Question for the financial mags...

[Lonnie]

An older lady (65) here at my work came to me with a question today.

She worked a job about 10 or more years ago and got a letter in the mail regarding a pension. She did not realize that this was going to happen.

Here's her situation.

The payment to her is approx $85/month for life (again, she's 65).
She could take a lump sum payment of approx $12K (that she would roll to an IRA to avoid paying taxes in the short term)
The break even point for taking the monthly payments vs the lump sum is about 12 years.

Her partner died within the last year and left her with some credit card debt ($4k @ 21% apr).

She should get a decent retirement from our current jobs when she retires in a few years.

She doesn't have much extra money and basically lives paycheck to paycheck.

Her dilemma is should she take the lump sum payment, and pay off the credit card debt or take the life time payments and continue to slowly pay down the credit card?

WWMD?

Thanks in advance.

[mcsquared]

Lump Sum. $85/month isn't going to make any difference in her finances. Won't even pay her utility bill now much less in 20 years. pay off the credit card debt and then IRA the rest.

[Lonnie]

Lump Sum. $85/month isn't going to make any difference in her finances. Won't even pay her utility bill now much less in 20 years. pay off the credit card debt and then IRA the rest.

That's what we thought, but I wanted to double check with those in the know...

[jepilot]

I'd be inclined to say lump sum as well. Especially since if she just used the $85 a month to pay off the CC (given 85 was more than the minimum payment), it would take 8 years, and she'd end up paying $4,120 in interest.

Best pay off the 4k and stick the extra 8k in a high yield fund or CD.

[Tippster]

21%...? Holy crap! Mine are at 8%!

[cranked]

Her dilemma is should she take the lump sum payment, and pay off the credit card debt or take the life time payments and continue to slowly pay down the credit card?

Definitely the lump sum. The lump sum and monthly payments are actually the same amount based on the assumptions of the fund. If she lives to be 70 (hopefully not), she will do much better taking the lump sum now. If she lives to be 120 (hopefully not ) she would do better taking the monthly payments. So, they are essentially factoring a ~6% APR (meaning she reinvests the 85 bucks each month) and also that she will live about 20 more years.

Now, factor in the interest rate on her credit card, and she HAS to take the lump sum to pay that down. Unless interest rates were ~30%, is is a losing proposition to take te monthly payment. Tell her to get the lump sum, but then lock the extra away in CDs so she doesn't spend it...especially if she lives paycheck to paycheck.

[Lonnie]

Tell her to get the lump sum, but then lock the extra away in CDs so she doesn't spend it...especially if she lives paycheck to paycheck.

This advice (Lump sum/CD's) was exaclty what I told her when she first asked me about it this AM....

She was so pitiful after her companion died earlier this year. To make things worse she had no idea about the outstanding balance on the card (and a few other debts too). She keeps calling this money a godsend (if you believe in such things).

Thanks mags, I think we have this one wrapped up!

[mrw]

very,very nice of you to help her out.

[Brock Landers]

This is the exact shit I do every day- calculate these things.

She can probably split her delivery of the lump sum payout- I know many of the clients I worked on have that option. She can take the 4000 as a direct payment (actually take 5 cause youll get taxed, fed at prob 20%, state depends) and the remainder as a rollover if she wants. With the remaining 7000, either roll that over or just take it as a lump sum and spend it on elderly male gigolos and blow.

[Tippster]

You know - every now and then a thread comes along and reminds me that there are some really good shits that participate here. Kudos - I learned something today.

[woodstocksez]

Lump sum. BTW, the break-even point is much more than 12 years, because that 12K can be earning right away, the missing 85s cannot. Or, looked at another way, $85 ten years from now isn't nearly as nice as $85 right now.

[Brock Landers]

Lump sum. BTW, the break-even point is much more than 12 years, because that 12K can be earning right away, the missing 85s cannot. Or, looked at another way, $85 ten years from now isn't nearly as nice as $85 right now.

Thats already factored into the lump sum factor when converting the 85 to 12000 (or the 12000 to 85, depending on the plan). They are actuarially equivalent no matter what the age is, as the lump sum factor is based on interest rates and mortality tables.

[RShea]

If she was really smart and displined, she would as others state- do the lump sum or partial lump sum, pay off the CC debt and then take the money she is paying towards the credit card debt and monthly pay into the retirement IRA or whatever she moved the balance into. She is basically getting rid of 21% interest and foregoing some earnings now, but can build the funds back up if she starts to set aside the CC monthly payments she would be making.

[woodstocksez]

Thats already factored into the lump sum factor when converting the 85 to 12000 (or the 12000 to 85, depending on the plan). They are actuarially equivalent no matter what the age is, as the lump sum factor is based on interest rates and mortality tables.

They may be actuarially equivalent, but that's not what my post addressed. Lonnie indicated that the crossover point at which the two amounts would have the same value is about 12 years. (Obviously, if she dies tomorrow, the $12K was the better deal, while if she lives forever, the $85/month was the way to go.) Given the numbers and the fact that money has time value, that's not right.

144 (12 years of 12 months) x $85 = $12,240. I think that's why Lonnie said the break-even point is about 12 years. But that's ignoring discounting of that $85/month income stream. So, if 12 years of $85 monthly payments undiscounted is about $12K, the present value of that 12 year stream, assuming any reasonable discount rate, is going to be much less than $12K. That stream for 12 years discounted at 6% is around $8700 in today's dollars. So, it'll take much longer than 12 years for that stream to equal a present value of $12,000. That's all I was saying. It's a tangential point and, I think, not really important for her decision, since, given her situation, it seems to me that she needs to take that money now.

[bigairnbumps]

If she takes the 12K lump sum, she has new investment options. The time value of money calculation is always difficult to estimate someone’s remaining time and discount rate – but it’s probably pretty close and good to stay conservative.

With current debt of $4k @ 21% APR she has to call the credit card company and negotiate a low APR or better, get a low FIXED rate. Discuss options for paying the debt off with little to no interest. If those options aren’t provided by the credit card compnay, open a new card (or look for a consolidation loan) with a low or 0% rate on balance transfers (then close the old card), and pay off the debt over time with the low % rate.

She has to minimize the interest expense that is accumulating on that debt. If she invests the 12K now, that may start providing additional value from the rate of return she would receive on the new investment. Hopefully, it is more than the interest rate she is paying on the debt, so she comes out ahead each year. She has to get that interest rate down to a low fixed rate to stabilize the interest risk and invest the monies she has available.

Have her talk to a financial professional. This is not a situation to take lightly, especially given the economy right now and her age.

[Lonnie]

If those options aren’t provided by the credit card compnay, open a new card (or look for a consolidation loan) with a low or 0% rate on balance transfers (then close the old card), and pay off the debt over time with the low % rate. .

Solid idea right there. I'll pass it along.

FWIW, our jobs are fairly well insulated from economic swings (both positive and negative)....

[bigairnbumps]

FWIW, our jobs are fairly well insulated from economic swings (both positive and negative)....

heh. do you work in a morgue or for the IRS?

[cranked]

Solid idea right there. I'll pass it along.

FWIW, our jobs are fairly well insulated from economic swings (both positive and negative)....

I would only play the credit card, balance transfer game if she is super responible with money and wants the burden of paying every month. Generally, the terms of those offers accrue interest at a massive rate and that interest is tacked on if minimum payments are missed.

It is a good idea if she is very diligent about paying her bills, but given the current interest rates...she will only see marginal gains from interest right now (given she need to put this money in riskless vehicles, ie CDs, savings accounts, etc.).