Pension/ annuity vs Index funds?

[alex123711]

I have a defined benefit pension plan that pays a percentage of the ending balance as an annuity at age 60 onwards. e.g if taken from age 60 onward the total final balance is divided by 12, if taken at 65 the final balance is divided by 10

For example an ending balance of 100k would pay around 8.3k/ year (+ CPI) if taken at 60.

It is also convertible to a normal superannuation/ 401k funds instead. I am wondering if it worth converting as I still have a while until retirement age, so the balance would have time to compound (25+ years). I did a calculation in firecalc, and a 100k balance for example would be worth ~600k after that time on average, which using the 4% rule would be 24k/ year vs 8.3k annuity. Obviously this option is more risky and not guaranteed, just wondering if I am comparing the 2 the right way?

[DutchGirl]

If you'd have an ending balance of 100k, you don't have a balance of 100k >25 years before that. So to compare apples to apples, I would compare what the ending balance of the pension will be versus what the conversion of its current value would grow to in the same amount of time in your 401k. I assume that if you're 30 years out, the current value would probably be more like 20k or so.

In the end, the pension would carry a very small risk of failing completely (company going bankrupt, economy collapsing bigtime, or something terrible like that) and would have a high chance of paying out what was promised and a smaller chance of paying out slightly more or slightly less.

Compare that to the other option where your end result *is* more unpredictable, a wider range of options are possible when you invest the money for 30 years. ($10k would likely become something like $40k, but could also end up only $25k or at over $70k).

So pension: less risk (not zero risk!), less potential upside. 401k: more risk, more potential upside.

[Bankai]

A couple of other points to consider: if you transfer out, your pension doesn't stop compounding once you start drawdown (assuming you keep it in stocks and not trade for an annuity) so the upside potential is even higher. Also, most DB pensions only pay while you're alive so no inheritance unlike index fund (unless you spend it all). They also offer only limited protection from inflation, like 5% a year, meaning it can diminish in real terms if we stay in a high inflation environment for longer.

I had a small DB pension which I transferred out, but that was at the best possible point when interest rates were close to 0% during covid, and because of that I got 40x my annual benefit, plus 20 years of compounding ahead made it almost a no-brainer as even assuming no growth for 2 decades, I'd still have the pot and only need to take out 2.5% a year to match the DB option while avoiding inflation risk and having massive upside potential. You'd need to run the numbers carefully and it's probably one to take professional advice on (in the UK you won't be able to transfer DB pot worth over £30k unless you've taken advice from IFA).

[alex123711]

If you'd have an ending balance of 100k, you don't have a balance of 100k >25 years before that. So to compare apples to apples, I would compare what the ending balance of the pension will be versus what the conversion of its current value would grow to in the same amount of time in your 401k. I assume that if you're 30 years out, the current value would probably be more like 20k or so.

In the end, the pension would carry a very small risk of failing completely (company going bankrupt, economy collapsing bigtime, or something terrible like that) and would have a high chance of paying out what was promised and a smaller chance of paying out slightly more or slightly less.

Compare that to the other option where your end result *is* more unpredictable, a wider range of options are possible when you invest the money for 30 years. ($10k would likely become something like $40k, but could also end up only $25k or at over $70k).

So pension: less risk (not zero risk!), less potential upside. 401k: more risk, more potential upside.

The pension goes up with CPI, so the ending balance would be e.g 10k + CPI per year, it would increase if still working but if you transfer out future payments would be transferred to the index anyway, so i think it is pretty much apples to apples e.g if i stopped working tomorrow it would be balance adjusted for inflation / 10 at age 60, vs index which would be current balance + whatever the market returns in that time.