The case for getting a monthly annuity
Anyone with a lump sum — a large amount of money — can get an annuity. Insurance companies will gladly convert it into a stream of monthly payments for life. But a company-provided annuity offers more protections than the type you can buy from a private insurer.
In this case, the company for which Tom Walters has worked for 35 years is giving him a choice in pension payout: He can get a monthly pension check or a lump sum of $475,000. If he takes the lump sum, Tom would have to manage it or hire someone to manage it for him.
Stephen Mitchell, chief operating officer of the Retirement Income Industry Association and former director of the retirement group for Merrill Lynch, seems an unlikely advocate for taking the pension annuity, since he’s devoted his life to retirement investments. But he’s a staunch supporter of predictable retirement income.
“I wouldn’t give up the pension annuity payout lightly,” he says. “Retirees should first establish a floor of reliable money that is guaranteed for life. A pension is an important part of that floor. Wrestling over converting a pension to a lump sum and then figuring out how to invest it so you still have a floor is just wasting a lot of energy.”
Consider these factors before getting an annuity.
Annuity income is predictable
If you are hale and hearty at age 65, Social Security predicts that you’ll live at least another 20 years. That’s a lot of rent to pay and groceries to buy. Taking the pension option means that no matter how long you live, you’ll continue to receive a monthly check, albeit one that is probably not indexed for inflation.
Women benefit more than men
Company pensions are actuarially gender neutral, even though women employees and spouses of male employees live longer. If you are a married man, the company pension is probably a better deal for your wife than anything that you or she can buy elsewhere. If you are a female employee, think hard before you take the lump sum.
You can’t lose it all
You don’t have to be an investment genius or superdisciplined when you take the annuity. No matter how you go about it, managing money to provide income for 20 or 30 years or more requires expertise, commitment and taking some risk. If you are eligible to take a lump sum, expect private annuity salesmen and portfolio managers to come calling, eager to manage your money.
Their interest in your future is enhanced by the fact that they will earn somewhere between 1 percent and 4 percent — and maybe even more — of the total that you invest in their company’s product. In the case of portfolio managers, the average fee is 1.5 percent annually of the amount they are managing.
Sharon Lechter, spokeswoman for the American Institute of Certified Public Accountants and co-author of the financial best-seller “Rich Dad Poor Dad,” says 1.5 percent is a bargain for good investment advice. Still, on $475,000, 1 percent is $4,750 and 4 percent is $19,000 — big money, especially if you don’t have a lot of money to begin with.
Mitchell is more skeptical. “Retirement is creating a feeding frenzy in the financial services industry. (Investment advisers) can provide a valuable service, but too often they’re like ambulance chasers,” he says.
Private annuity considerations
Some people shun the company pension annuity in favor of a private annuity, looking for safety or to escape any reliance on a previous employer. “But you are just shifting your risk from one company to another — from a former employer to an insurance company,” says Mitchell.
When an insurance company goes belly up — and it happens — the fallback is a state guarantee association. Insurance companies are generally required to participate in the guarantee association in the state in which they are based, or domiciled as it is called in the industry. Most states guarantee only $100,000. If you have more than that tied up in an annuity, you could lose it.
Mitchell recommends that anyone in the market for a private annuity should reduce the risk by splitting their money among two or three highly rated insurers domiciled in different states.
Protections with a company pension
Company pensions come with better guarantees than private insurance firms. If the worst happens and your company goes belly up, your pension will probably survive, mostly intact. The quasi-governmental Pension Benefit Guaranty Corp., or PBGC, insures against private pension failure. The PBGC estimated in 2006 that 84 percent of retirees who must rely on it receive 100 percent of their benefits. Those who get less than that are largely higher-earning employees whose benefits exceed the maximums, which for someone retiring in 2010 at age 65 is $4,500 per month for a straight-life annuity and $4,050 for a joint and 50 percent survivor annuity. The PBGC doesn’t permit lump sum payouts except when they are less than $3,000.
Your employer doesn’t benefit when you take the annuity instead of the lump. The Pension Protection Act was passed in an effort to make pension income more secure. Its provisions spell out how a lump-sum option must be calculated, making it actuarially equivalent to the life annuity payout. The law specifies the mortality assumptions and the interest rate based on a combination of the corporate bond yield curve and the 30-year Treasury rate. The change protects lower-paid workers and puts all employee participants on an equal footing. It also makes it unlikely that a company will have a vested interest in whether a retiring employee takes the life annuity or the lump sum.