People gamble at the casino at the Aqueduct Racetrack in the Queens section of New York, Tuesday, Aug. 7, 2012. More than a billion dollars bet by nearly a million customers last month is the latest evidence that the "racino" at Aqueduct Racetrack in New York City is capitalizing on its prime location and drawing dollars and gamblers from neighboring states' casinos.  (AP Photo/Seth Wenig)

I had a client meeting last week with a couple heading into retirement. The husband turns 60 this year and was offered an early retirement package by his company. He could choose between a “lump sum” retirement distribution or receive a $2,300 check every month until the day he dies in the form of an annuity.

He might live another year or he might live to be 100. Either way he gets a check every month until he dies.

In my opinion, the worst decision in this particular case is to take the monthly annuity option. The better choice; and this is about stewardship and legacy as much as it is mathematics, is to take the lump sum distribution and conservatively invest in the stock & bond market.

Not a little worse, but a lot worse.

Each retirement decision is different, but everyone needs to set aside a few heroic minutes to determine what is best for your family and leaving behind a legacy.

It has to do with the bell curve

Pretend you’re at the airport waiting for your flight to board. You decide to play a little game. You want to get a representation of the number of people who walk past you with hair color that is brunette, black, blonde or red.

The first thing you should do is take a pencil & paper to keep score. Draw three, evenly spaced vertical lines which make 4 columns and write the words across the very bottom of the page “Blonde, Brunette, Black, Redhead”.

Every time someone walks by you with one of those color attributes you put the letter “X” in the column above the word that describes it. After 100 people walk past, tally the results.

You’ll find that out of the 100 people, about 35 of them are brunettes, 33 have black hair, 26 are blondes and 5 were gingers.

Take your pencil and draw a smooth line connecting the tops of the columns of “X”’s. If you did it correctly, the edges representing blondes and redheads would have the least number of occurrences and the black and brunettes would have the greatest. The shape should look like a bell.

Statistically about 68% of the hair color would be in the center 2 columns representing black and brunettes; while 95 ½ % of all hair color would be contained in 4 columns.

Casinos & insurance companies operate the same way, predicting profitability by using a bell curve.

Casinos know that if 1,000 people walk through their doors each with $100 to bet, or a total of $100,000 of cash to gamble; if they stay there long enough 95 ½ % of that money is staying at the casino, while only a small percentage will leave with more cash than they came in with.

A life insurance company knows that 97% of all people with a term life insurance stop paying the premiums after 10 or 20 years and never collect the death benefit. (1)

Back To The Retirement Annuity Option

A company offering a retirement annuity option knows that the retired employee has a chance of dying sooner rather than later, and thereby releasing them from the obligation of continued the monthly payments. They’re betting you’ll die sooner rather than later.

Using the Present Value annuity function in Excel, a 30-year, annuity option that pays $2,300 a month is worth ($546,899) and is expected provide an annual return of return of 3.76%. Just slightly above the US inflation rate of 3%.

Compare that with converting a lump sum distribution into a Rollover IRA. Using the historical annual return of 8.41% for the S&P 500; 30 years of tax-deferred compound interest equals a projected account value of $5,591,934. Even a 6 % rate of return yields an expected value of over $2.8 million dollars. (2)

The good steward should choose the lump sum distribution and invest it conservatively leaving behind a legacy to beneficiaries and charitable organizations.

About the Author

Bill Ulivieri has been in the financial services industry since 1981. In 2004, he co-founded a registered investment advisory firm that specializes in providing 401(k) advice and portfolio management services to investors using Exchange Traded Funds.  Bill also provides independent investment advice and “benchmarking” to individual company 401(k) and 403(b) retirement plans.

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  • Retiring Without Risk, by R. DeFrancesco, p.97
  • Past performance is not indicative of future results. The information provided is believed to be accurate and is unaudited. There may be times where all investments and strategies are unfavorable and depreciate. In all securities, trading there is potential for profit as well as loss.

Photo: Google Images/ Al Jazeera