for themselves. The numbers are used to deceive. The reality is that if someone hasn't saved money by the time they reach retirement age and established the habit of saving and investing you aren't going to do it now. They are certainly not going to be a good investor either. The culprits are always the same. They overspent, invested too conservatively and now the cost of living has exceeded what their portfolio can produce or they invested too aggressively and due to bad timing have lost money they can no longer recover. If you reach retirement age and have no other investments I suggest you take the pension and forget the fancy numbers.
I have mentioned my Tio Segundo in An Unexpected Tale. He was very wise and as a practicing attorney in Cuba he had seen much. One day we are talking about life insurance and how much is an appropriate amount for a husband to leave his wife and family. Tio Segundo was still of the era where the husband made the income and the wife stayed at home which is why the question was framed the way it was. I apologize to the ladies if I sound chauvinistic. Nevertheless, since these tales are about a collective wisdom that has been passed down through generations and massaged by my interpretation I think what he had to say applies in the lump sum vs. pension analysis. He said that he would advise his clients to purchase sufficient death benefit so that the wife could if she was good at managing money survive. As he said and I remember the numbers like it was yesterday. "If you leave $100,000 and your wife can't survive she will just as surely be unable to survive if you leave her five times as much." His point was well taken and applies to the lump sum scenario. If you have been unsuccessful managing your money up to the point of retirement what makes you think you will succeed now. Take the pension unless you have a history of success.
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Carlos M. Sera, Principal and Co-Founder of Chicago Wealth Management, currently resides in Maryland and has developed a unique way of explaining complicated investment topics to his clients and friends. For a sampling of other tales you can visit www.financialtales.com.
