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The Clark Howard Podcast
02.11.25 Ask An Advisor With Wes Moss
00:38:22
Monthly Pension vs. Lump Sum: The 6% Test and Is the Market Too High To Keep Investing?
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- [00:00]
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- [01:05]
Wes Moss
Welcome to Ask An Advisor, our weekly show where we answer your questions about investing, retirement and all things money.
- [01:13]
Krista
Krista, hello.
- [01:14]
Wes Moss
Hello, Wes Moss. We are back this week and you're going to talk about something we get a lot of questions about on the Clark Howard show but we rarely talk about and that is if you're lucky enough to have a pension, which is, you know, pretty legacy at this point but many people do.
- [01:28]
Krista
Still a lot of people that have them.
- [01:29]
Wes Moss
Still a lot of people that have them. And if you're given the choice, take a lump sum or get the pension payout, what do you do and what else are you going to talk about later on today?
- [01:38]
Krista
Well, the other thing is that so far in 2025, the markets have been strong again and they're kind of bumping up and hitting new highs and it's kind of nerve wracking to invest around that time. So I want to talk about some of the history there.
- [01:51]
Wes Moss
I love it and I have lots of great questions for you today.
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Krista
I'm excited.
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Wes Moss
We'll get started.
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Krista
Let's start with pension lump sum. Yes. So there's a couple of things. Companies don't love to be in the news about this because no company likes to say how many people they're laying off. But the reality is that in the multi million workforce that we have companies from time to time say, wait a minute, we've got a little too many employees and we've got pension obligations and people are living longer. A couple years ago, 2019, GE announced and this was a headline. They offered 100,000 people. They wanted to downsize by 100,000 people. Typically, when that happens, those with a pension are going to have to make a decision. Do they take a big chunk of money, a lump sum, or take a lifetime payout either for their life and or their spouse's life instead of the lump sum? That's a tricky situation. I think that we're gonna hear a lot of this with the government employees this year. There's been an offer to 2 million some government employees to resign or not work anymore. And a lot of those folks have pensions. I've heard from a lot of those people now they're not gonna probably have to make that decision until later in 2025 at. There's gonna be a lot of that coming. So the question is, what's a better deal, the big chunk of money or the monthly almost guaranteed pension for life? And I look at it first with the math. So I think the math is the first way to start. And very simply, you're gonna get a couple pieces of paper and it's gonna say, here's your monthly amount that you can choose to take. And then there's another amount, typically, and there's usually five or six options. Here is that. Here's an amount that'll be less per month that will cover you, your life, and your spouse. It's called 100% Joint Survivor. So let's say one is $10,000 a month. It's just your life. You die in a year, it's gone. Nobody gets anything else. I've almost never seen anybody take that. But once in a while, that might be the right option. More typically, what I will see is folks, they'll take the one that covers their life plus someone else in case something happens to them. So it's going to be a lower amount because the annuity company on the annuity tables have to cover two lives. So the longer the expected life, the lower the payout per month will be. So let's start with that. Let's say instead of the $10,000 single life per month, and these are big numbers, that'd be a great pension to have. It's $8,000. So we take that number, you take your monthly pension amount and you multiply it by 12. You get your annual amount, and then you divide that number by the lump sum that you could otherwise take. And if the monthly pension amount is 6%, I call this the 6% test, is 6% or more. Then you can start thinking, well, maybe I do take this monthly amount, because it's quote guaranteed, it is for the rest of my life, the rest of my spouse's life, and I don't have to worry about investing it. So there's some real benefit to that. If it is anything 6% or lower, then I think it's not a very good deal because they're essentially giving you your own money back. We think that over time, the way I look at this, not just from an investment perspective, but you can take your own money. You take 5% out for 20 years before you run out. That's just without any sort of rate of return. So 100 divided by 5 is 20. If you're only getting 6%, that's just the bare minimum they would put promise you before you would consider taking the monthly amount. Now, I've run a lot of pension numbers over the last couple of years and sometimes they're 7% or 8%. And that really makes people think, well, it's a pretty good rate of return. The other thing you have to think about is that's a static number. Now, some pensions, like for instance, the teacher pension, the trs, typically in most states, those pensions do increase for inflation. So that's a consideration. Most, if not everyone, I've ever seen corporate pension is static. So it might be Your offer is $6,000 a month. Okay, that sounds pretty good. But it's still going to be $6,000 a month in 10 years and in 20 years and in 30 years, if you live that long, it'll still be $6,000 a month. So inflation will have reduced how powerful that money is. You got to really take that into account. So, so there's a lot of considerations. Do you have any other income streams? Do you have any other savings? Let's say you don't have a lot of liquid savings that would make someone lean towards taking the lump sum amount because the money is yours. You can typically just roll that into an ira. It's got to be the right decision for you. But that's one of those decisions. If that works and you want to invest in an ira, you can take the lump sum and you can roll it into an ira. Again, if the investment choices in your other plan maybe are not something that are working for you, you have the option to roll it in your own ira, invest it, and then just create your own pension. So that's the way I would look at this. And let's just run some quick math here. I'm going to make these numbers up. Krista, give me a monthly pension amount $2,500. $2,500. So let's say you get 2,500 bucks per month as the offer times 12 is $30,000 a year. Okay. Would you take $30,000 a year or would you take a lump sum of $200,000? What would be a better deal?
- [07:24]
Wes Moss
I would say taking the monthly pension would be a better deal in that case for sure.
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Krista
And it is, because that's 15%. 200 grand sounds like a lot. But if they're going to promise you $30,000 a year, 30 divided by 200 is 15%. You run through that way above the 6% number. Now, what if I give you a higher lump sum option? Okay, $30,000 a year, or let's say $400,000 lump sum.
- [07:51]
Wes Moss
Okay, that's tougher.
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Krista
That's tougher. That's probably $30,000 a year for life or 400k.
- [07:59]
Wes Moss
Probably 400k.
- [08:01]
Krista
Okay. I would say the pension still is above the 6% test there. It's pretty good 7.5%. But for most pensions, I see, it makes it to be a tough choice. They're usually, when math, it's usually between five. And then you say, oh, I probably want the lump sum. But then they'll creep up to seven, seven and a half, like the example we just gave. And it makes it a little tougher. More often than not, I'll see people say, I'd rather just have the money, the bird in hand. I'll invest it that way that if something happens to me, I know it goes to my spouse. I know it goes to my beneficiaries. But if you've already got a bunch of savings, one of the traits of the happy retiree, they have three or more income streams. So let's say you only have Social Security 1 and Social Security 2 for you and your spouse, and that's it. At that point, if you have a decent pension offer, if it's seven and a half percent, you at least would consider taking the pension monthly pension amount because it helps with your income streams and you've got some other money saved. So there's a lot to think about. But when it comes to taking a lump sum versus a pension, start with the 6% test.
- [09:09]
Wes Moss
Okay, we're going to go to some questions now. This one came in from Bruce in North Carolina. I have my 401k invested in Vanguard Target Retirement Fund 2025, but I will continue to work until March of 26. I'll be 67 years at that time. Should I move My money to the 2030 Target Fund or leave it alone.
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Krista
This question for Bruce. The short answer is you got to get your allocation right. A target date fund is just a shortcut to do that. I think we think these target date funds are kind of some automatic magical as if they know you and they know your retirement. Just because you say I'm going to retire in 2030, that means I need the 2030 fund. That's not correct. It's a good way to look at it, but it's not necessarily a great way to look at it because first of all, target date funds are not all created equal, meaning some have a ton of international, some get more conservative more quickly. The way I see this is that most target date funds get to the point where about 50% of the fund is in bonds by the time you get to your retirement year. 2030 fund, you say, I'm going to retire in 2030. Typically that target date fund, and they're almost every mutual fund family has a bunch of target date options. But I think they get overly conservative, overly quickly. Imagine if you retire and you're 58, that'd be great. And you've picked this target date fund that matches the year you retire and now you're at 50% in bonds right out of the gate and then it gets even more conservative for the rest of your life. So by the time you're 70, you might have 70% of bonds. I love the allocation that target date funds give people because they automatically balance you between US Stocks, international stocks and a couple different types of safety, which I love. But they typically get really, I would say the percentage gets really high in conservative investments almost too soon, particularly in the world we live in where God willing, we're in retirement for 20 or 30 or maybe even more years. Bruce, it's not about the target date fund and what it does. It's about what allocation is right for you. If you want to have 60% in stocks and only 40% bonds, then either find the target date fund that is in that posture or just use the funds of that fund family to create your own balance. And then you can choose when to make it more conservative or more aggressive whenever you want to.
- [11:43]
Wes Moss
Bruce Great Ron in North Carolina wrote in with this Wes when analyzing stocks and ETFs, one important financial metric is its beta. However, this term seems to be a misnomer as it seems to be used synonymously with the term volatility. Also, when checking the beta values across financial various financial websites, each site has often assigned a Very different beta value to a given stock. Can you please clarify the meaning of the terms beta and volatility and provide guidance on where to get an accurate beta beta value.
- [12:16]
Krista
Wow. Good luck, Ron. Because they're different everywhere. A couple of distinctions here. Volatility just means how much any given asset class has a propensity to move up or down. Beta similar, and this is why I get that Bruce is a little confused on that. But beta is volatility relative to something else. A beta for a stock usually is measured against the S&P 500. So if the S and P beta, let's say is 1 and a stock is 0.5 of a beta, that means in any given movement over the course of, let's say a year, the stock market's up 20%. Well, that stock with half the beta may only be up half. If the stock market's down 20%, maybe that stock's only down half of that, only down 10. Same thing in reverse. A beta of one and a half will have 50% more volatility relative to, in this case the S&P 500. What makes it hard to standardize and find a beta and why they're different on every site is that very often it's for different periods of time. Well, what's a beta over a year? What's the beta for the stock over a three year period? Over a five year period? And different websites will use different time frames to assign where the beta is relative to. And that's why it's going to be hard to find an exact beta from site to site to site. I think it is a really good way to look at it because. Because a lot of investors, not every investor, like a little less volatility than the overall market. So Whether it's a one year or a three year beta that is underneath or below the S&P 500's beta, I think that's a smart thing to look for. The other thing again on top of that, more icing of why this beta conversation could be a little confusing is that it doesn't have to be relative to the S&P 500. The beta of a stock can be relative to the Russell 3000 or the NASDAQ. So it's a volatility term, but it's a relative volatility term, Ron. Hope that helps.
- [14:20]
Wes Moss
Great. This question came in for you from McKay in Colorado. I've been helping family prepare for retirement by motivating them to save more. I have one family member, however, who is going to sell their business and that's going to be a big chunk of money that fuels their retirement. What do we need to consider the situation? Is there somebody we should be consulting to structure this best for tax purposes? And how should I be allocating their current savings to their 401k, knowing that this huge chunk of money is on the horizon and could be used for the cash bucket or the bond bucket?
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Krista
Oh, sounds like McKay is the family advisor now. McKay, you may not want to hear this, but I'm going to. The short answer on this one is lawyer. Lawyer, estate planner, cpa, then financial advisor.
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Wes Moss
Okay?
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Krista
And I've been through a lot of these for families I've worked with over the years where they're selling a business. And I've been through this myself as well. Selling a business. You're thinking, well, I'm going to sell the business and then I've got all this money and I've got to invest it. And that's what you're focused on mentally. Well, how am I going to invest the money? Wait a minute. Okay. There's so much that goes into it before you get the money because you got to figure out the terms of the deal. So you need a good deal attorney. Million dollar business sale. Well, you need a deal attorney. 5 million, 10 million, 20 million. So anytime you're selling a business, it's usually a pretty big number. So you need a deal attorney to make sure the terms of the deal are right. The second thing would be an estate planning attorney. Where are these assets going to go? Are they going to go into a trust? Are they going to go into someone's personal name? Those are all huge considerations because that also can impact the taxes. Now you need a cpa. So your CPA should be planned. You should be planning what this sale looks like. Is it over time? Is it one lump sum? Is it long term capital gain? Is it ordinary income? You gotta be able to plan for that because if you don't know how much there will be in taxes, then you really don't know how much you're going to be investing after the taxes are paid and then when the taxes are due. So as much as nobody likes paying lawyers in a big transaction, this is where I've seen them really come in handy. So deal attorney, estate planning attorney, cpa. And then you can go to a cfp and maybe the CFP or a financial advisor is quarterbacking all that to begin with. Maybe that advisor is McKay. But all these disciplines really matter right now when you're selling a business and then you can figure out what the best way to invest it over time.
- [16:51]
Wes Moss
Okay. And maybe for that financial planner. And coming up next, you're going to talk about how to invest when the stock market is around all time highs.
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Krista
What do you do when the market's already high?
- [17:04]
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- [17:38]
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- [18:02]
Krista
Welcome back to Ask an Advisor. I'm Wes Moss. Chris of Dibiaz. Hello.
- [18:08]
Wes Moss
Welcome back.
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Krista
Well, we're talking about the market for a minute here.
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Wes Moss
We are.
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Krista
I think we all struggle with this. We're born and we're taught and we hear forever. We buy low and we sell high high.
- [18:21]
Wes Moss
Ideally.
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Krista
Ideally, that's what we want to do. What makes investing really difficult sometimes is that we go on these longer stretches when the market's doing pretty well and you've got the market 2024. I remember the beginning of the year. We hit an all time high and everyone's scared. Well, I don't want to put money to work when I'm at an all time market high. So we went back and looked at history and have been doing this now for a long time. And talking about these statistics, we tend to get more all time highs than people really give credit to because they don't really make the news. So The S&P 500 can go up a half a point and it can be an all time high. So it doesn't get a lot of fanfare. They happen way more often than we think. There's something like since 1950, there are over 1,250 new market highs. There were 57 new market highs in 2024. So at the beginning of the year we hit an all time high. And you said, well, I'm going to wait, I've got ca, I want to invest it, but I'm not going to invest it because we're at an all time high. Guess what? You missed out on a 25% rate of return. So last year is emblematic of actually what happens over the course of history. All time market highs tend to come in big clumps. We'll get 20 of them in a year, 30, 40 last year, 57 all time highs. Then we'll go into years that are in bear markets and we'll go a year or two or maybe more without any all time highs. So they tend to come in clumps. So first of all, they're not that rare. Second of all, if you go back over the course of history and I pulled some numbers from 1970 until through last year, if you were to choose to only invest money once the market hit an all time high, the average rate of return over the next year is actually higher than just investing in any other random day. That was a study by J.P. morgan. There's another study that looks at 1988 through 2020 and it shows that investing at an all time high was even greater. So picking the hey, the market hit an all time high. Well, 14.5% average rate of return a year later versus any random day is more like 11. So I go through this data and I think, well, why, why is the market even better once it's already hit a high? I think a big part of it is a lot of things have to be going right to get to an all time high. So you've got to have a pretty good stock, you've got to have a pretty good economy, you've got to have inflation relatively in check. You've got to have a pretty decent outlook for the economy and for corporate earnings in order for the market to get to the point where it has an all time high. And I think there's a little bit of this, what I would think of a flywheel effect. Once you get some momentum going, it's a little harder to stop the momentum. And this is in a positive way. So the numbers support that once the market hits at all time high, there's a high propensity that continues to have more all time highs. And the frequency of corrections, so negative 10% rates of return once you hit an all time high is actually lower over the course of economic and stock market history. It's a lower probability than when the market is not in an all time high, which is also interesting. So it's almost as if once the market is doing well, it tends to continue to do well for a little while. Now, it doesn't mean we don't go back into corrections. We hit a recession. Market corrects down 10%. Sure. Bear market down 20%. But the other really big part of this is that bull markets last a lot longer than bear markets. So bull markets tend on average to last or the median length of a bull market is something like 46 months. That's a long time. Let's call it four plus years. And the average bear market is more like five years. So median four, average five bull market, good markets. The average bear market is much shorter than that. It's one quarter of the length on average over the course of history. So that's the other reason why you don't necessarily want to try to wait, wait, wait, wait, wait to put money into the work just because the market's done well. To wait for a bear market because you can miss out on huge, huge gains that you'll never be able to recoup just because you got to the point where I bought when the market was down 20%. So it goes a little bit against our natural instinct. We want to buy when market's already down. The other thing, when it comes to markets being down, most people don't want to buy when markets are down 20%.
- [22:47]
Wes Moss
True, but you're buying at a discount.
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Krista
You're buying at a discount. But there's even more fear sometimes the markets are not doing well. So investing is about participation, it's not about perfection.
- [22:59]
Wes Moss
Would you say dollar cost averaging is the key?
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Krista
Dollar cost averaging is a wonderful robituss and elixir for this problem of I'm not comfortable putting money to work, I've got some cash. If you're not comfortable putting to work, figure out a way to just dollar cost average it in over the course of six months. That's another way to kind of fight this mental block that a lot of investors have.
- [23:25]
Wes Moss
Stanley in Iowa wrote in with this one for you, Wes. I currently make Roth contributions to my 401 up to the max and also contribute a significant amount into a joint brokerage with my wife for liquid. However, I was recently educated that a better option is to make a mega backdoor Roth contributions periodically roll over the funds to my Roth IRA so I can withdraw the contributions as needed. It seems like a cheat code since withdrawing contributions is not a taxable event. But after some quick research, it seems there are some caveats to doing this. That is additional tax forms, the spouse has no assets, etc. Is that really a better route or should we continue putting money into the brokerage account?
- [24:07]
Krista
The short answer is it's not a cheat code, it's a real thing. If you go online and look this up, you're going to find 20 different articles about it from lots of different financial institutions. So it's a very real thing. And if you can do it, it is something to consider. However. However, there's always a but or however. It's pretty complicated because one, your retirement plan has to allow for it. Not all retirement plans allow you to put money in and then do an in service withdrawal that same year. So it's something that a your plan has to allow for. What Stanley from Iowa is talking about here is that most of us, if we have a 401, we've got our limit of $23,000 a year. Some plans will allow you to contribute more than that, but those are now after tax dollars. So again, you've got to have a plan that allows for that too. So instead of 23,000, you put in your 23 and another 20. I believe the limit's something like 70,000 with after tax contributions. So Stanley puts in his 23, puts in another 20, and then he can convert that into a Roth. His plan has to allow for it. That's a way to get a ton of money into a Roth. Now where it gets more complicated is if that money grows. So you put that Money in, your 43,000 is now 53,000. The contributions should not be taxed to get them into a Roth, but the gain is. So now you have to worry about the gain. You have to file special forms. You're putting money into a Roth, which is just in your name, whereas a brokerage as an example is an account where it can be a joint account. There's a little more flexibility about that. The other thing to consider is that yes, the Roth is great because it grows tax deferred. It comes out tax free. However, when you're in retirement, if you've managed your tax bracket to be pretty, let's call it in the 15% tax bracket, which a lot of Americans are. Just remember that dividends and long term capital gain rates can be zero. So we can access our money. Depending on your tax bracket, it's got to be 15% or lower. The long term capital gain rate and the dividend tax rate is zero. So you don't have to get money into a Roth. But if you're going to be in a higher tax bracket in the retirement in the future, then sure, it's a great idea. So I would just know the complexities of this, Stanley. You've got to consult with an advisor to do this, I think. But if your plan allows for it and you want to do this every single year and make sure you're filling out the proper forms every single year, by all means.
- [26:46]
Wes Moss
All right. Charlotte in Arizona says, I recently lost my parents seven months apart. So sorry to hear about that, Charlotte. Which led me to inheriting some money from their estate. I inherited Both a traditional IRA and a Roth IRA. I know I need to exhaust both within 10 years. My plan is to let the Roth ira sit for 10 years and grow. As I've been told, I don't need to make RMDs. My plan for the traditional is to take only the minimum RMD until I have a year where my income is lower, maybe even by design like a sabbatical, and then take the bulk of it out then. Is this a good strategy? Is there a better way to withdraw? With regards to the taxes, The Roth is 38k and the traditional IRA is 160k. I have to start my RMDs by this December of 2025. Any input for a different strategy is appreciated.
- [27:34]
Krista
I love the sabbatical idea. So Charlotte from Arizona, this is also about managing your tax rate. A lot of finance and investing is around understanding what your tax rate is today and then what your tax rate may be in the future. And she's got. I've seen this has worked out really well for some folks. Let's say Charlotte knows that she's. Some companies allow six months off. Now, granted, usually you're still getting paid for that. Those are sabbaticals. But if she just. If you're Charlotte taking six months off and you know you're going to do it or a whole year and that's still okay with your big picture retirement plan. You know, your income is going to be virtually zero except for some of these required minimum distributions. So you end up, let's say Charlotte's income falls all the way down to $10,000 a year. Well, she's got a lot of room while she's still in a really low tax bracket to do some of these RMDs or more than the required minimum distribution. So a, yes, I like the strategy what she's considering. You don't need to take out anything from the roth until the 10th year. So let that thing grow and then if God willing, it doubles, triples, it's still tax free, so you're great. So let the inherited Roth go the full 10 years. Once you distribute it, it's still tax free. On the traditional IRA, the 160A, she can wait and take a bigger chunk out during the sabbatical year. But again that quickly fills up her tax bracket. Remember we talked about different the lock system in Denmark. Your the boat has to go from here to here. And in each point you've got to fill up the new chamber of water, that's your tax bracket. New chamber of water, that's your tax bracket. So Charlotte, if you know you're going to do a sabbatical, great year to do more distribution from the regular ira. If you don't know and you think you are going to end up continuing to work, then you don't want to be stuck with taking the 160, which could be 260 in 10 years, out all at once. So I would spread out knowing that you're probably going to have to take out more than 160, more like 200 over 10 years because it should grow. So you're going to be looking at probably averaging around $20,000 a year to make sure it's done by the 10th year so that you don't get a giant amount all in that same year. That pushes you into the 35 tax bracket.
- [30:01]
Wes Moss
Perfect. Eric in Georgia says Wes, I actually have a very small pension account from a former employer whom I worked with long enough to be vested in their plan before they moved completely to a defined contributions program. The current value is about $30,000. It's managed by a big benefits management company who includes tools to calculate out what the pension fund will be worth depending on when you actually take it. That calculator shows if I take it as an annuity at age 65, it will be around $350 a month for the rest of my life. The problem is the calculator assumes a 6% growth on the balance, but the actual accrual formula is based on annual interest rates. The one year treasury constant maturities plus 1%. Yeah, prior to about 2006 that did amount to closer to 6%. But going forward it really hasn't come up past maybe 3% in the last almost 20 years. Going forward, I'm not confident in that 6% calculator rate. And changing that assumption to 2%, which is closer to the actual average, shows an annuity of $180 a month. I was wondering if it made more sense to take the pension payout now. $30,000, roll it into my IRA and let it grow there instead of as a pension. My IRA has performed spectacularly over the last few years and even assuming a reversion to a return closer to 6% annually over the next 10 years, I think I'm better off taking the risk. This goes back to what you talked about in the beginning of the show.
- [31:24]
Krista
But there's another wrinkle here. He also is looking at what the lump sum is today, what it could be well into the future. And like a lot of pension plans, Eric, they're going to be invested super conservatively. So if it's the one year treasury, which is essentially what sounds like, that's the rate that is not going to be 6% anytime soon and we'd have to have a lot of inflation. The Fed would have to raise rates a whole bunch today. That's closer to 4%. Right? It's closer to where the federal funds rate is. And if the Fed lowers rates it could be in the threes. And that's probably why he's noticed that it hasn't grown a whole lot. It's basically a fixed income investment. So that's a consideration is that it's going to be a really conservative rate of return. Now I would look at these numbers. We do the 6% test. Even if it's 180amonth, 180 times 12, it's 2,100 bucks a year. 2,160 a year divided by 30 is 7.2% still beats 6% test. If it is in fact 350amonth times 12, 4,200 bucks a year divided by 30,000, that's a 14% annual rate of return on the pension. So it makes the monthly amount a really good deal. I just don't know if it's going to get there. So I would consider this is a little bit less about the 6% test because he's not there yet and more about how you would like to invest it. Again, I don't know if he gave us his age, but if this is 10 years from now, if it's still going to be stuck at the one year treasury rate, that shouldn't really grow all that much. If you're comfortable doing so and you want to take it under your control and invest it and looking for a more market stock oriented rate of return or even a balanced portfolio, 6% to 10%, then I think that weighs on this decision more to do, Eric, if you're looking for more like a 6% to 10% rate of return. It likely has to involve some other assets like equities, real estate, REITs, et cetera. If that's the case, then you would really want to consider putting that in your own retirement account and investing it so that you can get a better rate of return. The 6% test here doesn't really stand because it's so far out in the future, we don't know exactly what those numbers are going to be.
- [33:49]
Wes Moss
Okay, well, that does it for us today on Ask An Advisor. We'll be back tomorrow. Clark and I will be back with a new episode. And if you have a question for Wes or for Clark, go to clark.com ask.