Plan administrators generally find it difficult to counsel employees on this choice. Given the significant number of factors involved in the decision and the potential legal ramifications, the plan administrator is not in a position to make these decisions for the participant, and can only provide education. On the other hand, many companies fear that their retirees are making the wrong decision. So what can you do to help them make more informed decisions? One option is to show the probabilities of outliving the lump sum under different investment return scenarios.

Subsidized and Unsubsidized Annuities

By law, a participant's pension benefits may be paid as a lump sum if the payment equal to the actuarial present value of the participant's accrued normal retirement benefit under a specified set of assumptions for interest and mortality. The law does not require that the lump sum be equal to the present value of an early retirement benefit that may be available. Under current specified assumptions (about 6 percent interest), the ratio of an annual unsubsidized age 55 benefit to a lump sum benefit will be about 7.7 percent and the ratio of an annual unsubsidized age 60 benefit to a lump sum benefit will be about 8.4 percent. If the ratio of the annual benefit to the lump sum benefit exceeds these percentages, the annuities are considered to be subsidized.

Probabilities of Outliving Lump Sums—Unsubsidized Annuity

The mortality table generally used to develop lump sum values is a unisex table that reflects a blend of female and male mortality. Therefore, on average, most females are expected to live longer than predicted by this table and most males are expected to live shorter lives than the table predicts. All things being equal, use of this table in determining the lump sum favors males over females.

The table below shows the probability of male and female 60-year-olds outliving a lump sum of $100,000. This assumes that each year the participant withdraws the "unsubsidized" annual payments of $8,400 that could have been paid under the pension plan.

Age 60, Lump Sum of $100k vs. Annuity of $700 Per Month
Probability of Outliving Lump Sum Average Mortality
	Investment Return
	4%	5%	6%	7%	8%
Male	69%	62%	53%	38%	12%
Female	84%	79%	73%	60%	29%

This table shows that 60-year-old males and females of average mortality can expect to outlive their lump sums more than 50 percent of the time if they only earn the interest rate used to develop the lump sum of 6 percent per year. These probabilities assume that they roll over the lump sum to an IRA and they withdraw the unsubsidized annuity amount of 8.4 percent of the initial lump sum amount each year.

Longer Life Expectancy

What if your employee is one of the "unlucky" ones with longer than average life expectancy? If their family history or general health indicates that they may live longer than average, they should consider this factor in choosing between the lump sum and the annuity.

The following table shows the probabilities for the two 60-year-olds with the same choice. For purposes of this table, however, the two are assumed to exhibit the same mortality as an average person five years younger.

Age 60, Lump Sum of $100k vs. Annuity of $1k Per Month
Probability of Outliving Lump Sum Average Mortality minus 5 years
	Investment Return
	4%	6%	8%	10%	12%
Males	91%	89%	86%	79%	53%
Females	96%	95%	93%	90%	73%

This table shows that because they are healthier than average, they must earn more than 8 percent per annum in order to have less than a 50 percent chance of outliving the lump sum.

Probabilities of Outliving Lump Sum—Subsidized Annuity

The following table shows probabilities of outliving the lump sum, but in this case, the two 60-year-old participants are given a choice between a $100,000 lump sum and a subsidized annuity of $12,000 per year (12 percent of the lump sum amount).

This table shows that, under this situation, two-thirds of the males and more than four-fifths of the females of average mortality would be expected to outlive their lump sum payments.

Age 60, Lump Sum of $100k vs. Annuity of $1k Per Month
Probability of Outliving Lump Sum Average Mortality
	Investment Return
	4%	6%	8%	10%	12%
Male	84%	82%	77%	67%	35%
Female	93%	92%	89%	83%	57%

Summary

The choice at retirement between a lump sum and an annuity is not an easy one. In addition to estimating one's own life expectancy and the investment returns that one will be able to earn in the future, the participant will need to consider goals for retirement and whether Social Security and other assets will be sufficient to provide adequate retirement income if he lives too long. The company may wish to consider helping its employees with this choice by providing probabilities of outliving the lump sum under different investment return scenarios.