Milliman’s John Ehrhardt was quoted in a recent Wall Street Journal article entitled “Should you take a lump-sum pension offer?” (subscription required). The article highlights one individual’s experience with a former employer’s lump-sum window.
Here’s an excerpt:
One of the simplest ways to evaluate a lump-sum offer is to find out the extent to which the money compensates you for the loss of your pension. I asked New York Life Insurance how much it would cost me today to buy a deferred annuity that will pay me $423 a month, starting in 14 years.
The answer: $45,896, which means my lump sum falls $13,808 short of what I would need to replicate my pension’s guaranteed income with an annuity.
Along the same lines, New York Life says my $32,088 lump sum will buy a monthly income of $296.13 starting at age 65, which is 30% less than my $423 pension benefit.
Of course, I can always invest my lump sum myself. But is it realistic to think that over the next 14 years I will be able to turn my $32,088 into $127,000? That is the amount I would need, starting at age 65, to generate $423 a month using the 4% withdrawal rate that long has been considered a “safe” level of spending over a 30-year retirement.
The answer: probably not, since I will need to earn 10.35% a year, net of investment fees. A portfolio evenly divided between U.S. large-cap stocks and bonds has returned 7.7% a year, on average, since 1926, according to investment-research firm Morningstar.
With a 7.7% annual return, my $32,088 would appreciate to $90,650 by the time I turn 65. Applying the 4% rule yields an initial monthly withdrawal of $302 that, with annual inflation adjustments of 2%, would grow to $423 by the time I am about 82.
…”It’s important to find out whether there are benefits or features that are available to you with the pension that you’d leave on the table if you take the lump sum,” says John Ehrhardt, principal at actuarial consulting firm Milliman.