Your Choice- $1 Million or $5,000 per Month for Life?

Most of our readers will likely have to make that type of decision someday.  From our perspective, it’s a pretty easy answer.  As Cuba Gooding, Jr. famously told Tom Cruise in “Jerry Maguire”:  “Show me the money!!”

Yet, an article in the WSJ on Monday tried to make the decision sound really tough, with losers on both sides.  It would have you believe that many will suffer from either an “illusion of poverty” or an “illusion of wealth” and are likely going to experience a disappointing retirement.  Really?

Researcher Daniel Goodwin at Microsoft Research asked people how adequate they would feel if they have $1 million at the time they retired.  He used a seven-point system with one being “totally inadequate” and seven being “totally adequate.”  Then, he asked them to rate instead an income each month in retirement of $5,000.

In theory, the choices are similar based on pricing of annuities. If a 65 year old paid $1 million for a “single premium immediate annuity” they could receive payments of $5,000 each month for their life.  Actuarially, a 65 year-old is expected to live 18-20 years.  So, 19 years of monthly payments of $5,000 would be $1,140,000 and represent a 1.4% annual return on the investment.

Yet, believe it or not, many people, feel that $5,000 per month is more adequate than the $1 million lump sum.  Mr. Goldstein says that this group suffers from the “illusion of poverty.”  Apparently, these folks are “inclined to think about wealth in terms of monthly income” and don’t want the “burden” of a lump sum which could run out someday.  Hence, they dial down their expenses, eliminate any wants or wishes and make do on their $5,000 per month.

Mr. Goldstein then suggests that I and most people may suffer from the “illusion of wealth.”  He thinks that those selecting the lump sum, through a false sense of security, may spend too much and run out of money. In fact, the larger the lump sum, the more likely the “extra millions will lose their meaning.”  Really?  Do we all suffer from illusions, as Mr. Goldstein suggests?  Are we all on the road to an unsuccessful retirement regardless of our choices?  It certainly doesn’t have to be that way.

Perhaps I should contact Mr. Goldstein and invite him (and his wife) to go through the DWM Boot Camp.  First, we’d sit down and help them with their goal setting. We’d help them identify their needs, wants and wishes.  We’d look at their assets, health care costs, income taxes, expected inflation and investment returns, and insurance and estate matters.  Ultimately, we’d help them design a financial plan.

If Mr. Goldstein was under an “illusion of poverty,” we’d show him that his $5,000 per month program is a poor choice.  To begin with, his $5,000 per month would lose its purchasing power each month due to inflation.  With 3% inflation, after 15 years of retirement, his $5,000 would only buy $3,200 worth of goods in today’s dollars.  Second, if he did a “personal annuity” by simply taking the lump sum, investing it, earning 6%, e.g., and withdrawing the $5,000 per month, his family would still have the $1 million in principal when he passed away.  No need for an illusion of poverty here.

On the other hand, if Mr. Goldstein was under an “illusion of wealth”, the plan would help him identify his needs, wants and wishes and would have helped evaluate whether those potential expenses were affordable based upon his assets, expected investment returns and the other metrics.  We would have created numerous scenarios to ultimately result in a plan that was successful.  The plan would be stress tested for items that could negatively impact that plan and monitored and modified over time.  In short, the plan would not suffer from an illusion of poverty nor of wealth.

We’re glad contributors Shlomo Benartzi and Hal Hershfield ran the article Monday focusing on Mr. Goldstein’s findings. Retirement/financial independence planning is extremely important.   However, we don’t agree that it has to be a dire situation with poor choices, lots of suffering and disappointments.   It’s simple: take the lump sum and put together your realistic plan with a fee-only adviser like DWM and then have us help you monitor it for the changes that will undoubtedly occur in the future. You’ve worked hard for your money, the time will come to enjoy it. As Ginny’s blog pointed out a few weeks ago, retirement/financial independence should be a time for “jubilation” not illusions or disappointments.  Proper planning with the right team can make that happen.