I would like to discuss one of the biggest decisions you will have to make when you retire. Should you take your cooperative's monthly pension or should you take the lump sum?
Deciding between the monthly pension or the lump sum option is one of the most critical decisions of your financial life! Most importantly, it's a decision that can't be corrected later! Once you sign the papers, that's it. Sometimes the monthly pension is the right choice and sometimes it can be the single most devastating decision you can make for your retirement. Let's look at the options:
What is a lifetime pension annuity offer?
A lifetime pension annuity offer is a monthly payment based on a percentage of your income history, current interest rates, and years of service. The payment will continue for your entire life or your spouse's life or for a certain time period or... a combination of any of these. See my blog on annuity payment options in plain English here.
What is a lump sum offer?
The lump sum distribution is a one-time payment from NRECA. You gain access to a large sum of money by taking a lump sum payment which you can then spend or invest as you see fit.
The thing I like to emphasize to potential clients about the lump sum offer is the flexibility and control that comes with taking this option. A 30 year retirement means more than likely facing many surprises with which a flat monthly payment isn't going to help.
The lump sum option, invested properly, offers flexibility to meet those surprises, can be strategically invested to provide regular income, and most importantly could possibly change the lives of the loved ones you leave behind.
Which option is the better deal?
It depends on your unique financial situation, but if you look at your options mathematically you can figure this out pretty easily. Start by asking if the monthly annuity option passes the 6% test.
What do I mean when I say pass the 6% test? If your monthly pension offer from your employer is 6% or more of the lump sum then it may be worth considering. If it’s below 6%, then you can likely do just as well (or better) by taking the lump sum and working with a financial advisor to invest the money strategically, and then paying yourself a salary from the lump sum amount. This allows you to create your own personal pension that you control.
Ex. Let's say you were given the choice of taking a $7,000 per month annuity or a $1,700,000 lump sum.
Here’s how the math works:
Take your monthly pension offer and multiply it by 12, then divide by the lump sum offer.
Example: $7,000 a month for life beginning at age 65 or a $1,700,000 lump sum today? $7,000 x 12 = $84,000. $84,000 divided by $1,700,000 equals = 4.9%
In this example, by accepting the life only annuity you are getting a return on your money of approximately 4.9%.
Keep in mind that what a monthly pension annuity is doing is just paying you back your money. If you took the lump sum option of $1,700,000 instead and transferred it to an IRA and worked with an advisor you could still and withdraw 4.9% per year you could create the same salary of $7,000 per month for the next 20 years and still have a balance of $1,700,000 when you pass. Read this again and again until it sinks in.
I use 6% because stock/equity investments have historically yielded 10% per year since the inception of the market. Inflation has averaged around 3% a year. That gives a return net, including inflation, of 7%. (10-3=7).
Which should you choose?
If we are just looking at this from a math perspective then, in this example, taking the lump sum would be the best choice. However, retirement isn't just a math problem and the choice will be dependent upon your unique financial circumstances. We can help you decide which is better for you based on your retirement goals.
At 80/20 Financial Services we create and manage retirement income and investment plans for electric cooperative retirees to ensure your 401k and R&S lump sum pension lasts the duration of a 20-30 year retirement and beyond.
As humans, we worry about many decisions in our lives but almost all the decisions we worry about can be undone. Even if we choose wrong, we can fix it later. When choosing between the monthly pension and lump sum offer this is NOT the case. You can't change your mind later. You can't undo the decision.
At 80/20 Financial Services, in almost every situation, we believe that you, not the company you worked for, should be in control of your money. In the current interest rate environment there are very few instances where taking the monthly pension annuity makes sense. With the lump sum amount you have control, flexibility, options and security. You have control of your money and can make your own salary, flexibility in case of emergency or other financial needs, the option to leave a legacy to your heirs or to your favorite charity and you have security knowing that all of your money is in YOUR Individual Retirement Account (IRA).
You need a plan
At 80/20 Financial Services, we are retirement planners and we specialize in working with electric cooperative employees. We can help you answer questions like:
I started this firm specifically to help electric cooperative employees with retirement planning. I worked for an electric cooperative for 11 years and I know your profession and benefit plans better than any other financial advisor will. You have excellent retirement benefits available to you. I can help you maximize those benefits while creating a retirement income and investing plan that aligns with your retirement goals.
Contact us to set up a consultation. The consultation is free and without obligation.
Thanks for reading!
80/20 Financial Services is an Independent Registered Investment Advisor (RIA) registered in the state of Missouri (CRD# 300772). We help electric cooperative employees in Missouri and throughout the United States transition into retirement. Being independent allows us to work exclusively for YOU.
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