How to Choose Between Multiple Pension and Annuity Options

Our topic on this episode of the Ready for Retirement podcast is about understanding how you can best choose what’s best for you when provided with multiple pension and annuity options.

Questions answered: When might electing a lump-sum option make more sense than an annuity? Are there certain annuity options that make more sense than others? What are the best strategies when it comes to deciding between all of my options? What is the best approach for my individual situation? 

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Key Points

• Retirement Expenses
  • Before determining the best option, understand your expenses in retirement.
    • What are the pre-tax expenses?
      • If you’re in a 20% tax bracket, the goal isn’t to generate $80,000 of income, but $100,000 of income. 
      • How do we generate $100,000 of income to retire comfortably and not worry about running out of money?
  • Income Floors
    • If $100,000 is the goal, let’s determine where this will come from.
      • $53,000/year will come from Social Security.
      • What will the annuity look like on top of that?
        • Assuming the lifetime annuity option, I’m going to assume this is ~$15,000/year.
      • $32,000 of our $100,000 retirement budget is what we need our portfolio to generate for us. 
  • What annuity option should I take?
    • Lifetime Annuity
      • You and your spouse will receive the same monthly amount as long as one spouse is alive.
    • $10,000/year for as long as you are living, with the $245,000 base staying in tact.
    • Withdraw all $245,000 in equal installments over the next 10 years. 
• Pros & Cons
  • Option 1: Lifetime Annuity
    • Pros:
      • When you annuitize, you are creating another income source for the rest of your life.
      • Annuities protect against longevity risk (as long as the annuity company is solvent).
      • The longer that you live, the better the return.
    • Cons:
      • When you annuitize, you’re going to receive a lesser amount than if you had invested, in most cases.
      • If you were to pass away earlier than expected, you receive no benefits and there are no assets to be passed down. 
        • If you were to elect a lump-sum option, you are able to leave assets to desired beneficiaries.
  • Option 2: $10,000/year of earnings with the $245,000 base intact.
    • Pros
      • We don’t know if the earnings are the earnings guaranteed or if this is an amount that will fluctuate.
      • Can you do anything with the $245,000 base if needed?
        • If so, this can be an additional rainy day fund or take care of a liquidity need.
    • Cons
      • Are you leaving money on the table?
        • $10,000 of earnings with a $245,000 base tells me you are creating 4.1%/year of income.
          • Could you invest in a way that generates in excess of 4.1% (guaranteed)? 
          • If so, this is leaving money on the table.
  • Option 3: Withdraw the entire principal in earnings in 10 equal payments.
    • Pros
      • The payments you receive will partially be principal and partially interest.
        • Keep in mind that much of your principal may be contributions as opposed to interests (with interests so low).
      • You’re guaranteed to have $245,000 in 10 equal payments. 
        • The reality is you’re going to have growth in addition to this, although we are unsure.
        • This option would cover the majority, if not all, expenses throughout the early years of retirement. 
      • This option allows you to invest the funds as they come due, increasing the chance for more return. 
        • Understand your IRR (Internal Rate of Return).
      • For tax planning purposes, it can often be most effective to keep income low in the first few years of retirement to allow for strategic Roth Conversions. 
• Overall Considerations
  • The best option comes down to a few options, including risk tolerance, life expectancy, and a deeper understanding of the details with all of the available options.
  • Considerations:
    • What is your life expectancy?
      • The person who lives longer has a much greater return on your money with the Lifetime Annuity option.
      • If you have a short-life expectancy, consider the condensed option with higher payments over a lesser period of time as it won’t be continuing regardless.
    • What is your risk tolerance?
      • Are you uncomfortable with the risk of the stock market?
        • You may be willing to give up a higher return in exchange for a guaranteed amount.
      • If you’re comfortable investing and want to attempt to maximize your return, consider the last option where you can maximize the portion of your portfolio that you do control. 
    • Compare the annuity payments to the starting value that was used to generate those payments. 
      • The IRR (internal rate of return tells us what gives us the greatest return on investment). 
      • This isn’t the end-all be-all, but a helpful factor when considering the multiple moving parts.

Timestamps

2:23 – Kind Review

5:49 – Understanding Your Options

8:55 – Income In Retirement

11:49 – Annuitizing 

14:45 – Liquidity Concerns

18:34 – Investing Capability

21:05 – Life Expectancy

23:22 – Internal Rate of Return

23:47 – Aligning Your Investments With Your Financial Goals

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