Pensions Advice Any actuaries here?

Hmmm,
'A friend' is due to have a pension fund mature soon and he has a range of options with regard to the initial tax free lump sum that he can take at pension commencement:

Standard terms: Tax free lump sum=3x standard annual pension
Max lump sum: Tax free lump sum = 6x standard pension, but pension for the rest of his life is reduced (commuted) at a rate of $1 reduction in annual pension for every extra $21 lump sum taken
or
No initial lump sum, but lifetime pension is enhanced by $1 per yearfor every $21 of lump sum not taken.

Now, bear in mind that he pays 20% tax on any pension when he receives it but the lump sums are totally tax free.

Quote: OnceDear

Should he put his lump sum all on red or black?

Find a triple zero roulette wheel and bet it all on 000.

Quote: VCUSkyhawk

Find a triple zero roulette wheel and bet it all on 000.

Only after waiting and seeing 0 and 00 come up in succession

Quote: OnceDear

Hmmm,
'A friend' is due to have a pension fund mature soon and he has a range of options with regard to the initial tax free lump sum that he can take at pension commencement:

I noticed you put the word friend in quotation marks. ;) Is there something you want to tell us? ;)

ask him to estimate his life expectancy. for example if it's 20 years

add up 20 years of drawing the lifetime pension after taxes with no lump sum and consider that figure.

compare that figure to the max lump sum figure and 20 years of the reduced pension amount after the tax

if those 2 figures are roughly equal then, then taking the lump sum option is a better deal because he can earn interest or dividends on the balance while he is drawing down from the sum

consider carefully if your friend has the discipline to manage the lump sum very strictly without overspending

if your friend does not have that strong discipline then the lifetime pension is better for him

since nobody can actually know how long they will live this method is not perfect. but it probably is the best way.





another good method would be to compare what an insurance company would pay this person, also considering taxes, if he took the lump sum and purchased a single premium immediate lifetime annuity. if what the insurance company would pay per month after taxes would be greater than the monthly payout from the lifetime pension after taxes then it would obviously be a better deal. if not, then the lifetime pension would be a better deal.



since interest rates are very low right now, and probably were not nearly as low when your friend's lifetime pension was calculated it is a good bet that the lifetime pension is a better deal.

Last post is good, but allow me to expand on that point: (I'm confused about the pension options, so for simplicity let's just assume you have a pile of money you've saved up).

Buy a life annuity. This is insurance against the risk of living too long.

If the possibility of you pushing up daises shortly after buying it is too scary, you can "insure" against that with a 5 or 10 year certain period in exchange for less $/month (i.e. payments to your beneficiary continue should you die before that time has elapsed). It doesn't decrease the monthly payment very much.

I've never understood why people try to make their retirement assets last their lifetimes. You don't know the future. You have absolutely no idea exactly how long you will live. This is what insurance is for... your house, your car, so why not your retirement. Mortality tables only work with the law of large numbers (i.e. insurance company). On an individual basis, a mortality table is near useless. If you try to do this yourself, you are virtually guaranteed to draw either too much or too little every month.

KevinAA: ........................... your answer is a good one if a person is totally relying on this payout to cover his living expenses and cannot cover them without this payout

.................................but not all people are in that situation


if a large part of this payout will end up being discretionary funds then a person can afford to accept some risk and try to get the largest payout and have more to spend

Quote: Nathan

I noticed you put the word friend in quotation marks. ;) Is there something you want to tell us? ;)

OK.... 'My friend' also likes JD and recreational blackjack.

Some great and thoughtful answers.
FYI this is how UK pensions work. up to 25% tax free lump sum at commencement and the rest taxed at 20% after tax free allowance of £11k.

I liked the suggestion of comparing to what the lump sum would get from buying an annuity.

Fact is, this is not sole source of income or capital. There is no burning burden of debt to throw the lump sum at. Similarly, this money will probably not get spent in my lifetime. Discipline and financial stability are mostly in place.
The spoiler question was tongue in cheek and there is the serious point that only by forecasting date of demise can give the correct answer.

Quote: OnceDear

No initial lump sum, but lifetime pension is enhanced by $1 per yearfor every $21 of lump sum not taken.

After retirement, it’s all about income. Not assets.

The higher guaranteed lifetime income with the third option, is a hedge against inflation.

If your friend takes any of the lump sum options, he has a greater risk of running out of money.

“To retire successfully, you must take longevity risks off the table.” -Tom Hegna

“The day you start taking money out of a portfolio, all the retirement rules you thought you knew, go out the window.” - Tom Hegna


Part 2 of five excellent segments:

Quote: Tanko

The higher guaranteed lifetime income with the third option, is a hedge against inflation.

But if he* dies soon, his estate either has the residual lump sum or it doesn't have anything. Oh and there is the tax relief that is wasted by not taking the lump sum.
* Ok. I admit it. My friend is me :-)
Also the pension grows with inflation anyway.

Quote:

If your friend takes any of the lump sum options, he has a greater risk of running out of money.

and of going on a life changing spending spree.

Quote:

“The day you start taking money out of a portfolio, all the retirement rules you thought you knew, go out the window.” - Tom Hegna

you could say that about starting to draw the pension.
thanks. Watching that now.

I think there's a number of factors to consider, strangely the tax you have to pay is a very important factor (e.g. if you go into the 40% bracket, then it's more likely to be better to take some lump sum).

Personally I would create a spreadsheet with various options using life tables from something like https://www.ons.gov.uk/peoplepopulationandcommunity/birthsdeathsandmarriages/lifeexpectancies/datasets/lifetablesprincipalprojectionunitedkingdom . In this case, 1951 are old figures, you have 100000 people born and the lx give the number of people alive, e.g. 13 make it to 100; so look for a more up-to-date set of figures.

The question is also whether you want money now, while you can still enjoy it, or ensure you don't go broke if you get to (say) 85 or 90. By then I suspect one takes fewer expensive holidays so your needs are less. You also need to consider the effects of inflation, whether it's better to get an inflation protected pension and how much profit the pension company makes. You can work out the true value using the figures above and evaluate whether you'd rather lose if you die sooner or gain if you live longer. Personally I'd trade for living longer, for instance putting money in a pension and then snuffing it early probably doesn't matter if you're single, whereas if there's a family you may look for a joint-life annuity.

There's no obvious answer, so I'd recommend playing with a spreadsheet and seeing which looks best.

Not an actuary, so I have not replied. I have had to deal with these questions in recent years, though, so FWiW:

My determining factor would be, if you took the largest (tax-free) lump sum, would what's left meet your subsistence needs (and your wife's, should she survive you)? It's good that it's indexed to inflation.

If it does, then why not take the lump sum, avoid the taxes, invest it somewhere else where you have control and use of it? The pension stops when you die, so money not taken is money you don't have.

I don't know British law, but Congress is constantly messing with my retirement. So far the punitive stuff has only been applied from a certain date forward, but several retroactive cuts have been proposed (and so far, defeated). If you determine that amount, is that reliable, or does Parliament change it at whim? If so, all the more reason to take a large lump sum now.

Anyway, If the pension remainder doesn't cover subsistence, figure out what your minimum needs are, plus maybe a small buffer, and take the largest lump sum that allows. You can leave any left over to your heirs. It would be a useful account for your wife if you pass first.

I'm a big non-believer in annuities. I think most of them are losing propositions for the annuitant, if not all. Your insurer is taking the cream off your money. Your principal is better put into a trust account of some sort where you get the interest and dividends, re-invest any percentage you can afford to, and the principal continues to work for you. Just make it a little difficult for yourself to get at the money.

My trust account has a 48 hour waiting period between sell request and receipt (processing time). That helps a lot with large impulse expenditures. YMMV.

Quote: beachbumbabs

Not an actuary, so I have not replied. I have had to deal with these questions in recent years, though, so FWiW:

My determining factor would be, if you took the largest (tax-free) lump sum, would what's left meet your subsistence needs (and your wife's, should she survive you)? It's good that it's indexed to inflation.

If it does, then why not take the lump sum, avoid the taxes, invest it somewhere else where you have control and use of it? The pension stops when you die, so money not taken is money you don't have.

I don't know British law, but Congress is constantly messing with my retirement.

Cheers BBB.
We already established that 'my friend' is me. My commenting here was somewhat tongue in cheek and I've been impressed with the sensible replies.
Without revealing everything about myself, this is a company defined benefit scheme. The scheme is constantly getting messed about with because it is massively in deficit, so part of the argument for taking more lump sum is to avoid losing all to some future shenanigans or scheme failure. E.g. There have been threats for years that we might lose the tax relief aspect. Plus the scheme just closed to existing members who are suddenly besieging it with withdrawals. State pension age is on the rise too, but I get a respectable state pension from age 67 ( as things stand)
Wife gets a half pension if I die first, so she is accommodated.
I'm fortunate ( or unfortunate ) in that I can afford to take any of the options without dreadful risk. Hardest part will be spending it to save burdening my beneficiaries with stupid wealth. Dad lived to 93 and didn't manage to spend his money. His dad died at 65 and never had any.
I wish I knew when I'll die.
Actually I wish I knew where I'll die and then I'd just avoid going there.
$:o)

The analysis comes down to figuring a cross over point whereby at what age given reasonable rate of inflation protected return and future tax assumptions is taking the lump sum money now make more financial sense. Then you factor in your risk tolerance if the assumptions are not met (eg rate of return & life expectancy...how financially hurt are you going to be if you assumptions are off).

I rarely recommend a client buy an annuity, but if I do it is when they purchase an immediate annuity which provides the income stream immediately after purchase. This type of annuity is pure “insurance” of lifetime income and was the orginial intent of the product. That insurance, as with all insurance, comes at a cost as the internal rates of return on annuities can normally be out done by investing elsewhere. The client decides the cost of insurance is worth the benefits of the security it provides.

In your case you already have the option for a lifetime income stream...not sure why you would pull the lump sum out and turn around and buy a private insurance annuity unless the private annity paid you more on an after tax basis...that would be odd but worth checking out.

You have to take the present value of money into the calculation...adding up future income streams and comparing to the current lump sum amount doesn’t work. The discount rate used is one of the agreed to assumptions by the client.

Bottom line is the cross over point can be determined given a chosen presnt value of money interest rate factor. You then have to decide whether you feel you are going to live that long and then decide if the spots along the way and those outcomes with your chosen path are acceptable based on your risk tolerance (e.g. if I take the lum sum and live 5 years passed the cross over point or if you opt for the annuity and die in 5 years, what are the comparative outcomes and are you OK with them).

One last point to consider which is slightly different than absolute present value considerations but in a similar vein. Let’s assume taking no lump sum has a 14 year cross over point and you are 65 today. How much do you value more income at 79 versus having more dollars to spend during years 65-79? Maybe less income when your 79 is OK based on what you expect to spend at age 79.

Lots to consider and provided you have all the options/information calculated, you can’t make an incorrect decision...the well informed decision that you make for yourself might be different than the decision made by “a friend” with the same set of facts and both could be correct for each of you.

Quote: OnceDear

Without revealing everything about myself, this is a company defined benefit scheme. The scheme is constantly getting messed about with because it is massively in deficit, so part of the argument for taking more lump sum is to avoid losing all to some future shenanigans or scheme failure. E.g. There have been threats for years that we might lose the tax relief aspect. Plus the scheme just closed to existing members who are suddenly besieging it with withdrawals.

This is a huge factor to consider...if there are no Pension Guarantees in place or substantial risk of changing future benefits or tax consequences, that has to be considered and to numerically impact the equation, you might be more aggressive on what the discount rate/alternative investment rate of return is to be used.

Conservatively, you might use 4-5% as an inflation protected rate of return...to factor in the risk of pension benefit change, you might bump that rate to 6-7%.

Quote: Paradigm

The analysis comes down to figuring a cross over point whereby at what age given reasonable rate of inflation protected return and future tax assumptions is taking the lump sum money now make more financial sense. Then you factor in your risk tolerance if the assumptions are not met (eg rate of return & life expectancy...how financially hurt are you going to be if you assumptions are off).

Cheers Paradigm. Yes, I have spreadsheet analysed this to hell and back. It's all about maxing my lifetime after tax income for various scenarios and longevity, stirring in scheme uncertainty and future tax and inflation uncertainty too.

Quote:

I rarely recommend a client buy an annuity, but if I do it is when they purchase an immediate annuity which provides the income stream immediately after purchase.

There won't be an annuity. it was just useful in comparing what lifetime income I COULD buy with the lump sum.

Quote:

In your case you already have the option for a lifetime income stream...not sure why you would pull the lump sum out and turn around and buy a private insurance annuity unless the private annity paid you more on an after tax basis...that would be odd but worth checking out.

No. won't be buying an annuity. Maybe a new car or a visit to Vegas.

Quote:

what are the comparative outcomes and are you OK with them?

Apart from dying soon, most outcomes are acceptable. Even Dying soon is covered.

Quote:

Lots to consider and provided you have all the options/information calculated, you can’t make an incorrect decision...the well informed decision that you make for yourself might be different than the decision made by “a friend” with the same set of facts and both could be correct for each of you.

Indeed. Thanks. Decision is actualy now made. Forms filled. Deposit and wagering restrictions put in place on my casino account. Wife informed of my choices, so she knows to keep my wilder impulses in check $:o)

Regarding the video, Tom Hegna, I believe, is trying to sell annuities. He is good at it, very good, a top salesman I can tell. For example, at this point* he hasn't used the word 'annuity'

*I am most of the way through with this video, I'll have to watch it all to be sure.

Quote: odiousgambit

Regarding the video, Tom Hegna, I believe, is trying to sell annuities. He is good at it, very good, a top salesman I can tell.

He doesn't sell annuities.

In this video, he mentions “I don’t sell anything anymore." “I am a speaker and an advisor”.

Quote: Tanko

He doesn't sell annuities.

Another thing a brilliant salesman might say. Although I will accept he is no longer working for commissions, which, by the way, those who sell annuities get.

I wouldn't say all annuities are bad for all circumstances. My father probably could have used one, if he had bought one around age 45 to kick in at 65 or so... it would have paid off OK. He only invested in bank CDs that were FDIC insured, only thing he trusted.

There may be some decent annuities, but my experience is the salesmen consistently oversell the product.

Quote: billryan

There may be some decent annuities, but my experience is the salesmen consistently oversell the product.

I think the simpler the annuity the better it is in terms of having a fair payout. If the terms are very complex it gives them lots of places to hide fees and to disguise the actual value of it.