Only late last month I was reading an article about the billions of dollars that nobody claims and I was thinking “who’d ever forget being owed money like that?”. Well it turns out that I would!
It was an unexpected surprise to open a big envelope in the mail Friday afternoon and learn that I’m still invested in a Pension Plan from the first company I worked for in the US! I’m amazed that the mail even reached me as I hadn’t updated my address from Alabama and I don’t think I’ve ever logged onto the Pension’s website.
I didn’t even really think about Retirement when I first moved to the US – I was 30 at the time and still in a “retirement’s so far away” mindset. Eventually the company transitioned over to a 401(k) plan which I didn’t worry about either until about 2007 or so, and I just assumed that the 401(k) included my Pension contributions.
But no, the Pension is still intact and I’m vested with 9 years of contributions! Today’s mail is actually a “one-time special invitation” to cash-out the pension obligation although curiously the Pension Plan allows me to do this at any time as far as I can tell. So I thought I’d write about the various options I have and try to figure out what I should do.
Option 1: Do nothing.
If I do nothing now, I have two further choices when I’m 65. I could receive a fixed monthly payment of $607 starting in the year 2036, for life. Or I could take a lump-sum payout of $95,863 in that year instead.
If I were to take the monthly payment then I’d receive $7,292 a year (this would lose value to inflation and would be taxed as income). Assuming I lived until I was 80 years old, then by the end of 2051 I would have received a total of $116,544. This is higher than the lump-sum payment, but is also contingent on how long I live – the break-even point is 13 years.
Option 2: Receive a lump-sum of $43,889 immediately.
The offer I received is to accept a $43,889 lump-sum payment now (i.e. next month) instead and leave the Pension Plan. This is lower than the lump-sum I’d receive when I reach 65 because the Pension would be ending 22 years short.
To take $43,889 and turn it into $95,562 in 22 years’ time, you’d need an annual growth rate of 3.6%. So the Pension Plan is quite conservative in its projection. This is a good option if I’m confident that I could beat a 3.6% total return.
There are some restrictions to this lump-sum payment however. If I take the money and put it in a taxable account, then I’ll be liable for federal income tax at my marginal rate (28%), state taxes plus an additional 10% early withdrawal tax. So that’s not going to happen – there’s no value in throwing 40% of the capital away today when I don’t urgently need the money.
A second choice is to take the lump-sum but roll it into my Traditional IRA at Vanguard. My Traditional IRA account has a $0 balance at the moment. If I do a manual roll-over (receive a check from the Pension Fund addressed to me and manually pay it into the IRA) then there’s an automatic 20% federal tax with-holding which has to be claimed back. However, if I instruct the Pension Plan to address the check to Vanguard and pay that into my IRA then there’s no with-holding and no taxes due until I start receiving distributions in retirement.
Option 3: Receive $214 a month now for life.
It’s not quite the Publisher’s Clearing House annuity, but this option would mean $2,565 a year for life – the amount is fixed so it will lose buying power to inflation, and the income would be taxed at my marginal rate.
Face Value Comparisons
This is simple a comparison of how much my Pension is worth at face value based on the different options I’ve been offered. The face value is the amount of money paid out by the Pension I would receive by age 65 and age 80. It ignores any additional income or total return I might obtain from the pension payouts. These figures also ignore taxes and inflation.
|Option||Amount||Face Value at 65||Face Value at 80|
|1 – Lump Sum at 65||$95,863||$95,863||$95,863|
|2 – Monthly payment at 65||$607 / month||$0||$116,544|
|3 – Lump Sum now||$43,889||$43,888||$43,888|
|4 – Monthly payment now||$213 / month||$56,430||$94,905|
The above numbers suggest that I’d get the highest value (assuming I live until I’m 80) by doing nothing and taking the higher monthly payment that’s paid when I turn 65. However, this doesn’t take into account additional capital and dividend gains from investing the pension money if I received it now.
The effects of investing the Pension money
It’s all well and good receiving a lump-sum or monthly payments, but I’d be investing this money. So I want to look at the total return I might expect to get from the different options.
For this analysis I’m going to assume a total investment yearly return of 5%; this is still fairly conservative since the investments would likely be mostly stocks but I am projecting out over 37 years so I think it’s a good value (historically stocks have yielded 8% annual returns). I’m also not considering withdrawals during retirement in this analysis as I plan on having enough money from my dividend income to retire on in any case.
This comparison is mixing taxable investment options (orange and yellow lines) that are monthly payments paid post-tax into taxable accounts, with tax-deferred options (the lump-sum payments).
For the monthly payment options, I’ve showed the effect of reduced capital resulting from a 35% (federal and state) tax rate until age 65 and an 80% tax rate afterwards; I wouldn’t receive the whole amount each month as some would be withheld by the government. This has a big effect on the final outcome.
|Option||Amount||Total Return at 65 (est)||Total Return at 80 (est)|
|1 – Lump Sum at 65||$95,863||$95,863||$199,291|
|2 – Monthly payment at 65||$607 / month||$7,284||$137,857|
|3 – Lump Sum now||$43,889||$122,271||$254,193|
|4 – Monthly payment now||$213 / month||$64,595||$178,575|
Letting the Pension continue and receiving a lump-sum at age 65 is the easiest option to discard; I’d be better off by taking the lump-sum now and investing it in my Traditional-IRA as I’m confident I can beat 3.6% annualized growth.
Based on the effect of taxes and the extremely long recovery time of the monthly $214 payment option; I don’t see that it’s a worthwhile option either. I don’t need the extra income now and I think from a total return perspective that it’d be better to invest the lump-sum in my Traditional-IRA.
The monthly payment starting at age 65, isn’t as bad as it seems from the chart above. I’d be receiving $7,284 a year gross. If I went with the lump-sum now instead, starting at age 65 I’d have to draw it down at 6% a year to get the equivalent amount of income (unless I can beat 5% growth). But I’ve no idea how long I’ll live or what emergency might come up so I think I’d rather have the capital in my IRA where I could access it if really needed.
So all thing’s considered, I’m going to go with the option to cash-out my Lost Pension and deposit the money in my IRA, unless someone points out something I’ve missed!
Quote of the day
The secret of getting ahead is getting started.