I’m retiring this summer with over 30 years’ contributions in my Virginia Retirement System (VRS) account. Because I’ve worked past the full retirement age of 65, I can participate in Partial Lump-Sum Option Payment (PLOP) plan. If I participate in PLOP, I will receive a $29,588 lump sum rolled into a retirement account. If I choose to do that, my monthly VRS income will be reduced by $216. Is this a good choice?
A bird in hand or two hundred in the bush? Analyzing financial options can be a daunting task. The choice of nearly thirty thousand dollars seems much more attractive than a little over two hundred dollars a month. In this case, since the VRS counselors can not offer financial advice, it pays to ask a professional.
At first glance, you might be tempted to analyze the choice this way: $216 per month is about 8.75% a year of $29,588. So if your investments can earn more than 8.75% you should take the lump sum and manage the money yourself. But this answer is too simplistic.
Imagine you take the lump sum and earn exactly 8.75% the first year. You pay yourself $216 a month and think that you have broken even. You have not. If inflation begins running at 5% again you will need to earn $226.80 a month or 9.2% the next year just to keep up with inflation.
Since the VRS payouts are indexed for inflation by the Virginia General Assembly’s annual votes, to match the system would require that you earn 8.75% more than the rate of inflation every year.
A more accurate analysis asks, “If you were to suddenly have an additional $29,588 in investable assets, how much could you withdrawal from this sum without depleting the account before age 100?” Our conservative guidelines say that at age 65 you can withdraw 4.36% of your assets each month and still have money when you are 100 years old.
Therefore, if you had $29,588 in investable assets, you could safely withdraw $1,290 each year (4.36% of $29,588). However, $1,290 a year turns out to be a mere $107 each month.
Giving up $216 each month in exchange for a lump sum of investable cash that has a withdrawal rate of just $107 each month turns out to be a bad deal. It is possible that your investments would do much better than our conservative retirement estimates, but it would still be unwise to take anything more than $107 each month, at least initially.
There is one more rule of thumb that you can use in situations like these. If you are being offered a choice that seems to be outside of the ordinary, it is usually not in your interest to take it. As the old adage says, “If it is too good to be true, it probably is.”
In this case, the VRS is offering retirees an immediate cash payment in exchange for a higher standard of living during their retirement. Many people in this situation will probably choose the offer of quick cash. The VRS knows this. Those who do, save the Commonwealth a bundle of cash.
A different personal situation may result in a very different analysis. All of these calculations underscore the importance of seeking professional advice when facing critical financial decisions.