A Lumpy Tale





I write this tale because every day people who are soon to retire must tell their employer if they want to receive a lump sum for all their years of service or a lifetime annuity.  This is a complex decision and an irreversible one.  They often enlist the services of advisors to help them make this decision, and it comes as no surprise that these advisors, who have an ulterior motive, advise the soon-to-be-retired that a lump-sum distribution is the favorable route.  In fact, according to the Society of Actuaries, almost 90% of people, when faced with this choice, choose the lump sum.

I have not found this to be the case for people that I have advised.  I often find that people should not take the lump sum.

Let’s look at some numbers and use some common sense.  What people want to know is whether they can generate the same level of income for the rest of their lives from their lump sum as they can from a monthly pension.  The answer lies in how long you will live and how good you are as an investor.  If you are in poor health and longevity is not on your horizon, you of course take the lump sum.  If you are a good investor, you also take the lump sum because in all likelihood you have saved and invested enough money outside of your company pension plan to recognize yourself as a good investor.  In this case, the lump sum is just the icing on the cake.

The question is now more refined and two-fold.  The first question is, “Should I take a lump sum or a monthly income if I am in good health, I expect to live a long life, I am not a good investor and I have saved money.”  The second question is, “Should I take a lump sum or a monthly income if I am in good health, I expect to live a long life, I am not a good investor and I have not, let me repeat, not saved money.”  The difference between the two, is one has saved money and the other has not.  In the second case, I invariably advise that the person take the monthly income option because they haven’t developed the savings habit.  In some cases, I recommend they purchase a tax-deferred annuity or longevity policy with a small portion of their money.  It serves as a type of insurance policy in the event they live too long and gives them a bump up in income when and if they reach the age of 80 or 85.

Why don’t I go through the elaborate financial calculations as other advisors might?  Here’s why.  If someone hasn’t saved money by the time they reach retirement age and hasn’t developed the habit of saving and investing, they aren’t going to do it now.  Advisors who don’t recognize this are either deceptive or ignorant, while people who can’t see this are delusional or optimistic.  Excuse me.  You’ve had a lifetime to save money and you haven’t done it yet?  Take the income for life or else you will be broke in the near future.

If ever in a lump sum vs. income decision, you need to reflect on who you are.  Numerical analysis is simply a technique to disguise the advisors desire to generate income for themselves.  If you take the income, they don’t make anything, but if you entrust them, they do.  So, the elaborate analysis and subsequent report that tells you, “Everything will be alright” is not worth the paper it is written on.

Let’s switch gears.  There are those who should take a lump sum.  They are healthy and expect to live a long life.  They have saved money.  They just aren’t great investors.  What should these people do?  This has turned into a complex question it seems, with myriad papers and disagreements everywhere.  The practical answer is self-evident, however, and steeped in behavior and circumstances.  Let’s see if we can simplify it.  There are only three types of people who reach retirement age—those that don’t have enough money to retire, those that do and those that might.  There is nothing complicated about those that don’t and those that do.  The recommendations are also simple.  If you don’t have enough to retire, you must keep working or you must ultimately rely on the charity of country, family or friends.  If you have enough, then my solution is to keep your post-retirement income the same as your pre-retirement income.  Why?  Because the reason you have enough to retire is because you have developed the savings habit.  I find that when I recommend this approach, often a year or two after a person retires, they come back and say they’ve been saving money and we put it back in their account.

So the real question is what should people do who might or might not have enough money to retire.  That is a complex question and it doesn’t belong in a simple tale such as this.  But let me give you a little hint, the question needs to be addressed well before your retirement date and readdressed at and after retirement.  Retirement planning is a lifetime affair.  If you approach it any other way, it is a mistake.  It is one of the reasons for example that I don’t like target funds.

Target funds neglect the obvious.  Retirement is like a long game of chess.  Using the target fund as an example, if a person puts all their money into a target fund when they reach retirement age, they have neglected one important thing.  What is it?  They have neglected knowledge.  They could just as easily do what the manager in a target fund does for himself /herself.  They should.  Otherwise, there is a high probability they will be unpleasantly surprised at a future date.  Target funds have a major flaw.  They keep you dumb.  Don’t be dumb.

I have mentioned my Tio Segundo in other tales.  He was very wise and, as a practicing attorney in Cuba, had seen much.  One day we are talking about life insurance and how much is an appropriate amount for a husband to leave his wife and family.  Tio Segundo was still of the era in which the husband made the income and the wife stayed at home, which is why I framed the question as I did.  Nevertheless, since these tales are about a collective wisdom, passed down through generations and massaged by my interpretation, I think what he had to say applies in the lump sum vs. pension debate.  He said that he would advise his clients to purchase a sufficient death benefit so the wife could, if she was good at managing money, survive.

He said, and I remember the numbers like it was yesterday, “If you leave your wife $100,000 and she can’t survive, she will just as surely be unable to survive if you leave her five times as much.”  His point was insightful.  I think it applies to the lump sum scenario.  If you have been unsuccessful managing your money up to the point of retirement, what makes you think you will succeed now?  Take the pension unless you have a history of success.  If you’ve been successful, take the lump sum.  If you are in between, study your alternatives.

The message of this tale is clear.  However, many soon-to-be-retired folks are “persuaded” to take a lump sum and invest it in a private annuity because it offers “income for life” and “peace of mind.”  Although this may in fact be a viable option, it is often an inferior alternative to the company-sponsored alternatives.  So make intelligent comparisons.  I say this because whenever I hear the phrase “peace of mind,” I translate it to the salesperson wants a “piece of what’s mine.”

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