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lump sum vs annuity

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pdx13
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lump sum vs annuity  Reply with quote  

My wife has option of taking $950k lump sum or half of that plus guaranteed monthly payment of $3300/mo plus 2.5% cola for remainder of our lives. I am 63 and she is 58. We dont need this money as my pension and investments are sufficient for our needs . Are we better off taking lump sum and investing or lump and annuity?
Post Sun Sep 15, 2013 2:29 am
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Wino
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This is an ideal candidate for my "investment comparison spreadsheet".

https://dl.dropboxusercontent.com/u/104508282/InvestmentComparison.xlsx

I have reworked it to show your initial 950K investment "negative" 2.5% annual payment (COLA), and assumed 8% return on both investments. This assumes no withdrawals.

It shows that she should break even around 10 years, and then be ahead with the annuity. I think it is the guaranteed 2.5% that has the most effect. Without the COLA, the lump sum wins over twenty years.
Post Sun Sep 15, 2013 2:52 am
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pdx13
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Thanks very much. How many years does it take to break even assuming a 2% cola? And dont taxes come into play if we are taking the annuity rather than just investing the whole lump sum ?
Post Sun Sep 15, 2013 5:38 am
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Wino
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I will recalculate the spreadsheet. I wonder if I did not apply the variables properly. I will not be able to do this until this evening (my time).
Post Sun Sep 15, 2013 8:44 am
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Wino
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https://dl.dropboxusercontent.com/u/104508282/InvestmentComparison.xlsx

It's the same link, but an updated copy. It appears that unless interest rates are below nearly dirt, the lump sum is better. I went down to 4% rates, and it takes about 12 years just for the annuity to come out ahead. The figures are correct this time.

The lump sum will almost assuredly come out ahead, unless we have a real tank in the stock market.

You need only pay attention to the "At withdrawal" numbers near the bottom. Those are what the investment will be worth at any given time. Unless you're putting the money into a CD or money market, the annuity loses. In a money market or other "safe" investment, the annuity wins, but it takes several years for this to occur.

How much risk are you willing to take? If you put it all in an index fund, you'll be best with the lump sum. If you put it all in a money market, then the annuity is better after a few years.
Post Sun Sep 15, 2013 3:16 pm
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oldguy
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Annuity.If you spend $475,000 on an 8.33% annuity (and start receiving $39,600/yr) and invest the $39,600 @ 5% each year, you'll have $522,989 in 10 yrs, $1,375,000 in 20 yrs, $2,763,000 in 30 yrs.

Lump. If you, instead, kept the $475,000 & invested @ 5% you would have $773,724 in 10 yrs, $1,260,316 in 20 yrs, $2,053,000 in 30 yrs.

It appears that they cross between 15 & 18 yrs. Try 17. The annuity is $1,074, 400. And the lump iis $1,088,700 - pretty close. (And that's w/o the 2.5% cola.)

But the big variable is the performance of your investment. In the example, I picked 5% in both cases - ie, the annuity checks and the lump get invested in the same thing. But if both were placed in a 10% investment, ie, the 17 yr cross-over would be different. (putting the whole $475k into a 10% fund early gives it a big boost).
Post Sun Sep 15, 2013 3:51 pm
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Wino
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Oldguy, you should look at the spreadsheet I posted. You can do "whatif" with any numbers you like, and it comes out with the lump sum winning except in an anemic economy. If the OP is VERY risk averse (CD's or money markets), then the $475K plus monthly payment wins in a few years. If he's willing to risk some principle and get even 5%, the lump sum wins for the foreseeable future.
Post Sun Sep 15, 2013 4:24 pm
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oldguy
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quote:
the lump sum wins for the foreseeable future


Yes - and with the lump sum you still have the money - ie, if there is a death the money is inherited. If you spend the money for an annuity it is gone.
Post Sun Sep 15, 2013 5:00 pm
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pdx13
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We can tolerate rewsonable risk. On the other hand I dont think the spreadsheets take into account the 2 or 2.5% COLA. I habe a sizeable amount of our retirement money in index funds now. We have probably 50% of our retirement income needs being met by guaranteed pension right now as I took combination lump and annuity when I retired from govt job. I am now working essentially for medical benefits until medicare kicks in. I think we are in good shape but am somewhat concerned about a 40% market drop that we wouldnt live long enough to recover from. We are fully invested in equities as I see no upside for bonds in next several years.
Post Sun Sep 15, 2013 7:46 pm
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Wino
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The spreadsheet allows for 2.5% cola, and you can change the value in cell C10. Also, if you want to adjust it some later year, you can change it in row 25. Cell B10 and row 24 are for a cola in "investment 1" but since investment one has no monthly deposit, the cola there will have no effect.
Post Mon Sep 16, 2013 12:28 am
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pdx13
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Thank you all again. This is very helpful to me.
Post Mon Sep 16, 2013 12:30 am
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coaster
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quote:
Originally posted by pdx13
I think we are in good shape but am somewhat concerned about a 40% market drop that we wouldnt live long enough to recover from.

I can almost guarantee there will be another market crash within your lifetime; and I can almost, but not quite, guarantee that if it happens in the near future, you will live long enough to more than recover from it.

That being said, you're at an age when you should probably be gradually shifting your portfolio to more conservative, high-quality, less volatile equity investments; like blue chip dividend-paying stocks. Just my opinion; only you can know whether it's suitable for you.

I agree about the bonds. Probably not a good place to be right now.

~Tim~
Post Mon Sep 16, 2013 4:47 am
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pdx13
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We are in primarily low cost index funds. Would blue chip dividend stocks be a more conservative option?
Post Mon Sep 16, 2013 11:06 pm
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coaster
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An index is everything. It's fine when you just want to follow the general overall market. If you don't want to do that, you have to start doing some due diligence and some picking and choosing. You want to discover what stocks are likely to decline the least in a bear market. "Conservative" and "Blue Chip" are just labels and may or may not correlate to that profile. Sorry, but it's time to go back to school again. Laughing

There's a wealth of learning on this website: www.Morningstar.com

Click on "Stocks" then scroll down the blue index on the left-hand margin to "Learn"

Best wishes & good luck. Smile

~Tim~
Post Tue Sep 17, 2013 4:46 am
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superkc
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Well.. a few options..

You can keep it where it is and live out a low-end life for ever and ever.. because $3300 is hard to live on. You will be 'secure' but generally unhappy at best.

You could take the lump sum and it will increase your stress and you will have to learn to invest (or just by Apple stock and call it a day).. and you will make a whole lot more money.. I would gamble over 10% a year.. +$70-80k realized on your money..

But.. honestly what is the point? You two are retired age.. the only thing you have to look forward to is (a) grand kids and (b) bad health. So why are you still 'planning' for retirement.. your retired.. go enjoy it. When you die plan to do so with $0 in the bank.. travel and enjoy your life because when your gone it doesn't matter if you left anyone money.. inflation will eat up any value it has and the rest will be gone by other poor choices. Its not your job to leave money behind.. its your job to live your life in a wonderous way and you owe it to your significant other to let them enjoy the fruits of your labor. At some point say to yourself.. I spent my life living smart and now its time to spend my life living happy and enjoying what I have earned.
Post Wed Aug 27, 2014 7:07 am
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