Ann is 65 and has just retired. She can select a pension of $1745 payable at the

Question

Ann is 65 and has just retired. She can select a pension of $1745 payable at the end of each month guaranteed for the rest of her life, but not indexed for inflation, or take a lump sum of $312,000. Assume she can invest the lump sum at 6% per year, compounded monthly, and draw the same income as the pension. If she lives to be 95 years old, which is the better choice? Select one: a. The pension since she might live past 95 years. b. The lump sum since it is equivalent to a pension of $1871 per month. c. The lump sum since it is safer. d. The pension since it is equivalent to a lump sum of $320,000.?

Explanation / Answer

Present value of annuity = P * (1 - (1+r)^(-n))/r  

where P is monthly payment

r is interest rate

n is time period

Putting the value of all parameters and will find the vlaue of P

312000 = P * (1 - (1+.005)^(-360))/.005

P = $1871

So the correct option will be (b) the lump sum since it is equivalent to a pension of $1871 per month.

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