Show Notes

• (00:49) Should I Take My Pension as a Lump Sum or Monthly Annuity Payments? (Nick, Moreno Valley, CA – video)
• (08:36) Retirement Pension Spitball Analysis: Let It Ride, Roll, Or Annuitize? (Randy, WI)
• (16:36) Retirement Pension: Lump Sum or Annuity? (Cathy)
• (26:00) Pension Options: 10 Year Period Certain or Joint With Rights of Survivorship (JWROS)? (James, AZ)
• (37:23) Should I Move My Pension to an Investment Plan? (Brandon, Ft Myers, FL)
• (46:35) How to Pay Grandma for Daycare and Minimize Tax on Her Pension: Lump Sump or Monthly Payments? (Mike, DC)
• (51:00) Listener Comments

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Transcription

As we approach the end of the year, some of you are thinking about retiring, and you’re considering your pension options: should you take that pension all at once in a lump sum, or spread it out over monthly payments? Maybe your lump sum option requires moving your pension to an investment plan – should you do it? Or maybe your pension doesn’t offer a lump sum at all but a choice between 10-year period certain and joint with rights of survivorship instead – then what? Joe and Big Al have spitballed on all of these variables before, and today we’re compiling all of those discussions into Your Money, Your Wealth® podcast episode #354 to help you make your own pension choices. Visit YourMoneyYourWealth.com and click Ask Joe and Al On Air to send in your money questions. I’m producer Andi Last, and here are the hosts of Your Money, Your Wealth®, Joe Anderson, CFP® and Big Al Clopine, CPA.

Should I Take My Pension as a Lump Sum or Monthly Annuity Payments? (Nick, Moreno Valley, CA)

Joe: Nick, from Moreno Valley, California. “I am 54 and plan to retire to the Philippines in January 2020. Total monthly income needed to start is $4,000. We will have no mortgage when I retire. Currently all will be sold at a gain of $80,000 to pay out of home in Philippines and money left to purchase car and build a vacation home.” Holy buckets! You can pay off your home, buy a car and a build a vacation home for 80 grand.

Al: Yeah, I like it.

Joe: Okay. “My pension starts at” let’s call it $2,000 a month with 50% survivor-

Andi: At age 55.

Joe: We will start withdrawing 3% from 401(k) with 3% inflation, or wait two more years and get $2,400 a month from pension and withdraw $4,000 a year from the 401(k) for two years. We will claim Social Security at 65, $3,000 a month.” What’s your question, Nick? “We have $550,000 in 401(k) $120,000 in Roth, $12,000 in an IRA $120,000 in brokerage accounts, $8,000 savings bond, $14,000 in a Philippine mutual fund, $75,000 emergency funds.” Man you’re doing pretty good, Nick. “40/60 split. My question-” Thank God. Here it is. “Is should I do an annuity pension or lump sum?” So let me see. “The total amount after retirement is $380,000 at 55 before -.” Well what’s the pension amount? Does he even give us – how am I going to answer your question Nick when I don’t have the annuity amount?

Al: Maybe that’s the 380 if you keep reading.

Joe: “The total amount after retirement it’s $380,000 at 55 or $420,000 if I wait two years before I start pension.”

Al: That’s the lump sum, and the pension you already read. It’s $1,900 at age 55, and if he waits two more years it’s $2,400. I think.

Joe: Oh, okay. So there are a few ways to try to figure this thing out. There has to be a couple variables. Life expectancy is the biggest. Because when you have a standard pension, most people will have options. And Nick has options, and it’ll be all right, “would you like a lump sum. We’ll cut you a check right now.” In his case, it was about $380,000 lump sum and his annuity or income payment,

he could either take the $380,000 or they say, “you know what, we’ll keep the $380,000, we’ll pay you $1,900 a month for the rest of your life.” OK, so that sounds pretty good. The other option is that he’s going to wait two years and say, “I’m gonna take $420,000 versus the $380,000, or I will get $2,400 per month for the rest of my life.” So what Nick needs to do, is he needs to figure out what the internal rate of return is on that cash flow stream. Because then he can compare. Because I would say Al, I don’t know, maybe 10-15 years ago with pension plans, the internal rate of returns were quite high, so it would make zero sense to take the lump sum, because either the government or the employer or whatever, is giving you such a high payment that it would be almost impossible for you to take the lump sum and try to replicate that income stream. And if it’s “guaranteed” by that organization, well you know those are a lot of positives. However, what has happened today is that the amount of payment versus lump sum has slowly gone down. Because A), a lot of these companies can’t afford these pension plans. Before they did some terrible actuarial tables of figuring out they mismanaged. We had 2008, 2000, and all sorts of variety of things.

Al: Right, and fixed income has been really low for quite a while.

Joe: Right, so it’s like OK, I’m trying to get some income and then my interest rates on my bonds are one or two percent. So we did a little bit of math and the internal – and right now if you run this stuff to life expectancy age 85, I mean, it’s almost a break even. The companies are smart, they get this stuff too. They’re not going to favor one or the other. It’s like, “if you want this we’ll give it to you, if you want that we’ll give it to you.” There’s no really better deal in most cases. The better deal is going to be based on the individual to see how long they live. If they’re going to live a long time, then the annuity payment, that internal rate of return is going to increase. If they die, prematurely of course, then their internal rate of return is going to be a lot lower. And so what did we run, until age 95 with this gentleman?

Andi: Correct.

Joe: So let’s say if Nick lives until age 95, so that’s a 40 year life expectancy, his internal rate of return over that 40 years if he took the annuity payment was roughly 5%. So then Nick’s gotta make a decision to say, “well okay, I have a guaranteed fixed income for the rest of my life if that company is still around and that pension is still going to come to me.” So I guess that’s another risk.

Al: Yes, well plus it’s a 50 percent survivor.

Joe: And if he dies then the wife only gets 50 percent. At 5 percent what would you do, Al? Would you take the annuity or would you take the lump sum?

Al: Well, I would probably take the lump sum just to have more control over it I think.

Joe: I think so too. At 5? If it was 6 or 7, I would probably take the annuity.

Al: Yeah and I think the way that you described is the best in correct way to do it, but a lot of people don’t really know how to do that. Here’s a shortcut, just to give you an idea, is just take the monthly payments, in this case $1,900 multiplied by 12 to get the annual amount. Divide that into the lump sum and see what the distribution rate is. And if it’s 8% or higher, then maybe you might want to consider the payment stream. If it’s 6 percent or lower you might want to consider the lump sum. And it kind of depends, of course, all this is predicated on what your expectation is on life expectancy. And a lot of people tend to like to take the lump sum just because it’s a known thing. We don’t really know how long we’re going to live. And in this particular case, the numbers he gave us was 50 percent survivor, so this could all change if he passes and then his spouse only gets half of it.

Joe: Nicf has about, let’s see, five six seven, I don’t know, $800,000 already in liquid assets. He’s only looking to live off of $4,000 bucks – was that a month? And so it’s like OK, well I don’t know, you’re going to have Social Security of a couple thousand dollars. You know, it all depends on life expectancy and control. But I think the internal rate of return on the overall cash flow streams, the net present value, I guess, of what he’s going to receive from cash flows from that pension is decent. So it’s looking at risk at that point. Do I think I can beat 5% over 30-40 years in my portfolio? If I feel that I could do that then maybe you invest it yourself. If you say, you know, what 5% I’m happy with, if I got 5% for the rest my life, then take the pension.

Al: Right. And of course now, what if you think you’re going to live to 105?

Joe: Yeah, then you absolutely take the pension.

Al: Right. Cause it changes then. But we don’t know that, do we? At least most of us. You don’t know how long you’re going to live, do you?

Joe: No, I wish. No, I don’t wish I knew that. (laughs)

Retirement Pension Spitball Analysis: Let It Ride, Roll, Or Annuitize? (Randy, WI)

Joe: We have Randy. He writes in Alan. “Hello, YMYW team. I live in Wisconsin, drive a 2018 Chevy Colorado 4X4 pickup truck.” Yeah, you got to have a pickup truck in Wisconsin.

Al: You know, I think that’s the perfect vehicle for Wisconsin, don’t you?

Joe: Yeah, I think so.

Al: Take your dogs in the back and anything else that you want to-

Joe: Kegerator. Something like that.

Al: Kegerator? Well, I suppose.

Joe: He’s got a 6 year old beagle mix, Cooper, who is also a Packers fan.

Al: How do you know Cooper-?

Andi: Cooper’s a Packers fan?

Joe: That just shows you the intelligence of Packer fans, they’re beagles.

Al: The beagles are all rooting for the Packers.

Joe: Yeah, you know, since I am from Minnesota, I can say that.

Al: You understand it?

Joe: I do. All right. Is it hot? Is-

Al: It’s pretty hot.

Joe: She’s got a hot box today.

Al: She’s got the heat up for us.

Joe: Okay. “My wife and I-” just to keep us limber here.

Al: Yeah, right.

Joe: “My wife and I have a globally diversified, age-appropriate portfolio of Vanguard index funds and bond funds totaling $1,300,000. At this time, only $30,000 is in a Roth, with the remainder $1,270,000 in pre-tax money. We will convert some of that pre-tax money once my wife goes part-time. We have one year worth of expenses in savings. Since I’ve recently turned 55, I can roll over my $77,000 cash balance pension plan at a previous employer, which is currently guaranteeing a 3.79% interest rate. My wife is 58 and will go part-time till 62. We probably won’t draw on our retirement assets until I retire in 10 years at 65 and possibly defer our Social Security until 70. Our home will be paid off before I retire.” Sounds like Randy’s pretty dialed in here.

Al: I think he doesn’t really need our help, does he?

Joe: I don’t think so. “My option for the $77,000 cash balance pension plans are: do nothing and let it ride at 3.79% for up to the next 10 years, roll it over to my current IRA, or annuitize it now or in the next 10 years.” All right, so he’s got some options. So he’s got a cash balance pension plan that the previous employer gave him. And usually with those plans, you could take the lump sum, roll it into the IRA that he suggested, or he can take a lifetime income stream from it. And that’s what annuitize means.

Al: Right. Which is the same as any retirement plan. And annuitize is like you receive monthly payments generally for the rest of your life.

Joe: Right. You can have $100,000 lump sum or we’ll give you $2000 a year for the rest of your life.

Al: Whatever it is.

Joe: All right. “3.7-“ I’ll continue- “3.79% is a very good guaranteed return. I know over the long run, I’ll earn more in the stock market. The math tells me to roll it over. Am I nuts for wanting to take it out of the plan with that guaranteed return? What do I need to consider if I leave it in the cash balance pension plan? The previous employer is a strong financial company. I’d love to hear your spitball, back-of-the-napkin conversation on this. Your loyal follower, Randy.” OK, one thing Randy didn’t give us, Alan. What is the annuitization? Because he’s got two guarantees here, right? He’s going to get a 3.79% roll up on the overall pension that he’s receiving. So he could continue to keep it in the plan. He could roll it out into an IRA. Then he has no guarantees for the income later. So he’ll have to create the income on his own. Or he keeps it in the plan for the next 10 years at close to 4% guarantee and then annuitize it. But what I don’t know what the annuitization is. What’s the income tax?

Al: Yeah, right. So that- correct. So that would help us answer this question if we knew what the income was now- if he annuitized it now versus 10 years from now. We know what the lump sum is and we know what the rate of return is. So at least we’ve got part of the equation.

Joe: Right. The biggest.

Al: So based upon what we know, though, what would you- what’s your spitball analysis?

Joe: Well, it’s $77,000 out of $1,300,000.

Al: Yeah, I guess it’s not that big a deal.

Joe: You know what I mean? So I like- I would keep it in the plan and I would use that as a bond option because bonds are paying almost nothing. So- what is that? $77,000 into $1,300,000. So what, 5%? 6%?

Al: Yeah, you couldn’t do that in your head?

Joe: Sh- It’s early, Al. And this studio is like 200 degrees.

Al: Too hot to think.

Joe: Yes. And I’m telling you, I’m not good at math.

Al: It’s under 7%. It’s probably about 5%. Because if you take $70,000 into $1,000,000, that’s 7%, just to give you a little frame of reference.

Joe: Got it.

Al: So I agree with you, Joe. I think bonds are not paying very much right now and to get a guarantee of 3.79%, that’s pretty good.

Joe: Yep.

Al: So I think I would use this cash balance plan as part of my bond. Like, let’s say, for example, I wanted 70% stocks and 30% bonds. Well, this would be part of the bonds. And to make up the rest of the 30%, I would go into the rest of the portfolio.

Joe: Absolutely.

Al: And there’s no reason to create income right now, Randy, you don’t really need it. But 10 years from now or whenever you retire, it’s like, OK, well, let’s look at the options and make the best plan at that point based upon what the income stream is.

Joe: Right. Because the second phase of this, Randy is going to have to make another decision in 10 years to say, do I annuitize it in 10 years? So OK. Then you look at- oh, let’s see if you can do this in your head, Alan-

Al: What the monthly payment will be? Well the $77,000 will probably be $100,000-

Joe: It’s gonna grow to $110,000.

Al: Yeah, say $100,000. OK, $110,000 is what you get.

Joe: Right. So he’s going to have $110,000 in that cash balance plan in 10 years. So then you have to figure out, what is the annuitization rate? What are they going to give you from a pension?

Al: Probably be $5000 or $6000 a year. Wouldn’t you- if you had to guess?

Joe: Yeah, maybe-

Al: Something like that.

Joe: Maybe a little bit more than that, because-

Al: Because you’re getting return of capital.

Joe: You got it. So then you could add that on top of your Social Security and then that- little beer money, walking around money, something like that. The more guarantees that you have in retirement, depending on what the guaranteed rate they’re willing to give you is the key. So some things to ponder on, Randy. Hopefully you like that little spitball. And thanks for being a loyal follower. A follower. They’re following us.

Al: Apparently.

Joe: Kinda freaks me out.

Al: Do you ever have to look over your shoulder?

Joe: I will now, big Randy in his pickup truck with his beagle dog rooting for the Packers.

Andi: Chasing ya.

Is your pension plan safe? What happens if it’s underfunded? Check out Threats to Your Retirement Income, the YMYW TV episode on this very topic, along with other free pension resources, in the podcast show notes at YourMoneyYourWealth.com. For one-on-one guidance on making your pension choices, and for an in-depth financial plan specifically tailored to your retirement needs and goals, click Get an Assessment in the podcast show notes to schedule a no-cost, no obligation financial assessment at a time and date convenient for you. It’s a private video meeting between you and one of the experienced financial professionals on Joe and Big Al’s team at Pure Financial Advisors, and you can do it right from the comfort of your own home, wherever that might be. Click the link in the description of today’s episode in your podcast app to go to schedule your financial assessment and to access all our free financial resources.

Retirement Pension: Lump Sum or Annuity? (Cathy)

Joe: Cathy writes in, “Joe, Big Al, been listening to your show for a year or so now. Love it.” Love you, Cathy. “I’m 53 and single. I have a financial question for both of you. When I looked in my shoebox the other day, I found a pension account from a previous employer with $53,000. I could take a lump sum or alternatively, I could take a single-life annuity starting now for $200 a month. If I don’t do anything with it, it’s been growing interest, for example, 1.1% for the year 2021.” So she’s got a pension. She found it in the old shoebox, Al.

Al: Yeah, I’d say keep digging. What else you gonna find?

Joe: What else you got? Right?

Al: Right? Maybe some gold coins or something.

Joe: All right. 53. She takes it now. She could either take a lump sum. $53,000, roll that into an IRA or she could take $200 a month. She doesn’t do anything with it like it has been, it grows at a very low interest rate. 1.1% is what she’s thinking. “I don’t need this money now, but I may need to secure some basic income needs in the future. I like the idea I have an annuity to secure basic income needs. However, I’m not sure if this is a good idea. I calculated the monthly payment against the lump sum, which comes out to around 4.7% now. If I wait until 65 to take the annuity, it comes out to 6.2%. Since annuity gives me a lifetime income I compare it with the 4% withdrawal rule, and it looks better.” Well, yeah, the 4% burn rate is- ideally you don’t touch the principal. In the annuity, you’re touching principal and interest.

Al: Yeah, that is a difference, the 4% rule basically allows your lump sum or principal to grow. That’s the whole idea. So in other words, the payment is higher each year because it’s 4% of a higher number.

Joe: So you have $100,000. You’re taking $4000 out. And you’re anticipating, let’s say, the market 7 out of 10 years goes up. So let’s say it grows at 6% on average, you’re taking 4%, the 2% combats inflation and taxes. So at the end of the day, you still have the $100,000.

Al: And plus every year you get a raise.

Joe: Or you could get a demotion if the market goes down.

Al: You could in certain years. You bet.

Joe: “However, I’m still not sure about this since the balance earns a very low interest that is tied to some bond, seems losing money considering what the market’s done if I leave this account there untouched until 65.

What are your thoughts about this money? Should I take the lump sum and invest in an IRA or take the monthly payment or leave it there. Appreciate and love the show.” Um, OK. What do you think? Do you wanna take the lump sum or do you want it to- is there a follow-up email or what is this?

Andi: Yeah, that’s from Cathy as well.

Joe: Should I read the follow-up email?

Al: Yes. She’s got different options it looks like.

Joe: Oh great. “Hi. Forgot to detail the options that I can think about. Leave it there untouched. Ok, you’ve already said that. Let it grow to earn the low interest rate. Wait till retirement to take the single life annuity. Take the lump sum of $53,000 now and invest it in a target date fund deferred tax by rolling it to an IRA. For this option, do I lose access to the money before 59 and a half penalty-free? Take the money of $200 a month and invest it in a target-date fund, in a taxable account. Which one would you do? Any other suggestions you might have? Thank you.” All right. So-

Al: You’ve got 3 choices.

Joe: She waits until retirement. And so instead of taking the $208 at retirement, it’s something a lot higher than that. I don’t know what that number is.

Al: Well, let’s- I don’t know if she’s doing it on the $53,000. Let’s assume she is. $53,000, 6.2%. Divided by 12 months. That’d be $273 per month, roughly, maybe.

Joe: So she could take $208 now or $273 at 65.

Al: I think so. That’s what I’m guessing.

Joe: $53,000 now or $57,000 in the future. Something like that. If it’s growing at 1.1%, it’s tied to some bond index. We don’t know what that is.

Al: So what would you do if you were Cathy?

Joe: How old is she?

Al: 53.

Joe: And she could get $208 right now?

Al: Yep.

Joe: OK, $53,000. Do you think Kathy has longevity? Let’s assume she does.

Al: Yeah, I would say so. Sure.

Andi: She’s single. She doesn’t have a man in her life, so she’s probably got longevity.

Al: She probably would have told us otherwise because she’s liking the annuity.

Joe: If you have longevity, the annuity probably will work out for you. So let’s say you take the annuity now at $208 and let’s say she lives until age 95, which is, what, 40 years from now?

Al: Yeah, call it 40. 93?

Joe: OK, I’ll just go 40 years and she’s doing that a month and she gets 6%. Future value of that is $414,000. She’s single. I don’t know if she’s got kids, does she want to pass it? But she wants to spend the money so she’s not going to invest it. She’s going to invest in a target-date fund until she retires at age 65 you think?

Al: Or if she just takes the lump sum at 6% for 40 years, let’s see what she ends up with-

Andi: And she does want to know if she can access the money before 59 and a half penalty-free if she takes the lump sum.

Joe: No.

Al: She cannot.

Joe: It’s an IRA.

Al: $545,000 if she takes the lump sum at 6%.

Joe: OK, so she takes the lump sum and then she grows it at 6% until 93, it’s $540,000 versus the $208.

Al: In other words, or she takes the $208 and invests each of those payments. And the reason why-

Joe: Or you could reverse that and take the present value of that, the lump sum is going to be worth more.

Al: You could. You could.

Joe: So I could take $208 to age 93 and take the present value of that of some discount rate.

Al: And the reason why we’re ending up with the lump sum being better is we’re using 6%. Now if you’re going to put it in a CD and earn less than .1%, then you’re better off taking the annuity.

Joe: Yep.

Al: So me personally, I would take the lump sum. Because I think that over the long term that I could probably earn 6%, which would work that out to be a better deal. That’s me personally. Cathy, it depends upon your ability to invest and your ability to weather the ups and downs in the market and all that sort of thing.

Joe: Right. But if you like the idea of a fixed income stream, then that trumps it all.

Al: It does.

Joe: Because then you’re looking at what’s my internal rate of return on the $208,000 over-? Because there are variables that you don’t know. What’s your life expectancy? You take the annuity payment and all of a sudden you get hit by a bus in a couple of years. Well, you’re single, so you’re going to take the single life. And so now it’s gone. If you take the $53,000, you can at least pass it on. But if it’s only growing at that rate- usually the lump sum and the annuity payments is almost identical from an internal rate of return standpoint. So what we would look at is, what are the other fixed-income options or available fixed income sources? Do you have other pensions? Do you have- what’s your Social Security benefit? What is your other retirement accounts, non-retirement accounts? What’s your lifestyle? Things like that, to really dial it in. But if you want the fixed income and you like some beer money and, well, travel money or whatever, by all means, just make it simple. Just get the $200 a month and call it good. But then you get the $53,000 and I’ve got a target-date fund. I don’t know, you take some money out of there. The break-even on that without any growth is 21 years. So you put- just put $2500 into $53,000 is what, 21, 22 years.

Al: That’s true.

Joe: If you don’t grow the money at all. So you’re 55, so that’s 75.

Al: Another factor here is what’s your mentality on if you have $53,000. I know it’s in an IRA and it would be- you’d have to pay a penalty, but if you’re the kind of person that at 59 and a half, you’re liable to pull it out and spend it, then you might be better to take the annuity, protect yourself. If you’re the kind of person that’s like, well, I don’t really need it because I got Social Security or I have whatever then- and I can just let this grow, then I kind of like the lump sum, but that’s- But yeah, I agree, Joe. It’s kind of a personal thing. And it’s not- we’re not talking about a lot of dollars, so it’s a little bit more personal for what Cathy would like to do.

Joe: So here’s the internal rate of return, so if I got 208 times 12, $2500. And let’s say 42 years- discount rate inflation, call it, what, 3%. Present value is $59,000 versus the lump sum of $53,000. It’s almost identical.

Al: Yeah. As you said, it usually works out that way.

Joe: So whatever preference you want.

Pension Options: 10 Year Period Certain or Joint With Rights of Survivorship (JWROS)? (James, AZ)

Joe: Got James in neighboring Arizona. “Hello Joe-” Did you write ‘neighboring’? Who writes- ?

Andi: See how he signed the email?

Joe: Oh, James- sorry. I don’t read the emails, Andi.

Andi: I know. That’s why I’m telling you now.

Joe: When they’re hot off the press-

Al: So they’re fresh.

Joe: Fresh.

Al: Fresh in your mind.

Joe: Yeah. And that’s why it’s such an awful experience listening to me read aloud.

Al: People seem to like it. They binge listen.

Joe: I don’t know how. I can’t even listen to 7 seconds of this godawful mess. Oh man. Okay. “Hello Joe, Al and Andi. Thanks so much for your podcast. It really does help so many of us as we consider our retirement strategy. I’m a few years away from retirement and I would like to get your thoughts on how to handle my company pension option. The company froze our pension several years ago when they increased the 401(k) match. The pension does not have a lump sum payout option. And does not adjust for inflation. So there is no COLA. I’m thinking it might make the most sense to take the 10-year period certain option and go towards our early living expenses while we delay taking Social Security and allow our other investments to grow. When I retire at age 62, the pension options I’m looking at are as follows: 10-year period certain, $45,000 annually, $450,000 dollars total. Or joint with rights to Survivor. $18,500, so $18,500 annually with no cost of living. And this is at age 62.” Can you tell me Alan, what the present value is of $18,500, let’s say 62, 72, 82, let’s run 25 years and let’s run a discount rate of call it 4%.

Al: Okay. $289,000.

Joe: Okay. Wow. That’s it?

Al: Yeah. If it’s 5%, it’s $260,000. Yeah. It’s low. I mean if you just take $18,500 into 450 which you can’t really do. But that’s only at 4%.

Joe: So yeah. You look at the present- and what you want to do when you- there’s two ways to look at it I guess. Well, there’s multiple ways to look at this. So for those of you that have a lump sum pension option or an annual payment or in this case James from neighboring Arizona says I’ve got a 10-year period certain. What a 10-year period certain means is that he’s gonna get $45,000 a year and if he dies the next year the beneficiary is still going to get $45,000 until the10 years. Or a joint with rights to survivor is $18,500 that will pay for both lives. So if they live until 105, $18,500 is still going to come to the overall household. So if he’s getting a 10-year period certain of $45,000 with no COLA, 10 years, he’s going to receive $450,000 dollars as they add up over that 10 years. So what you kind of want to figure out is what is the present value or what is the internal rate of return.

Al: So I did that wrong.

Joe: Yeah that seemed way too-

Al: It’s actually the present value at 4% is $462,000.

Joe: Ok.

Al: $462,000.

Joe: Ok. So see what the company is doing here? It’s usually the same or very close to that. And that’s why Al and I are good team. Because I knew that was wrong and then he was like well wait a minute-

Al: I had that number in the future value button, I didn’t realize it.

Joe: Got it. Oh, you’ve got to clear out your calculator, Al.

Al: I know.

Joe: So $18,500 on an annual basis, then you look at what is the present value of that $18,500, so you can make an informed decision. So you’re making apples to apples. Because when people look at $45,000, $18,500, well $45,000 seems better. But wait a minute, you’re gonna get the $18,500 for that many more years, so what is the present value of that? You can use certain discount rates of whatever that you think that you could grow the money out or inflation is or you can make your own assumptions here depending on how aggressive or conservative that you are.

Al: If you think you can earn 6% then the present value is $308,000. So then maybe you just take the take the money, $45,000 a year and invest that 6%.

Joe: Right. So looking at- they use usually conservative discount rates. And so it’s usually the same. So $450,000 if you take the 10-year period certain or we’ll give you a joint with rights to survivor and if you live a normal life expectancy. Guess what? We’re going to be out roughly $450,000.

Al: That’s right. Same-same. We don’t care.

Joe: Same-same.

Al: That’s actually usually how all these are run, basically so it’s same-same for them.

Joe: Correct. So then you just want to make sure that you’re placing this income into your overall financial strategy so you don’t have to spend hours upon hours to decide, look at all these pension options we have. In most cases, unless someone’s has impaired life expectancy or someone that lives- you have ancestors that are still alive from the- I was going to say something, but I won’t- let’s say that you have a very long life expectancy or short life expectancy, then you can kind of play with your own financial plan to see what makes sense. So he’s got some other details here. Let’s see we don’t get a ton of time to go through all of this but he’s got some Social Security. He’s got the spousal benefit. And if they delay, it’s going to be around $50,000. Got a portfolio of about $3,000,000, mostly he’s got tax-deferred and $1,100,000 tax-free. Look at this guy. Look at James.

Al: Wonderful. Yeah, right?

Joe: He’s killing the game. He’s hoping to spend $165,000 annually. “Current plan is to pull from the tax-deferred to minimize the 12% tax bracket each year-

Andi: Maximize.

Joe- “- maximize and then pull the remainder from tax-free. I realize the tax brackets may change in the future. So this plan could change. Your general opinion would be appreciated.” All right. You know what? I’m going to spend a little bit of time here, Andi. Sorry to keep blowing up the clock.

Andi: Yep. No, go for it. It’s alright.

Joe: This is kind of the theme of today.

Andi: Blowing up the clock?

Al: Right. Yeah, that too.

Joe: The what?

Al/Andi: Blowing up the clock.

Joe: Yes blowing up the clock, too. So he’s gonna take $45,000 let’s say over the next 10 years that’s going to cover some of his living expenses. But let’s do this math again first. This is where people you always need to start. He wants to spend a $160,000 per year. And he is 62 years old? Yes he is. When I retire at 62. So he wants to spend $165,000 a year. So he’s going to receive Social Security of $50,000 at age 70. And then let’s see, Social Security 67, well 38, excludes spousal benefit, so let’s call it, I don’t know, $60,000 at full retirement age. So he needs $105,000. He needs $165,000 for about 4 or 5 years and then about $100,000 thereafter.

Al: I’ll agree.

Joe: He’s gonna take the pension option of $45,000 so really he needs $45,000, $50,000 from the portfolio, plus tax. You kind of with my math there?

Al: Yeah. $50,000, $60,000.

Joe: So if I look at $60,000 and if I divide that into $2,800,000-

Al: We get 2.1%.

Joe: So 2.1%. So it’s not bad. It looks pretty good.

Al: Yeah I agree. Good distribution rate.

Joe: Okay, so first step. Check. Check that box.

Al: I think when you’re retiring at 62 let’s just say, 4% is probably a little too rich. 3.5% is probably fine. 3% is better. 2% is great.

Joe: Yep. And so what he’s looking at doing here is that he’s got $600,000 outside of retirement accounts. He needs $50,000 a year. So he wants to take money from his retirement account to fill up the 12% tax bracket. So he could probably pull out $60,000 from the retirement account to keep him with the standard deduction.

Al: Well if you’re counting the $45,000, he’s already getting.

Joe: Minus $25,000. Yeah. And that’d get it up to $80,000.

Al: About, yeah about.

Joe: So $60,000 he’s pulling from retirement accounts, get him to the 12% and then so he’s pretty good just almost pulling money from the retirement accounts. But would you do that?

Al: No.

Joe: I wouldn’t either. Where you at? What are you thinking? What’s your strategy over the next, let’s just call it 5 years? What’s your 5-year plan for James?

Al: Let’s see, what would I do? 62. See my problem was I got sidetracked. I wasn’t really listening. You give me yours.

Joe: All right. I would not waste that 12% tax bracket on income. I would rather convert to the top of the 12% tax bracket. He has $600,000 that are sitting outside that he could live off of. So he’s got the $45,000 pension. I would take the non-qualified in cash to supplement my income. And then I would convert to the 12%. He’s got $1,100,000, I would convert that over the next couple of years. Then his RMDs are going gonna be fairly low and he’ll never ever touch anything higher than the 12% or 15% tax bracket for life. Because he’s going to push his Social Security out to age 70. And if he gets a little bit more money into the Roth, his Social Security could potentially be tax-free. And we’re talking almost $60,000 of Social Security benefit. So you would have to look at what the provisional income is going to be so I would forecast that out. Look at half your Social Security plus the interest or whatever distributions are coming out of your retirement accounts. That would be my play. I would still want to get more money into Roth because then thereafter you could be in the 0% tax bracket with $100,000 plus income.

Al: I think that makes sense to me too because when you’re able to get so much here converted then a lot of your Social Security will be tax-free as well, so you get a double benefit that way. And this is the case where you don’t have to go into the 22% bracket or 24% bracket because you got enough years to get enough out to still stay in the 12% the future. So yeah, I’m with you.

Joe: So yeah, pay just a little bit of tax, get a lot of money out. Thanks for the question, James. That was a good one.

Should I Move My Pension to an Investment Plan? (Brandon, Ft Myers, FL)

Joe: Brandon writes in. Fort Myers, Florida. Alan. “I e-mailed the show before, I guess my question was a bore. I thought it’d be funny. I need help with my money. Now maybe Al and Joe won’t ignore.” Wow.

Andi: I checked. I could not find any previous emails from Brandon, so I’m not sure what happened. It got lost in cyberspace or something.

Joe: Brandon, we didn’t get it. We answer questions here on Your Money, Your Wealth®. We don’t keep people behind. It’s like, someone gets shot. We don’t leave them behind. We grab them, pick them up, we put them in the helicopter.

Andi: I was trying to figure out where you’re going with that.

Joe: Watching a lot of war movies.

Al: I wasn’t sure either. But anyway, Brandon did write us a nice limerick, which seems to be a common theme of our show.

Joe: I don’t know.

Al: We didn’t ask for limericks, but they keep coming. ___ another format of poem that we’ll start getting.

Joe: “Joe, Big Al, thanks for all your podcast advice. I really enjoy listening to the show during my evening walks. I don’t own a dog. My wife and I are both 46. I am the main breadwinner. Combined, we’ll have substantial retirement savings at my age 55. My wife’s a school teacher with a fully vested pension. She is currently in year 21 out of 30. Her pension increases exponentially over the next 9 years. In other words, if she quits now, she would only receive $3400 per year versus $13,800 annually with 7 more years of work or $22,400 annually if she completes the entire 30 years. The Florida retirement system has a provision that allows for a one-time decision to move her pension to an investment plan. If we decide to take a lump sum distribution, which I intended on doing down the road, she would have to be in the investment plan to do this. I’m very leery on the information on the state website because I know deep down they want people to stay in the pension plan.” He knows this deep down. He just has a gut feeling.

Al: He does have a gut. He’s thinking big brother wants to keep the money. That’s what he’s thinking.

Joe: “See the options below that they are indicating with the assumption that she will retire after 30 years of service at age 55. Pension plan, annual benefit of $27,468.” So that’s option one. Take the annual benefit of $27,468 when she retires at age 55. “If you elect to enroll in the investment plan now, the estimated starting balance would be $130,000.” She’s 46, so she’s going to retire in 10 years. In 10 years, she’s going to get- call it $30,000 for life or she can roll now $150,000 into the investment plan. The $30,000 ln 10 years from now is no longer. But she’ll have $130,000 call it in 10 years from now. She’ll have a little under $300,000.

Al: Yeah, just double it to $260,000- ish. $300,000 Good enough.

Joe: OK, I’m rounding, Al. Rounding.

Al: I get it.

Joe: Got it.

Al: I’m giving some color as to how you got there.

Joe: Got it. Thank you for that color. “If you elect to enroll in the investment plan now, then terminate employment at 55 and start receiving benefit at age 55, the future value of your investment plan is estimated to be $244,000.” Oh, well, we did that just kind of back-of-the-envelope.

Al: Yeah, I got to $260,000. You got $300,000, rounded up.

Joe: So $250,000 is what they’re going to get. “If you elect to stay in the pension plan for the next 9 years and then just prior to leaving employment at age 55, change the investment plan, your estimated lump sum on the investment plan will be approximately $377,000.” OK. “I don’t understand how a pension plan is estimated to gain $133,000 more than the investment plan over the same 9 year period. Pension plans are highly regulated and typically don’t earn more than 5% to 7%. The investment plan assumption above, $244,000, is based on a default age-based retirement fund. I could obviously choose more riskier, higher performing mutual funds and probably come out better than $244,000. But even with a top performing mutual fund, I don’t see how I can get to $377,000 they are estimating if we stay in the pension until the last minute. What am I missing here? Thanks a bunch.” Well, what is Brandon missing here? Is it a magical rate of return that the state of Florida school system has? Do they got Warren Buffett there managing the money?

Al: He’s concerned about Big Brother. I think. He’s trying to figure out what their angle is.

Joe: Well, because he’s saying if he takes it out now, he’s going to get $250,000 if he takes a target date fund. If he keeps it in the plan, it’s going to be $377,000. So he’s taking the delta, the $350,000 versus- or $250,000 versus $377,000. It’s like I don’t get it. What’s the math? What are they doing? The pension plan can’t necessarily grow that much more than I could do on my own. So what’s the secret? What are they doing? The answer is, Brandon, is that there’s mortality credits or something that has to be involved here. Because it is a pension plan that is a pooled plan for many people. This is a guess. I have no idea. I’m just guessing.

Al: Wow. I was thinking I don’t know how to answer that one. You came up with something that sounded really good.

Andi: He’s a better BSer than you, Al.

Al: He is.

Joe: But this is logical to me.

Al: Yeah, that’s makes sense.

Joe: So some people live a long time. Some people die. Some people take the lump sum. And so let’s say if I take- I deserve $25,000 a year. I’m going to take the pension and my boy Brandon that we forgot to answer his question before, his wife is going to take the lump sum and we’re the same age and boom, I take $25,000 pension, single life, only me, and I die the next day, I get struck by lightning down in Florida playing golf. So where does the rest of the money go? They owe me $25,000, but I selected single life payment, right? I didn’t select a joint life. I didn’t select a period certain to make sure that it pays my beneficiaries out for the next 10 or 20 years. I picked a single life. I died. Where does all of my payments go? It goes back in the kitty. Goes back in the pool. It’s not going to get paid out because that was my election. It is a pension plan that you can elect to, say a single life, joint with rights to survivor, joint with rights to survivor with period certain. There’s all sorts of different types of ways that you can claim a pension income payment. And some people want the biggest bang for their buck and so they take a single life. If I took a joint with rights to survivor and if I died and it went to a beneficiary, it’s not going to be $30,000, there would be something lower than that because it’s based on two lives. So the annual benefit of $30,000, I die prematurely, that money goes back in the kitty. That is then distributed out to the other pension holders. That’s why they’re able to have a higher benefit if you hold on to that plan. I’m not working at the state of Florida. I don’t know what they’re doing in that. And I could be completely off base. But that is my best guess. We don’t give advice anyway here. We’re just shooting the you-know-what.

Al: Spit balling is what we call it. So I don’t know anything about this plan either. And every plan’s different. So it’s hard even for me to speculate. But I would say one of the basic considerations on taking a lump sum versus the pension is exactly what you said. If you take the pension, well, then it’s guaranteed for life. And that’s a pretty good thing, particularly if you live a long life. But if you live a short life, you didn’t really get much of anything. And if you took a single life, as you just mentioned, your spouse or your kids would be out of luck. On the other hand, if you take the lump sum, you know, you live long or short. The money is still there. But there’s reasons to take the pension. You know, sometimes the pension payouts are pretty good. Sometimes they’re indexed for inflation. Sometimes people are not very good at having a lump sum. They want to spend it. If that’s you, maybe a pension is better. So there’s different considerations. But the math on how they come up with all this, that’s very plan-specific. I don’t know in this case.

Joe: I think I nailed it.

Al: That’s possible.

It always comes down to taxes, whether you’re deciding between investments or withdrawal strategies or pension options. And y’know, just about any tax reduction strategies you want to implement for 2021 needs to be done before December 31st. That’s only a month away. Make sure all your ducks are in a row now – download our 2021 tax planning checklist from the podcast show notes at YourMoneyYourWealth.com for a list of action items to undertake now so you pay less tax when you file in April, as well as a helpful list of documents and information you’ll need when it comes time to file your taxes. Click the link in the description of today’s episode in your podcast app to go to the show notes, download the 2021 Tax Planning Checklist, and share the podcast and the free financial resources with your friends, family, colleagues, on social media – help out your friends, and help us spread the word about YMYW.

How to Pay Grandma for Daycare and Minimize Tax on Her Pension: Lump Sump or Monthly Payments? (Mike, DC)

Joe: We got Mike from DC calling in. He goes “Hey Joe and Al, big fan. Thanks for everything you guys do.” Well, thank you, Mike, for writing in. “I have a question about a pension plan for my mother-in-law. She’s planning to retire this Fall, age 55 soon to be 56, and move in with my wife and me to take care of our daughter instead of using daycare.” I don’t know. Mike?

Al: Are you going to give some personal advice?

Joe: I’m just saying.

Al: Do you have a –

Andi: This is where it becomes a lifestyle question?

Al: Do you have a concern already?

Joe: I do. It has nothing to do with the finances.

Al: Got it. I think I know what your concern might be.

Joe: I’m saying Mike, have you thought this one through? Oh boy. So, OK, let’s continue on here. “Her pension plan with CalPERS, California Public Employee Retirement System, is worth about $51,000. She doesn’t have any other savings besides this pension plan where she has been working for almost 15 years. My wife and I plan to pay her a monthly amount to take care of her granddaughter, day-to-day costs, and pay for her own expenses, phone, etc., when she moves in with us. What do you think is the ideal tax-avoiding approach in dealing with the pension plan? Do you suggest withdrawing the lump sum? About a 20% tax hit. Defer the payments to a later date, if possible? Or receive the pension monthly amounts when she retires? Is there another approach? Please let me know. Keep up the amazing work and look forward to your response.” So Mike’s looking out for mother-in-law, to having her move in, take care of the little granddaughter. Have another roommate.

Al: It sounds good on paper.

Joe: So good.

Al: Until you think about –

Joe: Look and it’s going to be great, grandma, because we can save you money in taxes.

Al: That’s right.

Joe: I’ll call Big Al –

Al: And we would pay daycare anyway. So just pay it to you.

Joe: Yeah, just pay it to you. Just makes a ton of sense.

Al: For the first week.

Joe: Yes, exactly. Mike, write back after a month. Let me know how everything is going. So what should grandma do here? Should she take the money and run? So if she gets $56,000 dollars, I’m assuming she’s single. So there’s going to be taxes. And at 55, she retires at 55. If she takes the pension as a lump sum –

Al: It’s worth $51,000 if she took it all, let’s say the year after she retired. So there is no salary whatsoever. $51,000 minus the standard deduction would put her in the 12% bracket. So that’s not too bad.

Joe: Plus, the state of California is probably 5, so that’s why he’s saying 20% tax hit.

Al: That’s probably about right.

Joe: So $10,000- So she walks away with $40,000.

Al: But she doesn’t necessarily need it all. So why not just take out what you need? She’ll be in a low bracket, really low bracket anyway.

Joe: Or roll it into an IRA without any type of tax hit whatsoever.

Al: It’s not like you have to worry about a big RMD. It’s not that big of an amount. And we don’t know what the payment stream is, so we can’t really evaluate whether she should take a payment stream or not.

But yeah, I think that’s right. You roll the $51,000, if that’s what the value is, into an IRA and take it out as you need it. And she’s going to be in a very low bracket anyway.

Joe: And at 55, she could probably take out, I don’t know, $150 a month. So I would look at what the pension is. So if there’s a guaranteed income higher than that, maybe you just take the pension because it’s not going to be a ton of money. But it’s something to – walking around money for sure. So, yeah, she needs to roll it and grow it. Because you’re going to kick her out and probably –

Al: Wait a minute, she’ll be 55, soon to be 56. She’ll probably live to 90. So this is a- what a 35 year process here.

Joe: But that’s the tax advice. Roll it into an IRA. There’s no tax. Then taken out when you need it and then you only pay tax on the distributions.

Al: Yep. Agreed.

Listener Comments

Joe: So we appreciate your comments. Got a couple new one stars, which are my favorite. Yeah, this guy goes “cashed out CalPERS pension. Are you guys insane?” So one star, he was very adamant that he thought we were crazy. We’re insane. “Enough said take the pension payment”. “A lifetime monthly annuity for probably another 40 years”. “40K rolled into an IRA is no way you’re going to provide her more to live off for her life.” Yeah, and I agree with that. I think did she have shortened life expectancy?

Al: I don’t know. I don’t remember the call.

Joe: I remember very little of it. But there was a reason why, I think we were saying that because she needed the cash to pay for some nursing home care. If I remember correctly anyway, I don’t know. Sorry about that. Yes. I mean, we’re spitballing in here. We’re not giving advice. Can I throw that caveat again? For all compliant purposes. Alan and I are just here chatting. We’re taking a break from our busy lives and trying to give you guys a little bit of insight into the financial planning world.

Al: Yeah, and the reason why it’s chatting and not advice is because we don’t have near enough information.

Joe: We don’t know any of you.

Al: We’re just going off what little we know from your questions and we don’t want you to write a five page question because it doesn’t work.

Joe: And we’re not going to read it.

Al: So keep your questions coming. The length is good. It’s just that we don’t have enough facts to give you a 100% answer with certainty.

Joe: We are fiduciaries.

Al: Right. So so we’re just trying to do the best we can with the information that we have and it’s just a chat. That’s what it is.

Joe: So, we got another great one. “One star, in my opinion, Andi and Al are excellent”. “Joe adds little value to the show and often appears bored”. Yes, you nailed that. This show is terrible! “Belittles his callers and really should consider retiring”.

Al: Wow. We just got that one a few days ago that must be from the last podcast. You must have gone off on something. That’s something. The name is real life ninja?

Joe: Yeah, he’s a real life ninja. He’s going to kick my ass. If you don’t retire I’m going to whip a Chinese star in your ass.

Al: I wouldn’t go out at night for awhile, until that podcast becomes old history. This is like you two days ago. You’re in trouble. Yeah, you’re right, those stars things look like they hurt.

Joe: He’s got like some magic dust and going to come out of the elevator… Wahhh, and start kicking my ass. I can’t believe you belittled my question.

Al: You better get a bodyguard for a little while.

_______

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