Pension to Rollover IRA Analysis

Pension to Rollover IRA Analysis

Employer pension plans, or defined benefit plans as they are sometimes called, were once the standard means of providing retirement income for many people. With the introduction of the 401(k), many companies began to slowly transition away from the pension plan to the point where today they tend to be the exception rather than the norm.

When I first began working at my prior employer approximately 17 years ago, they offered a pension plan–and the parent company still does to the best of my knowledge. However, due to several mergers and acquisitions, I was only eligible for the pension plan for a short period of time.

Shortly after leaving that company earlier this year, I received a packet of information from my prior employer that detailed the options available to me in relation to the pension plan.

Pension Plan Options

When departing an employer that provided a pension plan, as opposed to retiring from that employer, one is typically presented with three possible options for what to do with that earned benefit.

  1. Receive Full Benefit: In order to receive your fully vested benefit, you need to defer the benefit until the standard retirement age (which, at least according to my prior employer, is the end of the month that you turn 65 years old). Often times the benefit is provided in the form of a Single Life Annuity payment.
    • Advantages: The primary advantage with this option is that you know exactly what you will receive as a monthly payment in retirement. The payment is not subject to the risk of investment returns, as it is a fixed payment based on your years of service and your salary while employed.
    • Risks: At one point in time, pension plans had an element of guaranteed security. However, there have been numerous instances where employer pension plans have folded or been mismanaged and the funds to continue payments are gone.
  2. Reduced Monthly Benefit: Rather than waiting until the age of retirement, it is possible to begin receiving a reduced monthly benefit in the present day.
    • Advantages: Here again, the payment amount is fixed and you know exactly what you will be getting. In addition, because you begin receiving the payment now, you are reducing the risk associated with deferring your payment until retirement.
    • Risks: The immediacy of this option comes at a cost of a reduced benefit–the significance of the reduction is partly dependent on the amount of time until your retirement age, but it will be a small fraction of the full benefit.
  3. Receive Lump Sum: Instead of the reduced monthly annuity, you may elect to receive your vested benefit as a lump sum payment in the present day.
    • Advantages: The key advantage with the lump sum is that the money is in your hands right now. The risks associated with the long-term stability of the pension plan are eliminated, and you have the ability to use / invest this money as you see fit.
    • Risks: Unlike the fixed amount you receive in the earlier options, there is risk of losing money if you invest the lump sum poorly or don’t manage the money properly.

The above explanations may not be applicable to all plans and circumstances, however at a high-level it should be a general representation of the possible options available.

Analysis of Options

Looking at the above options as they pertain to my specific circumstances, the details of each option are highlighted below based on the data presented to me by my former employer:

  1. Full Benefit: By deferring my payment until 2040, my monthly benefit would be $298.92.
  2. Reduced Benefit: Starting my reduced monthly benefit this year, I would receive $54.92 per month.
  3. Lump Sum: Foregoing either fixed payment option, my lump sum payout would be $17,700.98 right now.

As I reviewed these options, the reduced monthly benefit was immediately excluded from consideration. There is little value or benefit to receive an additional ~$50 per month at this point in time, and once I am retired that would not move the needle at all to make that worthwhile for me.

Therefore, my decision ultimately came down to deferring payment for ~22 years and then receiving $300 per month versus taking the lump sum now and investing the money on my own (to hopefully provide a future benefit of more than the deferred payment).

My Decision

To make my decision, it really came down to whether or not I believed that I could self-direct the investment of the lump sum payment to provide me more than the fixed payment at the age of 65.

While I may be new to the DGI space, I have a long history of being confident in managing my own investment strategy with index funds and maximizing the retirement accounts that have been available to me. Therefore, it should hopefully come as no surprise that I have opted to take the lump sum payment.

But what does the forecast look like?

When discussing the cost of patience, I talked about the desire to add REITs to my DGI portfolio. Unfortunately I do not have new capital going into any of my IRAs, therefore I thought that rolling the pension over to an IRA would provide a great opportunity to build out my REIT holdings.

I have been researching REITs since that time, and have filtered the list down to a handful that I believe will be quality holdings for the long-term.

However, to truly understand the potential I needed to do a little number crunching.

Therefore, I created the table below to demonstrate the potential return based on the average dividend yield of the REITs I have identified. In addition, I averaged their 1-year, 3-year, 5-year, and 10-year dividend growth to calculate an ongoing growth component.

Recognizing that the history is not a guarantee of the future, I then discounted that average growth by 25% to account for some variance moving forward. However, one limitation in this model is that I have not accounted for capital appreciation of the shares themselves. While one would expect that to increase as well, again there are no guarantees.

Let’s look at the numbers:

Pension Rollover Analysis

Based on the numbers above, you can see that the annual dividend should provide a monthly benefit in excess of the fixed pension payment by the year 2029. If we carry that forward all the way until the year 2040, which is when I would be eligible for that fixed pension payment, you can see that the forecast dwarfs the monthly pension payment by roughly 566%!

In my mind, that really supports the decision to take the lump sum now and invest on my own.

Wrapping Up

Certainly the forecast above has no guarantees and carries an inherent level of risk, as does any investment.

There is a rather healthy dividend yield expected here, however with the REITs that I have selected, they have a solid track record of paying an increasing dividend. A couple of them in excess of 20 years.

Likewise, there are no guarantees that there will be sustained growth at their current levels. However, as noted, I tried to mitigate that risk by applying a discount to the average growth rate. Without the discount, the average growth has been 6.62% which would result in a monthly dividend of $4,295.33 in 2040, or roughly 1,337% more than the fixed pension payment.

All in all, I believe that the lump sum payment was a no-brainer decision for me.

For my retirement savings, I tend to be a bit conservative and don’t factor in any expectation for social security nor did I ever account for this pension payment. Therefore, even in a worst case scenario where I invest this money and lose it all, my current retirement strategy still has us on track to reach our goals.

This might just help us get there quicker, or provide more options later in life.

What do you think of this analysis?

Would you have done anything differently?

Also, stay tuned next week as I have already made a few purchases in this Rollover IRA that we will be talking about!

4 thoughts on “Pension to Rollover IRA Analysis”

  1. DD, The last plan I was in of this sort I left way back in 1999 (good ole’ Abbott Laboratories). I did the same, took the lump sum and rolled it into an IRA going through a similar thought process. At the end of the day I like having the money and controlling it for better or worse. Tom

    1. Talk about small world…guess what company my pension was with, haha. You and I are a lot alike in that regard, as for better or worse I prefer to be the one responsible for making the decisions and owning the outcome.

  2. I like the analysis, DivvyDad. I think using conservative numbers as you did is wise.
    I would initially be inclined to take the lump sum. Like you, I’d prefer to have the control over my future finances. Once I then also showed the benefits of that potential decision as you did, then I definitely take the lump sum.
    Some questions did pop into my mind as you went through this….
    The single life annuity benefit of $298.92/mo. is in 2040 dollars, correct?
    If so, did your former employer give you a present value of that future benefit? I would be curious to know what return rates and inflation rates they assumed over those years until you reach 65.
    Also, if the annuity benefit is in 2040 dollars, then you should be able to directly compare to the future monthly benefit you calculated for the lump sum (as you did), and can ignore any inflation effects.
    Hopefully, those thoughts made sense… if not… just ignore everything I said. 🙂

    1. Thanks for the feedback ED, and good questions. Yes, the Single Life Annuity was in 2040 dollars but unfortunately they didn’t provide the details behind the number in any of the materials they mailed me or have online. As you noted, I felt this was then comparable to ignore the inflation effect although my original did include an Inflation calculation with a 3% rate.

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