Mom's retirement plan = investment for me?

[buffett]

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No Brainer.. Go with option 2!

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Care to share with us the mathematics behind this statement?

[turnipmonster]

uhhh it looks pretty obvious dude. are the numbers in option 2 really correct? it seems too good to be true.

[DesertCat]

[ QUOTE ]
OK OK, numbers...

Option 1 - she gets $4600/month till she dies
Option 2 - she gets $4100/month till she dies; I get $1000/month till I die; my sis gets $1000/mo. till I die

She's 61. She's in pretty good health. She has no major, life-threatening health problems. (She has arthritis and an ulcer or two). Both her parents lived into their 80s even while smoking and drinking.

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She's going to live 30 years more and inflation is going to eat her up. She's at this wonderful time where she actually has more income than she needs, but it will soon be over. A decade from now she'll wonder what she was thinking.

Investing 500 a month at 8% gives you $679k in 30 years, which at 5% would generate $33k a year or $1300 per month for you and your sister each.

At 25 years you'd have $440k, you and your sister would then get a little less than $1k a month each. A 9% annualized return would give you both a little more than $1k per month.

Of course I am ignoring taxes here, god knows what capital gains and estate taxes will be in 25 years. Also 5% is pretty weak sauce for an income stream, you (in 25 years) could probably buy an annuity that will pay out as much as 7-8% a year. You must review an actuarial table, my guess is that your mom's life expectancy is another 28 years or so.

By saving the extra instead of forgoing it, you also gain a very valuable asset, flexibility. If inflation starts to catch up to your mother in 20 years, she'll have another $300k in savings she can draw on to maintain her lifestyle without asking you for help. Even if inflation is low, but she lives to 100, she's probably going to need that money.

Lastly, I'm assuming you've thought through the whole "assisted living" issue and have means to pay for it?

[Clarkmeister]

Good post.

I recall having this conversation with Ed and suggesting that it was likely much closer than one would think depending on life expectancy and discount rate assumptions. When in doubt, take the money now, put it aside in an investment. That way if your Mom needs it, it's there, and if she doesn't, it's still there for you to invest how you will instead of being stuck in an annuity.

[buffett]

[ QUOTE ]
uhhh it looks pretty obvious dude.

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Not to me, that's why I'm asking for the math. Would you care to spell out the math for us?

[ElaineMonster]

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I recall having this conversation with Ed and suggesting that it was likely much closer than one would think depending on life expectancy and discount rate assumptions. When in doubt, take the money now, put it aside in an investment. That way if your Mom needs it, it's there, and if she doesn't, it's still there for you to invest how you will instead of being stuck in an annuity.

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Yeah, because strangely his mom has a similar plan.

Another option if available: Mom gets $4100/month for her life and my nephew gets $2000/month for his. Nephew is almost 7 years old now.

[LittleOldLady]

[ QUOTE ]
Good post.

I recall having this conversation with Ed and suggesting that it was likely much closer than one would think depending on life expectancy and discount rate assumptions. When in doubt, take the money now, put it aside in an investment. That way if your Mom needs it, it's there, and if she doesn't, it's still there for you to invest how you will instead of being stuck in an annuity.

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Well, Edward and I were faced with a similar choice. The facts differ from the case of Elaine and her mom in that (a) Edward will get my entire pension when I, uh, no longer need it, and (b) since I already have significant damage to my heart, I am likely to no longer need it sooner, rather than later. I had to retire sooner than planned because of my health issues, and so my pension is not what I expected it to be--I would have participated in Louisiana's deferred retirement option in which I could have collected my full pension (placed in escrow) while working full-time and being paid my normal compensation. SO I lost that handy little lump sum. I had counted on the equity in my house to cover my future housing costs, but Katrina screwed that up. I was underinsured, but I can make some of that up with tax relief and the sale of my lot (or a government buyout). I can only collect a small percentage of the social security pension I earned at jobs other than my principal employment because the state of Louisiana does not particpate in social security. Personally I don't see why that should affect a pension I earned working for employers other than the state of Louisiana based on income on which I paid full social security tax, but there it is. SO I am skating on thinner ice financially than I had originally planned. I'm OK as long as I don't have to linger in some nursing home and as long as we don't have rampant inflation....

But knowing that I can leave Edward a nice little annuity for the rest of his life (he can protect the purchasing power of that annuity by investing the money when he starts receiving it--which I hope won't be TOO soon) gives me a certain peace of mind--which is also worth something however unquantifiable.

[DesertCat]

Ok, I was way off on your mom's life expectancy. According to this site, it's 22 years.

To generate $2,000 per month (and assuming you are 50 years old at the time), you'll need a $399k annuity according to this site.. Fidelity has a calculator that says $380k, but you'd have to be 55 years old. Of course, with $400k in cash, you should be able to get close to $2k a month from good quality corporate bonds without touching the principle. So it appears the annuities I've selected offer limited benefits.

Assuming you invest the extra cash in an index fund at 7% (8% stock market returns, minus 1% annual fees and cap gains), it would take 27 years to have $404k after tax (assuming 15% long term cap gains).

So, the net-net is that on average it appears you will come out financially ahead by having your mom reduce her payout so you can get an annuity. But if the stock market does 10% instead of 8%, it's close to a wash. Or if your mom lives an extra 5 years, it's a wash. If she lives an extra ten years it's a big loser, by investing the money your payouts would be $1,500 per month each.

Lastly, if inflation is 2% per year in twenty years $4100 per month will have the purchasing power of $2800. At 4% purchasing power is down to $1900. I know inflation has been relatively tame the last 20 years, but we are running some pretty nice deficits now. It's not beyond congress or the fed to decide to let inflation kick up a bit to avoid making tough decisions.

You should think about what resources she has to grow her income and pay for assisted living. If she will be paying off her house and it's a substantial value, and she has other investments, then you might not need financial flexibility. But if not, having the excess cash available might be very valuable, you essentially be taking on average a smaller future payout in exchange for more security.

Of course if you give up your annuity, your mom takes the higher payout, and she passes away next year, then the extra payout was worthless. That's a very important consideration (and you'll probably be looking to kick my a** as well). You could cover that risk with a small insurance policy, but that's an additional cost.

[buffett]

Thanks, DC, for articulating why this is definitely neither a "no brainer" nor "obvious."

[Sniper]

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Thanks, DC, for articulating why this is definitely neither a "no brainer" nor "obvious."

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Buf, you are right... no brainer was a bad choice of words for me to use, but Cat's analysis basicly mirrors the analysis I did last night.