Not taking the cash option is the wrong thing to do and I’ll tell you why in this article.
I will also show you an easy strategy to take your lump sum pension and invest it in safe non-stock market securities that will pay you more per month than your pension plan would pay, and also give you a very valuable asset you can will to your children or grandchildren.
Most people take the easy route in life and, in this case, not taking the cash option is easy. Most people have no idea what to do with $150,000 so they elect to take the monthly payments, which never go up by the way, and few live long enough to receive the amount of cash they could have gotten in a lump sum. And if all this isn’t bad enough, the surviving spouse and children get $0 when you die. Sure, you can opt for a “survivor benefit” where your wife gets a payment when you die, but then both of your monthly payments will only be half as much as they would be without the survivor benefit.
Research, get several opinions and options, then decide for yourself what is the best course of action. If you decide to do what I think is the smart thing to do and take the cash, the first thing is to roll your pension cash value over into your IRA. You could have them send you the check, then deposit it and electronically transfer the funds since your checking account is already linked to your IRA, right? Or you can mail it. Easiest Way: Do the roll-over. That way you are insured Uncle Sam is satisfied and you will not get taxed.
In this article I will example three different investment vehicles for your lump sum.
- Municipal Bond Funds
- Certificate Of Deposits (CD’s)
And remember, if at anytime you need 10 or 20 thousand you can always sell some funds or stocks and make a withdraw, but the main purpose of getting your lump sum is to invest it for dividend income all the while maintaining the balance, which by the way, these securities have a history of steadily increasing. Withdraw the dividend income and leave the balance intact for a rainy day…
Why Municipal Bonds?
- There are many funds with the highest Morningstar rating of 5 Stars.
- There are many funds that also have the lowest expense ratio.
- There are many funds that also have high returns over 3%.
- All these 5 Star, low expense ratio, high return funds pay a monthly dividend.
- And finally, all these funds present very low risk.
Dividend income exempt from federal income tax is among the many distinct advantages that municipal bonds offer to investors. They also show very little correlation with returns from stock investments. Thus, they offer relatively high yields at lower levels of risk and are considered second only to government securities in terms of safety of capital invested. By holding a well-diversified portfolio of such securities, mutual funds significantly lower the associated default risk.
The example below is not so much to prove this to whoever reads this, but to myself. Everything I do with investing starts with proof-of-concept before implantation.
I work for Coca-Cola and they a have a very generous Pension Plan where they take a percentage of your pay and place it into a virtual account. The calculations are a bit complicated and beyond the scope of this article.
After logging in to my employee website portal I enter the benefits site and find I have an option to create a “retirement scenario”. The values I enter are that I want to retire at 63 years of age and start collecting my benefit immediately. The estimation is based on my hourly wage and since I work overtime consistently, to the tune of about $15,000 per year, the estimation is very low since it does not take into account overtime. This is very important to me because now I know the scenario is not completely accurate and that I will have a lot more than the “scenario” tells me I will have. This “proof-of-concept” must use real numbers so I will go with the scenario value, which is a $72,000 cash lump sum, or $172 per month.
Now, $172 per month is is not so bad, it’s $2,064 per year, and when I add it to my Social Security payments, the dividends from my IRA portfolio, and a 4% draw from my 401K, I can live pretty comfortably. But my idea is to maximize my retirement revenue streams and leave my kids a nice inheritance, so I want the 72K in cash in order to invest it.
Everyone has a “life-expectancy” and mine is 90 to 100 years. To get the 72K I would have to live to 98, or 35 years after retiring. $172 per month, or $2,064 per year, times 35 years equals $72,240. Will I live to be 98? Only God knows.
Municipal Bond Funds
I’m going to make my selections from the Morningstar Fund Screening Tool.
First Search Criteria
- 5 Star Rating (highest)
- Less than 1% Expense Ratio (excellent)
- Risk Rating: Low (lowest)
|LMOOX||Western Asset Oregon Municipals Fund Class I||$10.57||3.51%||7.62 Years||5.61 Years|
|ENCYX||Wells Fargo Advantage North Carolina Tax-Free Fund Institutional Class||$10.42||3.41%||4.61 Years||4.82 Years|
Second Search Criteria
- 5 Star Rating
- Less than 1% Expense Ratio
- Risk Rating: Below Average
|MDXBX||T. Rowe Price Maryland Tax-Free Bond Fund||$10.86||3.69%||15.07 Years||6.32 Years|
|WMBIX||Wells Fargo Advantage Municipal Bond Fund Institutional Class||$10.36||2.91%||6.56 Years||6.56 Years|
Third Search Criteria
- 5 Star Rating
- Less than 1% Expense Ratio
- Risk Rating: Average
|FMHTX||Fidelity® Michigan Municipal Income Fund||$12.33||2.90%||5.04 Years||5.67 Years|
Fourth Search Criteria
- 4 Star Rating
- Less than 1% Expense Ratio
- Risk Rating: Below Average
|SHMMX||Western Asset Managed Municipals Fund Class A||$16.65||3.29%||8.45 Years||5.58 Years|
|SEKSX||American Independence Kansas Tax Exempt Bond Fund Class Institutional||$11.11||3.05%||8.70 Years||4.30 Years|
I like the number seven. Seven funds give me a good mix of the best funds available. This seven-fund portfolio includes well-run States such as Oregon, North Carolina, Maryland, Michigan, Kansas and two National Funds. They are all at, or below, average risk for the sector. They all have low expense ratios, the highest ratings, and they all pay a solid monthly income, averaging a 3.42% combined return.
The next step is to divide my 72k Pension Lump Sum by seven ($10,285) and see what my income would be. I will use the share price at market close Friday Oct. 31st, 2015. The dividend used will be the recorded payment for Sept. 2015.
Although bond funds monthly distributions fluctuate slightly from month-to-month they do not fluctuate wildly. I add up the seven payments and get $202.49, which is better than my Pension scenario generated estimate of $172. Plus I have a hard-asset that will go up in value over time. And if, when I retire at 63 and I don’t need the money, I can reinvest my dividends into more shares until the time at which I need to withdrawal the funds.
I just read an article at Seeking Alpha on this subject and thought I’d work up another senerio using a new group of Municiple Bond Funds along with one Preffered Stock ETF.
I’ll take the 72k lump-sum and divide it by 6 and buy $12,000 of each of the six securities.
This new group is a strong earner giving $352.23 per month, a combined 7.1% yield.
Dividend Champions Portfolio
My second exercise will be to build a seven-stock portfolio using the honorific Dividend Champions. To make the list a company needs to have a managed dividend policy whereby they increase their dividends every year for at least 25 years.
Many stock gurus will advise you to own about 15 different companies to produce a more diversified portfolio, and I agree. This exercise only uses seven to achieve a quicker conclusion. If it works for seven it will work for fifteen. It’s all about yield. The yield is determined by the price of the security. When you buy a stock your yield never changes unless the company raises, or lowers, it’s dividend.
By making our selections off the Dividend Champions list we can pretty much count on the shares we own paying a larger dividend year-after-year. And we can incorporate a simple strategy of looking at the Dividend Champions list every six months and selling any of our seven that are no longer in the top seven yielding stocks.
You might be thinking, why would we sell one of our seven holdings if they are no longer one of the seven that have the highest yield? The yield is determined by the quarterly dividend times four and divided into the cost of one share. So, if Company A and Company B both give a $1 dividend every quarter and Company A sells for $100 it’s yield is 4%. Company B sells for $75 it’s yield is 5.33%. It makes perfect sense that two Companies, both paying the same yearly dividend, that the lowest priced Company gives the highest yield.
So, looking at the updated list of Dividend Champions every six months and selling the ones that are no longer in the top seven and buying the new top seven, we are always selling our position at a profit. We also, at all times, own stock in seven outstanding, high-yield Companies that have raised their dividend every year for at least 25 years.
|UHT||Universal Health Realty||$49.69||207||$0.64||$132.48||$44.16|
|HP||Helmerich & Payne||$56.27||183||$0.69||$126.27||$42.09|
|MCY||Mercury General Corp.||$54.01||190||$0.62||$117.80||$39.27|
I pulled the above list from DripInvesting.org.
The free Excel spreadsheet has a ton of information when all we really care about is yield. Column I is the yield column. Simply click FILTER, and filter high to low, then click the arrow on column I and presto, the yield column is sorted from high to low. Now select the seven highest yielding stocks.
WOW. Although stocks pay quarterly the monthly value of those payments comes to $306.31. A lot better than both the pension monthly payment ($172) and the Municipal Bond monthly payment ($202.49). And when we revisit the Dividend Champions list every six months and sell those who come off the highest seven, and buy the new highest seven, our portfolio grows even more. We always sell high and we always hold the top seven Companies on a very exclusive list. Case Closed!
Note: There are other ways and lists to chose from. Check the links on my Stock Portfolio Page for other ideas…
A certificate of deposit (CD) is a time deposit, a financial product commonly sold in the United States and elsewhere by banks, thrift institutions, and credit unions.
CDs are similar to savings accounts in that they are insured and thus virtually risk free; they are “money in the bank.”
There are dozens of banking and credit union institutions that offer IRA’s that exclusively let you invest in CD’s. One such site that gives a very good list is DepositAccounts.com This site also gives you a lot of information about the process, benefits, and drawbacks…
Lets pick one for our exercise. Discover Bank | discoverbank.com
As of Nov. 10, 2015 an IRA purchased 12 month CD pays 1.14% interest. My $72,000 lump sum would generate $825.48 in interest, at the end of one year.
A three year CD pays 1.50% so let’s ladder a three year CD.
To ladder a three year CD I split my lump sum into three amounts.
$72,000 divided by three is $24,000
I purchase 3 CD’s. A one-year, a two-year, and a three-year.
At the end of the first year, instead of buying another one-year CD, I buy a three-year CD.
At the end of the second year, instead of buying another two-year CD, I buy a three-year CD.
At the end of the third year the three CD expires and I buy another three-year CD.
Now I have three three-year CD’s, one expiring every year. Calculating the return on a $24,000 three-year CD earning 1.50% comes to a interest return of $1,104.77.
Lets just say I’ll not be purchasing a CD with any of my retirement savings.
- Not enough income.
- My money is locked-up for the duration of the CD term.
- I have to wait to withdraw the interest income until after the CD matures.
Although Municipal bond funds are the safest and lowest risk, you have to admit the Dividend Champions comprise some outstanding Companies. Something about getting a dividend increase every year is very appealing and that’s the main reason I’m buying Coca-Cola stock in my 401K.