# Interest rates & pension vs. commuted value



## jtmann (Nov 5, 2009)

My brother recently switched jobs (he's 35 with 20-25 years left before retirement) and he has a choice to make re: keeping the pension for future payout on retirement or taking the commuted value now. 

I know this is a well-worn topic and there are a lot of considerations beyond the couple details I am providing to you here. But I read an interesting article on the topic lately that said "The current low interest rates used to calculate the commuted value give a low hurdle rate for a balanced investment approach to outperform in the long term." 

That was my feeling anyway based on some quick numbers I did before reading the article (in calculating the commuted value my brother's employer assumed 2.50% interest rate for first 10 years and 4% thereafter).

Again, recognizing there are other considerations, the low rate environment and low rate assumptions used to calc commuted make me inclined to go with the commuted value payout. Anything major I'm missing in my logic here?

Thanks very much


----------



## MoneyGal (Apr 24, 2009)

The current low interest rates create a very LARGE hurdle in that the future promised income stream cannot be discounted by a high assumed rate of return. The author of the article can't have it both ways: future pension obligations are larger (not smaller) in a low-interest rate environment. You can't say low rates help you on one side and ignore how they "hurt" you on the other.


----------



## jtmann (Nov 5, 2009)

bump


----------



## Four Pillars (Apr 5, 2009)

You haven't explained how you did your analysis, so it's impossible for anyone to know if you have made any mistakes.

Any kind of decision like this involves a ton of assumptions, especially for someone fairly young, which in my mind makes it impossible to truly calculate which option is better.

The one thing I've gotten out of previous discussions on this topic is from MoneyGal who has pointed out that DB option provides for longetivity insurance (ie it's guaranteed for life), where as the payout/self investment option does not. 

You should check out her book (Pensionize Your Nest Egg) - it's well worth reading for someone making this decision. 

My review: http://www.moneysmartsblog.com/pensionize-your-nest-egg-book-review-milevsky-and-macqueen/

Another item to think about (which I got from the book) is to consider brother's retirement income sources. Someone who is in line for a lot of pension money ie OAS, CPP, defined benefit plan - probably doesn't need any more guaranteed income in retirement. On the other hand, someone like myself who will only get OAS and CPP and will get most retirement income from investments, will likely benefit from having more guaranteed income. 

This could mean I might convert some investments to annuities at some point.

If I had the chance now to increase my guaranteed retirement income either by keeping a pension (like your bro) or contributing to an increased CPP - I would take it. On the other hand, if I were likely going to be continuing membership in a pension plan (even in the new job) for the rest of my career - then maybe taking the cash payout is a good option.


----------



## wandernorth (Mar 30, 2012)

Four Pillars said:


> You haven't explained how you did your analysis, so it's impossible for anyone to know if you have made any mistakes.
> 
> Any kind of decision like this involves a ton of assumptions, especially for someone fairly young, which in my mind makes it impossible to truly calculate which option is better.
> 
> ...


Thanks for replying. Didn't realize annuities is NOT life time income.
Anyway,just want to compare those three options from pure total return wise. You answer did opem my mind to know there is more things than just total return.


----------



## Four Pillars (Apr 5, 2009)

wandernorth said:


> Thanks for replying. Didn't realize annuities is NOT life time income.
> Anyway,just want to compare those three options from pure total return wise. You answer did opem my mind to know there is more things than just total return.


Annuities are guaranteed.


----------



## wandernorth (Mar 30, 2012)

Four Pillars said:


> The one thing I've gotten out of previous discussions on this topic is from MoneyGal who has pointed out that DB option provides for longetivity insurance (ie it's guaranteed for life), where as the payout/self investment option does not.


I am confused by this statement. I assume you meant annuities when you said payout.


----------



## wandernorth (Mar 30, 2012)

Four Pillars said:


> Annuities are guaranteed.


If that is the case, it is a fair comparison to DB plan as both are guaranteed. Can someone give one a rough idea how much monthly payout will be for me when I turn into 65 with lump sum purchase of $22,000. 40,male,good health.


----------



## Four Pillars (Apr 5, 2009)

wandernorth said:


> I am confused by this statement. I assume you meant annuities when you said payout.


I see what you mean. I wasn't very clear.

When I was talking about the 'payout' scenario, I was referring to the situation when someone takes the payout money and then invests it - in GICs, stocks, funds whatever. There is no longetivity guarantee with those investments.

If you were to take some or all of that money and buy annuities, then you have added the longetivity guarantee back into the equation.

As MG has noted however, the payouts from a decent DB pension are likely significantly higher than the equivalent annuity payments which could be purchased with the 'payout money'. In other words there isn't any good reason to go from a good DB pension to an annuity, unless you are concerned about the viability of the DB pension plan.

I'll let MG answer the specific payout amount questions - she is the actual expert here.


----------

