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When people retire, many face the biggest financial decision of
their lives. Do they keep their pension and its monthly payments or
do they take the lump sum? The pension provides security and peace
of mind, but having the lump sum would really be nice, too. Which
should you choose? Here’s a simple analogy that might make that
decision easier.
Steve, age 65, is retiring after 30 years of working for the phone
company. He logs on to the company benefits website and sees that he
has a decision to make. He can get a lump sum payment from his
pension of $300,000 or he can instead get $1,817.94 a month
guaranteed for the rest of his life.
Steve likes the thought of getting a onetime $300,000 check, but his
wife likes the security of a monthly guaranteed payment. What should
he do?
First, Steve (and you) need to understand the underlying concepts
involved in this decision. Either way, you have to have monthly
income to live on. Think of that monthly check as 10 gallons of
milk. You have the choice of being guaranteed that you will receive
10 gallons of milk a month for the rest of your life or, you can
take the cow that produces that milk instead.
For a moment, let’s look at it from the side of the one guaranteeing
that monthly supply of milk. They own the cow and know it should
produce 13 gallons of milk each month. (Don’t laugh farmers, I’m a
city boy!) In that situation, would they guarantee someone 13
gallons a month? Of course not.
They have the responsibility to care for and manage the cow. If they
don’t do that right, she (I do know that much…) may not produce as
much milk. Plus, they have to keep some of the milk for themselves,
or it’s not worth doing in the first place.
To decide what stream of milk to guarantee, they start with what
they know the cow will conservatively produce. Then they subtract
out the amount of milk they want to keep, and they see that they
should have 10 gallons left over each month. Thus, they guarantee to
deliver 10 gallons a month to you. It’s the same with the insurance
company; they won’t give you all the ‘milk’ the ‘cow’ produces.
Of course they own more than one cow, but they aren’t going to put
themselves in a position where they regularly have to take the milk
from another cow to make their guaranteed delivery to you. In the
same way, do you think an insurance company is going to guarantee
you so much in monthly payments that it might force them to take
money from somewhere else?
What if Steve decides to ‘keep his cow’ instead of receiving the
guaranteed monthly stream of milk? First, he and his wife get all
the milk. They might even breed the cow to get a calf. Second, if
Steve dies, his wife continues to get milk. Third, the cow can then
be passed on to their children when they both have passed away.
Fourth, if there’s an emergency and push comes to shove, they can
sell the cow and use the money for other things. None of these
advantages exist if all you get is the guaranteed stream of milk.
With ownership comes responsibility, though. The cow has to be cared
for so its milk production doesn’t decrease. The cow has to be
protected so it doesn’t run off or get stolen. If (like me) you know
nothing about caring for a cow, then you will need to hire someone
else to do it for you. And that hired hand might be more concerned
about his or her paycheck than your milk supply. Certainly the
amount of milk each month will fluctuate. By owning the cow, though,
you receive some milk and have the cow to boot.
Hopefully, this analogy will allow you to better understand the
decision you face. Receiving a lump sum allows you to maintain
control and maximize your returns. But if you know nothing about
investing, you may be a sheep waiting to get fleeced! Don’t believe
everything you hear and research every financial decision before you
make it. Feel free to contact me for help.
Nationally-syndicated financial columnist and Certified Financial
Planner® Jeffrey Voudrie provides personal, in-depth money
management services and advice to select private clients throughout
the USA. He’ll answer your financial question – FREE at
www.guardingyourwealth.com.
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