Recently on the blog we’ve looked at a few key decisions anyone retiring from Intel must make once they stop working. We saw how to generate a paycheck via a rebalancing process and learned how ‘withdrawal order’—a seemingly simple change—can have major ramifications on your ending wealth and the amount of taxes you end up paying. Another key decision those leaving Intel must make is what to do with their pension benefit.
We’ve outlined before how the Intel minimum pension plan works. But, here we want to break down the decision that comes at retirement: should you take the monthly pension income benefit or a lump sum withdrawal from the plan? (And don't forget to download your free excel tool to help with this decision)
Like so many decisions with wealth management, this is an individual decision that must be made in light of one’s goals, objectives, other assets and income sources, and risk tolerance. There is no global rule. Option A or B isn’t always optimal. The monthly income isn’t the best choice in all cases and neither is the lump sum. There are advantages and disadvantages to either option. The key is making this decision in light of your personal situation.
The remainder of this post will highlight the key decision criteria to weigh when making the pension decision with the goal of optimizing the result for your specific situation.
Step One: Be Proactive
Determine your benefit
The first step is less decision criteria and more deciding to act. Since Intel’s pension plan is a minimum pension plan, you first must determine whether you’re due a pension benefit or not. In our post “Understanding the Intel Pension Plan” we outline this in more detail, but essentially Intel looks at the balance of your Retirement Contribution account when you retire and compares this to an amount they calculate you should have based on your average compensation and years of service. If your Retirement Contribution account falls short, the minimum pension steps in to fill the gap.
While it’s a complicated calculation, the results are easy to obtain. Login to your Fidelity NetBenefits site, then click on Pension. You will see your monthly benefit (if you have one) and you can run estimates based on different dates (red arrow in the image below). This will give you differing monthly income based on when you start taking income and will show the current lump sum benefit.
Your total benefit will not change once you retire. However, your monthly income benefit will increase the longer you defer as less payments are expected to be made over your lifetime. The lump sum benefit will vary as interest rates fluctuate.
The risk in delaying
Once you retire, the fact that the lump sum varies with interest rates is a big reason to be proactive and contemplate making a decision as soon as possible. You can defer making a decision with your pension until age 65, but if you are considering or prefer the lump sum, delaying is risky. Your lump sum amount is determined by discounting the monthly payments over your lifetime back to today. And the higher the discount rate (based on interest rates), the lower the lump sum amount today. (We will see how much in a second). If you preferred the lump sum benefit and interest rates rise, you are now looking at a lower lump sum balance.
Step Two: Quantifiable decision criteria
From a purely financial standpoint, the income vs. lump sum decision has three inputs: the lump sum amount (which is then compared to the monthly income benefit); your life expectancy; and your estimated investment returns.
Lump Sum Balance
Your lump sum depends on your life expectancy and the discount (interest) rate applied to the monthly benefits. Intel uses the life expectancy table published by the Social Security Administration.
Next, the current level of interest rates is going to impact your lump sum balance. The lower the interest rate (or discount rate) used, the higher your lump sum balance. This is good for you as someone with a pension benefit, but bad for the company paying the benefit (as they need to set aside more to fund the pension plan or to payout a lump sum).
And as you can see below in the chart from Michael Kitces, using a common pension discount rate (the Federal General Agreement on Tariffs and Trade), discount rates are historically low currently—meaning the lump sum balances are historically high relative to monthly benefits.
Intel doesn’t use GATT rates but instead uses PPA interest rates in its discount rate (although PPA rates are also low). The PPA rates takes an average of three segments: The first segment discounts the payments made in the first five years, segment two the payments from years 5-15 and the third segment from years 15 on. These rates can be found on the Fidelity site.
This means with rates where they are, around 3.0% currently, a lump sum on an expected $2,000 joint monthly benefit for 30 years is around $470k. However, should rates rise to just 5% this lump sum amount falls by over $100k to $369k.
Next, you should consider your life expectancy when making the pension decision. The longer you expect to live the more valuable the monthly pension income, as you would expect more payments to be made.
Most people are going to start with the general assumptions (which you can find on the table published by the Social Security Administration or in the chart below) and customize from there based on family history, health history, etc. Additionally, you can use an online tool like the one available at Livingto100.com to further customize life expectancy to your situation.
Lastly, your estimated investment returns should be considered. There are a couple of ways to do this. First, you could calculate an IRR for each age (see chart below). This will tell you what your investment return needs to be for each year to match the pension benefit.
First, what you will notice is that if you (and your spouse in the case of joint benefits) die young, you are better off (even with an extremely large investment loss) taking the lump sum. This makes sense since you receive a limited number of payments in retirement.
Next, you should notice that the longer one lives, or expects to live, the higher the investment returns on the lump sum need to be to match the monthly income benefit. However, with rates being low as they are, the breakeven rates at age 90 is about 3% in this scenario and just over 4% all the way out at age 100.
Another way to do this analysis is to look at a scenario analysis. In the table below (click to enlarge) we show multiple different scenarios (by year and investment returns). The cells in green mean that under that scenario one would be better off taking the lump sum and investing it. The cells in red mean the monthly income would be a better choice in that particular case.
Step Three: Other decision criteria
While the numbers are obviously an important part of making this decision, there are a few more factors to consider as well. Things like your individual goals, objectives, and risk tolerance are an important part of making the pension decision as well.
Goals and Objectives
Wealth is only a tool or resource to achieve what you want to get out of life, and since this varies per person, it makes sense that retirees are going to have different goals and objectives. Some are going to prioritize assurance of lifetime spending and therefore a stable pension benefit is attractive. For others, caring for a spouse or other loved one is a critical factor, and therefore the joint benefit or a lump sum (as it can be passed on in death) is more attractive. Others are thinking beyond their lifetime and prefer the lump sum asset as a way to fund charitable and estate goals. And for still others, they prefer the flexibility of the lump sum benefit. Not everyone has stable spending needs over their retirement, and some prefer the ability to spend more in the early years—something that is not possible with a level monthly benefit.
Last, but certainly not least, is a proper assessment of risk tolerance. The key risks one faces are related to the key inputs: life expectancy, investment return and the risk of the monthly benefit in the form of company specific risk.
Answering the key questions surrounding these risks are important, and we find are best done looking at one's overall financial situation and usually with a financial advisor. Key questions are:
- Do I want to bear the financial risk of living beyond the average life expectancy or would I rather give up the investment upside in return for handing off this risk?
- Do I want to take investment risk with a portion of my retirement assets in return for the potential return and estate benefits?
- Am I comfortable with my former employer’s financial health and (or) any pension guarantee, and certain of its ability to payout my pension over my lifetime?
There are many inputs that go into weighing the pension decision. We recommend you be proactive about making the decision and analyze it taking into account your personal objectives, armed with data and after properly assessing your risk tolerance.
 For those who left Intel then rejoined at a later date, the pension calculation will need to be requested from Fidelity and scenarios are not available on demand.
 As of September 2016, the rate on the first, second and third segments are 1.39%, 3.27%, and 4.18% respectively.