“Take the Money and Run!”
“Zach, they’re offering to buy out my pension… And they’re offering me a lot of money! I just don’t know whether to take it or not.”
Back when I was a hedge fund manager and paid to give clients investment advice, I would get questions like this all of the time.
In this case, I was talking with Jeff who was a retired Delta pilot. He had a generous pension that “guaranteed” him a monthly paycheck for the rest of his life.
But to conserve expenses, Delta was offering him a big lump sum in exchange for canceling these monthly payments. Should he take it?
That question may be more relevant to you than you think right now. Because with the coronavirus crisis causing financial challenges for companies, states and municipalities, and even the federal government, we may see more of those offers in the future.
Heck, there is even some discussion of offering social security lump sum payment now, and deducting the amount from your retirement benefits. (Source:Forbes)
So what should you do if you’re offered a deal like this? (The answer might surprise you.)
A Dollar Today Is Worth… What??
Whenever a pension or endowment or even social security offers you a lump sum instead of monthly payments, the dollar amount might initially look disappointing. It will almost certainly be less than the total amount of money that you would receive if you chose to keep receiving payments over time.
But the thing to remember is that a dollar amount today is worth far more than that same dollar amount over time.
The reason is that you can invest your lump sum today, and continue to grow that cash for years and years!
So before dismissing a lump sum payment because you’ll get more cash over time without it, consider doing some math.
There are a number of very helpful online calculators —like this free one from Bankrate.com — that can help you look at different scenarios.
You can typically plug in different things like how much you have saved for retirement, how much income you’ll need when you’re retired, what rate of return you expect to generate on your investments, and more.
All of these calculations can give you a much better picture of how well you’re prepared for retirement and how much in savings you’ll need.
As you start to plan out what your retirement could look like, here are some important considerations to be thinking about.
What Return Can I Generate?
In many cases, you may be able to grow your wealth much more quickly than a typical pension plan. And that gives you an advantage!
You see, most pension plans — and even the social security administration — have strict rules about where and how they can invest the money that is used to pay your benefits.
Most of these investment plans require a large portion to be allocated to low-yielding corporate or treasury bonds. The current low interest rate environment has made it very difficult for big retirement accounts to generate the gains needed to pay your long-term retirement benefits.
But as an individual investor, you can put more of your wealth into dividend stocks that pay lucrative income. This way of generating income can also give you a chance to grow your wealth as stocks trade higher.
You can use a smaller amount of your wealth to invest in more speculative opportunities like buyout deals and more aggressive growth opportunities. While these plays often have more risk, a handful of small investments can keep your risk manageable, and these plays can really pay off quickly when you lock in a big gain!
Finally, if you’re disciplined enough to hold some cash, you can often use opportunities like the recent market pullback to buy cheap stocks on sale before they rebound!
So with a little research and discipline, you can use the diverse opportunities the market offers to grow your wealth much more quickly than a typical pension fund. (And good news… These opportunities are exactly the types of situations we cover here at The Daily Edge!)
Inflation, Solvency and Taking Control
A couple other things that you should keep in mind when deciding between pension fund payments or a lump sum right now…
Inflation is a challenge that affects all retirees. As prices for things that you need to buy continue to edge higher, inflation can eat away at the true value of your retirement savings.
Typically pension funds and social security payments are adjusted for inflation. So your benefits will grow over time.
But I have some concerns with those inflation calculations. Because they’re typically calculated based on the CPI or “Consumer Price Index.”
That index doesn’t always accurately calculate how your expenses will grow through retirement. Many retirees complain that inflation in things like health care, cell phone bills, and even things like travel expenses far exceed the paltry increases they receive as “inflation adjustments.”
But if you take a lump sum payment now and invest the money wisely, you should be able to earn a return that more than makes up for inflation and leaves you with more money to spend throughout your retirement.
Another thing to consider is the risk of insolvency.
I’m talking about whether your company will be able to continue to afford your pension payments. Or whether social security will really be able to continue to pay Americans!
Even the Social Security Administration admits that the fund it uses to pay retirees will run out of money by 2037. (SourceSSA.GOV)
Given these risks, and the opportunities we have in the market to grow your wealth, I’d almost always opt for receiving your cash now rather than relying on monthly payments over time.
This approach puts you in control. It lets you decide how and when to invest, and when to use your money for retirement.
Of course I’d love to be able to help you find the best ways to grow your income, protect your wealth, and live your best retirement!
Here’s to growing and protecting your wealth!