One great thing about taking a break from blogging is that once you start publishing again, people who missed your regular updates contact you with words of thanks and encouragement. Such was the recent case with BrewDog. You might remember him from Pension Series Part 19, in which I helped him analyze his annuity vs. lump-sum options connected to a small defined benefit pension from a previous employer. He recently sent me a note thanking me again for the help I lent him nearly five years ago (wow, how time flies)! In his polite email, BrewDog also provided an update on his lump-sum decision. Spoiler alert, he took the cash and forwent the annuity.

BrewDog taking the lump sum wasn’t a big surprise. He was leaning in that direction when I initially helped him. However, the ultimate reason why he took the lump-sum and some of the lessons he’s learned since are worth considering. They include the importance of:

1. making a correct survivorship decision if you take a pension annuity
2. directing your lump sum into a tax-efficient investment vehicle
3. having a clear investment strategy for a lump-sum

If nothing else, I encourage everyone to read the first lesson learned. It’s an important one for any pensionable worker who decides to take an annuity over a lump sum because sometimes life intervenes in unfortunate ways. As for the rest of the lessons, they will help guide anyone who’s got a lump-sum decision similar to BrewDog’s. Regardless of whether you take the lump sum, internalizing the points stemming from his choice will help you make a well-informed decision. And, as I’ve pointed out numerous times, helping you make well-informed pension decisions is what this blog is all about!

Background

To (re)familiarize everyone with BrewDog’s situation, he had a decision to make by age 55. That decision was to take a cash lump sum for a small pension from a previous employer or let it convert to an annuity that would pay $617 monthly starting at age 55. There was no Cost-of-Living Adjustment (COLA) connected to the pension, which means it would have been subject to the devaluation that inflation brings.

By way of an update, BrewDog informed me that prior to 55, he experienced a family tragedy. His father-in-law died unexpectedly. Why does that matter? Well, in BrewDog’s words, while “he wasn’t wealthy by any stretch, he did have a healthy teacher’s pension that, for whatever reason, he didn’t have survivorship on.” Unfortunately, this left his mother in a financial pinch when the pension checks stopped. Again, in his words:

So, we basically squeeze as much as we can from her social security and cash flow from her investment assets. She’s not eating cat food, but it crimps things a bit, particularly with the medical-related expenses creeping up.

These events taught BrewDog to look at his pension differently and gave him the final push toward taking the lump sum. In his eyes, the sooner he could convert the pension into an asset rather than a source of retirement income that could stop if he journeyed “to the Elysian Fields,” the better. Thus, he took the lump sum even earlier than the mandatory age 55 decision and deposited it into a separate Individual Retirement Account (IRA). He then started pursuing a cash-flow and a dividend-growth type of investment strategy.

What Is an Asset?

By labeling his lump sum as an asset, I believe BrewDog means financial asset. Investopedia defines a financial asset as:

A financial asset is a liquid asset that gets its value from a contractual right or ownership claim. Cash, stocks, bonds, mutual funds, and bank deposits are all examples of financial assets.

BrewDog is correct in that pension annuities are not financial assets, primarily because they are not liquid. I point out this fact in my Gap Number Method in Action article, in which I quote financial experts who advise retirees not to treat their pension annuity like a bond. One main reason? You can’t sell a pension annuity in a pinch like you can with a bond and convert it into cash.

While pension annuities come with contractual rights or ownership claims, once the annuity starts, there typically isn’t a way to liquidate them for a lump sum. That’s not always the case, but in general terms, that’s how they usually work. Thus, once you start the pension annuity, it only stops once you die. That’s when survivorship comes, and it determines whether or not those annuity payments continue.

Lesson #1: Getting Survivorship Right

Survivorship is the option to transfer some or all of the value of the monthly annuity payment to a spouse, or in some cases, underage children, when a pensioner dies. It’s crucial to understand this option, as it basically acts like insurance, and like insurance, there is a cost in terms of a reduced monthly annuity value. In the US, the law states that all defined benefit pensions must offer a survivorship option on the annuity as the default. If married, declining survivorship requires the signature of the pensioner and the spouse before the annuity starts.

Why would a married couple decline the survivorship option? Assuming they knew what they were signing, there are several legitimate reasons. Poor health of the spouse, a longer life expectancy for the pensioner, or the ability to insure the value of the pension for less through the life insurance market instantly spring to my mind. However, it’s important to note that waiving survivorship also puts more money in the pensioner’s pocket monthly. On the other hand, if a married couple doesn’t fully understand what they’re signing, or if they are unprepared at the time of the decision, they could be making a tragic mistake.

Is misunderstanding a possibility? Heck yeah, it is. In case you’ve never seen a final pension summary of benefits with all the offers for various forms of survivorship, I’ve inserted a picture of one below. That picture is from a reasonably well-structured summary that actually breaks out how much a survivor would get per survivorship option. I’ve seen ones that are not nearly explanative.

That said, you can see that the titles of many of the options in the picture are not all descriptive. Thus, many pension plans also have a cheat sheet explaining what each option actually does. Now, just imagine getting all this information as part of a larger retirement package, with all the paperwork that needs signing. You can probably imagine how things may get lost, set aside, or overlooked.

Let Me Be Direct

I don’t know what went on in BrewDog’s father-in-law’s circumstances. Still, the result was probably not what anyone wanted or expected. This is why I wrote in my survivorship article that survivorship is one of the few pension decisions a pensioner could absolutely get wrong. In that article, I point out that forgoing survivorship without the backup plan of life insurance puts the survivor at risk. In the meantime, the primary decision maker (i.e., pensioner) is dead and doesn’t get to deal with the consequences. That’s what happened in BrewDog’s mother’s case. She was left to pick up those pieces.

If you’re a pensionable worker approaching the end of your career or just doing some retirement planning and you still need to research all your survivorship and pension payment options, then you should. Once you’ve done so, read my survivorship article. In it, I provide several methods to ensure that pensioners make the right survivorship decision. I consider this one of the few imperatives on my blog.

Finally, if after all that, you’re still confused, want help, or just a second set of eyes, then take a look at my Services page and consider contacting me. Analyzing pension benefits options, especially against the alternative of taking a lump sum, is the bread and butter of my paid work. Since my move to a pay-for-analysis model, two-thirds of my clients have had questions about the supportability of various payment and survivorship options connected to their specific pension plan. Based on the enormity of their decision and the fact that most pension payment decisions cannot be undone, they felt the small amount they paid was worth it.

Lesson #2: Lump Sums and Tax-Deferred Accounts

Let’s move on from directives and sales pitches, shall we? Once BrewDog decided to take his lump sum, he directed it into a tax-deferred Individual Retirement Account (IRA). Why did he do this, and why is it so important? To avoid paying taxes upon receipt of the lump sum.

In the US, the value that a pensionable worker accumulates in their pension plan is often considered deferred compensation for tax purposes. This means the pensionable worker has yet to realize their benefits as income and, therefore, has not paid taxes on the money earned. They will only pay taxes once the pension payments start, or they take their pension as a lump sum. Not all defined benefit pensions are structured this way, so it’s essential to check if yours is. However, in most cases, this is how they work.

Some workers, especially those who stay at one employer while moving up the ranks and pay scales, can amass quite a significant value for their pension’s lump-sum offer. I recently helped someone whose lump-sum offer totaled over $1.5 million. Hypothetically, if that person had chosen the lump sum and not directed it into a tax-deferred account, then they would have found themselves paying tax at the highest marginal federal income tax rate in the US for this year, which is 37%. That doesn’t include state taxes, either.

Furthermore, lump-sum offers do not factor the need to pay taxes into their calculations. As a result, had that client taken the lump sum, the taxes would’ve theoretically cut the value of the lump sum, in comparison to what he could’ve made by taking an annuity, by 37%. This would’ve made the lump sum noncompetitive with the annuity options in terms of mathematical efficiency, assuming the money wasn’t directed into a tax-deferred account.

The Beauty and The Beast of Retirement Accounts

Now, the beauty of directing a lump sum into a tax-deferred retirement account like a traditional IRA, which is what BrewDog used, is that it allows the recipient to defer paying taxes on the money until it is withdrawn from the account. Thus, the money can grow and compound over time without an initial reduction in value due to taxes. And, since money can be withdrawn from an IRA in much smaller amounts than the lump sum’s total value, it makes the tax payments a lot more manageable once the money is finally withdrawn and “realized” as income. In fact, as the Mad Fientist famously addressed all the way back in 2013, using a tax-deferred account like a traditional IRA or 401K is the most efficient way to grow money for retirement, even for those who retire early.

Why does retiring early matter? One of the drawbacks of directing any money into an IRA, let alone a lump sum, is that it locks the money behind a 59- and 1/2-year age requirement for accessing the money penalty-free. Need it sooner than that, and it is typically going to cost you 10% more, in addition to the taxes, at least in the US. Thus, if you were planning on using your lump sum to finance a cruise around the world, then directing that money into a tax-deferred account may not be the best idea. Then again, what the hell are you using your lump sum money to buy a boat for anyway? It’s meant to sustain you in retirement, just like the pension annuity would’ve, not to have fun!

Lesson #3: Have an Investment Strategy

Speaking of sustaining you in retirement, BrewDog’s plan was to direct the lump sum into an IRA, invest it using a cash-flow and dividend-growth strategy, and harvest the monthly equivalent (or more) than what his annuity would’ve paid ($617). Has it worked? So far, it has. Here are some results he provided me:

In 2021 (partial year), my average monthly dividend payments were $1058. 2022 was when the REIT (real estate investment trust) crashes started, and my monthly average fell to ~$900/month. In 2023, it ran ~$1200/month, so it came back pretty good. Already, I am above what the early pension monthly payments would have been ($617/month), so I’m happy with that.

Before I argue the finer points of a dividend-seeking investment strategy, let me just point out the importance of Brewdog having and implementing an investment plan. The discipline with which BrewDog developed and implemented his plan has obviously served him well. It means that his lump sum money is working as designed by providing income equivalent to or in excess of the original annuity’s monthly value.

This is only sometimes the case for retirees. In fact, as the most recent MetLife research shows, 33% of retirees who take a lump sum from their retirement plan deplete it within 5 years. This study analyzed people taking lump sums from their defined contribution (DC) retirement plans and not their defined benefits (DB) plans. As a result, the driving factors for taking lump sums may be different. However, this is the second study by MetLife, and it shows an increasing trend of people spending the entirety of their lump sums within roughly 5 years of retirement.

Can the results of studies by an insurance company with a vested interest in selling insurance annuities to retirees through their DC retirement plans be trusted? While I think there is a conflict of interest, the results of their two studies speak for themselves. It’s the same conclusion I came to when citing the original report for my academic examination of lump sum offers for part 21 of the Pension Series. What’s more, I continue to see articles like this one from Wharton Business School, which discuss how hard it is for retirees who take lump sums from their DB pensions to generate the same returns as their pension plans. As a result, BrewDog’s strategy and discipline have helped him navigate around some severe hazards that other retirees have fallen afoul of.

The Dividend Investment Strategy

I’ll be the first to admit that using a dividend investment strategy as an alternative means of reproducing the same amount of cash from a lump sum that a pension annuity might produce has yet to be featured on my website. That said, guest author Chris Pascale summed up the general strategy well back in 2019 in his Golden Albatrosses Killed Your Golden Goose article. The primary reason I have yet to address the strategy, though, is the one major drawback that BrewDog himself points out when he mentions the REIT crash in 2022 — companies can cut dividend payouts in times of financial trouble.

Thus, dividends are less reliable than annuity payments from well-funded pension plans. Nor do they come with the legal guarantees that pension payments come with. In other words, companies are under no legal obligation to continue to give dividends in the future. History has plenty of examples of companies that went from paying significant dividends for decades to stopping them when times get tough. Check out the history of GE’s dividend payment post-2008’s Great Financial Crash if you don’t believe me.

Of course, I’m not trying to throw out the baby with the bath water. Despite the reliability issue, a dividend-based strategy for generating cash flow in retirement is a legitimate one used by millions of retirees (or their portfolio managers) to produce (at least some) of the money they need to live off of in retirement. Like with any investment strategy, though, it comes with a list of pros and cons that is well worth considering.

Conclusion

First, thank you to BrewDog for recontacting and updating me on his story and letting me use his update to create another article! As mentioned at the beginning, it’s always nice to hear how folks I’ve previously helped are doing. I’m glad to see that he is doing well and happy with his lump-sum decision. I also hope you found his update valuable.

Secondly, if you’re getting close to the end of your pensionable career, then definitely keep in mind the three lessons I gleaned from BrewDog’s update. The first was for those who decide to annuitize their pension; they need to understand the survivorship options and choose wisely. The second was a tax lesson for those taking a lump sum; they should ensure that it’s directed into a tax-deferred account. The third was also for those taking the lump sum; they should create and implement an investment strategy for when they receive the lump sum. Putting the applicable lessons to use will help pensionable workers achieve a successful defined benefit pension-based retirement.

Finally, if you have a question about any of the topics I covered in this post, feel free to reach out or leave a comment. Alternatively, if you would like some help with your pension situation, then there’s never been a better time to contact me (grumpusmaximus@grumpusmaximus.com). As BrewDog’s efforts to recontact me show, my work tends to stand the test of time.

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