Dukes 3.5% Annual Increase Pension Annuity Option- Is It Better?

 

We recently became aware of a new Duke pension option for retirees to consider. The new pension option offers a lower beginning annuity payment, however the annuity amount increases by 3.5% each year.

At first glance this new pension option looks interesting, as it provides 3.5% compound inflation growth each year for life (along with your spouse’s life if survivorship option is elected). To fully understand how this new option works, we decided to run an analysis of the regular level pension option versus the new 3.5% increase pension option.


assumptions:

For our analysis we assumed the following:

  • Fictitious “Mr. Duke” is retiring at age 61, and his wife “Mrs. Duke” is currently age 58

  • Mr. Duke is trying to decide between receiving the traditional flat pension vs the new 3.5% annual increase pension option.

  • Mr. Duke wants to have a 50% survivorship benefit for Mrs. Duke to provide her with ½ of his pension if he dies first.

  • Traditional Level Pension Option – Provides $2,777 per month (or $33,324 per year), with no annual increases for life.

  • 3.5% Increase Pension Option – Starts at $1,937 per month (or $23,244 per year), with annual 3.5% increases.

  • Disclaimer – This analysis intended to be used as an example only. While the process is the same, in order to make a decision for yourself you should consult your HR Department and get your own numbers and make your own decisions based on your unique situation.


results:

We ran analysis to compare both options using Excel. We determined 3 separate breakeven points:

  1. Annual Benefit Amount Breakeven - It takes 11 years for the 3.5% increases to equal the $2,777 per month that Mr. Duke would get with the level pension option. Or said another way, Mr. Duke would receive less annually under the new 3.5% option for the first 11 years, however he will receive more per year after the 11th year for the rest of his life. This is highlighted in the color “yellow”.

  2. Cumulative Benefit Breakeven – It will take another 9 years, or 20 years total, for the cumulative amounts received under the 3.5% option to catch up to the cumulative amounts received if the level premium option were elected. It takes a while for the 3.5% annual increases to compound and ‘catch-up’ to the level pension option because the level pension starts at a much higher $33,324 per year versus the lower $23,244 per year. This is highlighted in the color “orange”.

  3. Cumulative Benefits with “Time Value of Money” Breakeven – Receiving more money earlier is more valuable than receiving money later, because it can be invested and grow and compound. This analysis factors in the “time value of money” at an assumed growth rate of 5%. Here the breakeven point is extended another 5 years, or 25 years total. This is highlighted in the color “green”.

 
* This analysis intended to be used as an example only. While the process is the same, in order to make a decision for yourself you should consult your HR Department and get your own numbers and make your own decisions based on your unique situation.

* This analysis intended to be used as an example only. While the process is the same, in order to make a decision for yourself you should consult your HR Department and get your own numbers and make your own decisions based on your unique situation.


Conclusions:

  • The 3.5% increasing pension is a new option for Duke retirees, and can be appealing to consider.

  • In the scenario we analyzed, Mr. Duke will have to live at least 25 more years (or to age 86), before the benefits of the 3.5% annuity option starts looking better than the level annuity option taking into consideration the time value of money.

  • Our analysis is only an example
    - We recommend you run your own projections based on your own numbers and unique situation.

    - Your specific facts and circumstance are likely very different from our example, therefore your results will vary based on your personal goals, pension numbers, and financial situation.

    - A financial advisor can be helpful crunching your numbers and talking through what is importation to you.

 

 
 
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published by sam swisher

JD, CPA, CFP