Case #1: Building a "Pay Off Debt Quicker" Fund
A 47-year-old couple was wanting to retire in eight years at age 55. They had
$500,000 in investable assets and were making contributions of $650/month
to their existing investment vehicles.
If they had no debt, their existing investments were on track to reach their
financial independence number if they continued to contribute $650.
BUT, by contributing $650, it left them with limited cash flow to pay down
their outstanding mortgage, credit card & line of credit. As a result, they were
on pace to retire at age 65 instead of age 55.
With proper risk education, we showed them how they could improve their rate of return to reach their financial independence number with only $150/month contributed instead of $650.
This allowed us to repurpose $500/month towards debt, which would have it fully paid off before their retirement goal age of 55.
Case #2: Building your Own "Personal Pension"
A 26-year-old school teacher wanted to leave the profession to start
her own business, but was scared to lose out on the security that
comes with having a pension.
This individual had $97,000 of investable assets (outside of her
emergency fund) earning less than 1% return at the bank.
She wanted to invest, but didn't know where to start. We showed her
how to use an online investment calculator to project what her existing
savings and future contributions could grow to by the time she was 55,
60 and 65-years-old.
In her first three years as a client, her portfolio with us earned nearly an 18% average annual return, turning $97,000 into $150,000.
She knew that even if the fund performance decreased to 8% over time, this $150,000 would grow to over $1.6M by age 60 and would be more than enough to replace the pension she would have received.
This education and understanding of compound interest and how to maximize your rate of return reduced anxiety and gave her the confidence to pursue a dream.
Case #3: Another Underperforming Portfolio
A couple in their late 40's came to us for a free consult. They were
skeptical of our rate of return projections because they had always
identified themselves as medium-to-high risk investors, but never
saw the regular annual returns promised by their previous advisors.
They had $300,000 of total investable assets, had been investing for
15 years, and their contributions (rather than interest from investment
growth) made up the majority of the balance.
Through their first five years of working with us, their initial $300,000, plus an additional $130,000 in contributions to total $430,000 has experienced a double-digit rate of return.
With an account balance just shy of $700,000, nearly $300,000 has been earned in interest in spite of volatile market conditions.
We have also adjusted the portfolio from being 100% taxable on disposition to having over 30% of the assets in tax-free vehicles.
Case #4: The Cost of Staying Locked In
A 25-year-old male switched jurisdictions in a government role and was
given two options with the $40,000 that had accumulated in his pension:
1. Use the $40,000 to "buy back" service time. Meaning, he could retire
with a full pension at age 55 instead of age 58.
2. Transfer the $40,000 into a personal retirement account, accessible to
him at age 55.
Because some people aren't aware of how to use compound interest to
make their money work for them, they tend to choose the "security" of
the buy back.
Let's play out what they looks like.
Scenario #1: retire with a full pension three years sooner.
Let's say that pension is $80,000/year (which is a huge overstatement).
Getting it three years early would mean an extra $240,000.
Scenario 2: let $40,000 compound for 30 years.
At an 8% return, this would be over $400,000 that he would have access to, that can be liquidated anytime after age 55, not just from age 55 to 58.
If there is anything we learned from the previous example, it is that when you have a great advisor, it can be advantageous to be in control of your assets.
Many people are leaving thousands and sometimes hundreds of thousands of dollars on the table by not at least considering the option of taking their pension as a one-time lump sum (commuted value) rather than a monthly amount.
It isn't always the right fit, but it is always worth doing an apples-to-apples comparison of your options.
The example below was for an individual who, at the time of being introduced to our team:
Here was the simplified version of her options.
How it Would Play Out
This individual would work five more years full-time until age 58, then receive a $3,500/month income for life.
Pros
Cons
How it Would Play Out
At this point, they can either:
For context, even at only 6% return, $800,000 would grow to $1,070,000 in five years.
Using a "How Long Will it Last Calculator", assuming $1,070,000 invested, a 2% rate of inflation, and a 5% rate of return, if this individual wanted to withdraw $3,500/month (to receive the same monthly income as what option #1 would have been, it would take 47 years (age 105) for her investments to reach zero.
Using the same calculator, you can also determine how much she would be able to withdraw over a shorter timeframe. For example, for the investment to last for 30 years from age 58-88, she would be able to draw out about $4,500/month (which is $18,000/year more than option #1).
Here is one more example of where controlling your own assets rather than leaving them to a pension company could be lucrative.
Let's say you become terminally ill and are given 1-2 years left to live.
Pros
Cons
This couple decided to take the lump sum.
They liked the idea of being able to have flexibility on when to withdraw the wealth as some years they planned to work part-time in retirement and needed less fixed income, while other years they wanted to be able to not work at all and travel, in which case they would draw out more income.
They also wanted to make sure that any of what was left of the wealth they accumulated was passed on to their kids and not just funneled back to the pension company.
Lastly, having seen health issues arise in the past within their family, they liked the idea of having access to additional wealth in case it was needed for illness treatment or long-term care.
Required Conversation
Upon choosing this option, we needed to ensure:
To Summarize
The answer is definitely not as clear cut as "pension good, lump sum bad" or "lump sum good, pension bad". Which is why it is important to know and discuss all of your options.
Every family's situation is different and the final decision will factor in a mix of wants, needs, goals, math and emotion.
We don't yet know which option is best for you, but we do know that it is worth completing a proper breakdown of all of your options.
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