Just over a third of today’s retirees are lucky enough to have a pension to help finance their golden years. If you’re among them, you’re already a step ahead of many people. Still, you may have to choose how to take that pension—a choice that could make the difference in how financially secure you will be.
If your company offers you a lump sum payment rather than monthly installments, should you take it? Like so many personal finance questions, the answer is: It depends.
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Robert Margetic, president of Redwood Financial Advisors and author of How to Survive the Coming Retirement Storm, recently had a client whose pension had an annuity credit rate of 3.1 percent. They couple had three options:
- Take a $600,000 lump sum payment
- Take a $3,100 monthly payment for life, with the 60-year-old wife getting a 50 percent payment after the 62-year-old husband’s death
- Take a $2,600 monthly payment for life with the wife getting a 100 percent benefit after her husband’s death
After deliberating, the couple opted for the $600,000 payout. “We felt we could do considerably better than the 3.1 percent without taking on an inordinate level of risk,” they said.
There were other factors. The payments weren’t tied to inflation, so they’d be worth less as the years went on and they make no provisions for an inheritance for the couple’s children. “The lump sum worked because it offered the most flexibility and they have the financial discipline to manage it effectively,” Margetic says. “If they chose the lifetime payments, then there is no going back. They are stuck with that decision.”
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If your company offers you a lump sum payment rather than an annuity or allows you to take a portion of your pension as a lump sum, you’ll need to ask several questions to make the right decision. Here are the more important ones:
What’s the age difference between you and your spouse? This is vital if the husband is substantially older and is the one receiving the pension. Statistically, women live longer, so it may be better to choose an option with a higher survivor benefit to ensure the surviving spouse is provided for after the pension recipient passes away, says Mike Brown, a certified financial planner with Dowling & Yahnke in San Diego. Conversely, if the pensioner is a woman and her spouse is older, she may choose option two.
Can you do better on your own? Pension plans are designed to offer annuity income payments to workers when they retire, to decide whether to opt instead for a lump sum, you need to know what that annuity income is worth. “The question isn’t, ‘How much do I need from my pension?’ The question is ‘How much do I need from my retirement accounts?'” says Michael Baker, a certified financial planner with Vertex Capital Advisers in Charlotte, N.C.
First, use a retirement calculator to get a decent estimate of how much income your current retirement savings and contributions might provide. If that income, combined with Social Security, isn’t going to be enough to comfortably cover your projected expenses in retirement, you’re probably better off sticking with the pension, since it reduces the risk that you’ll could run out of money in retirement.
What other sources of income do you have? Take stock of your finances and the other investments and income sources you have. Come up with a Social Security strategy so that you have a solid estimate of how much money you can expect from Uncle Sam each month in retirement.
The longer you wait to claim Social Security, the more valuable it becomes, so you may be able to use your pension as a stopgap to put off taking Social Security for as long as possible. For the most benefit, the higher earner would wait until age 70 to file for Social Security. “The higher benefit will ultimately become the survivor’s benefit, and it’s important to consider the higher benefits over a long life expectancy,” Baker says.
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How healthy are you and your spouse? Pensions use actuarial tables as part of their life expectancy formula. If you believe your life expectancy may be shorter than average due to health issues, it could be a reason to take the lump sum. If you and your spouse both have health issues, a lump sum option may be favorable because the unused assets could be transferred to heirs.
However, companies make lump sum calculations based on averages, so if you’re healthier than the average worker, you’ll come out ahead overall by taking monthly payments, especially if they include an inflation adjustment.
How healthy is your former employer? You’ll want to understand whether your company will be around for awhile. Often pension plans don’t survive a company’s bankruptcy filing.
Even though public and private pension funds have benefitted from the rising stock market, many public pensions are still struggling, to shore up their deficits. The total pension deficit for companies fell by more than half, from $296 billion to $126 billion last year, according to an analysis by Towers Watson. That’s the smallest pension deficit since 2007 when plans had a surplus of $82 billion. The overall funded status last year rose to 91 percent from 78 percent.
Can you responsibly invest the lump sum? You’ll need to watch the expenses associated with the portion of your lump sum you invest. Look for funds with fees of less than one percent. Then be realistic about your habits. Do you have the discipline not to blow through a lump sum? This is definitely not the kind of windfall you use to spoil the grandkids or finance a trip around the world.
Is there a better deal ahead? Typically the decision you make at retirement about your pension is irrevocable. Yet as more companies look to reduce costs and get pensioners off their books, there’s a chance they’ll come back to you in a few years with a sweeter offer. If that’s the case, run the numbers again and see if any potential changes to your circumstances could impact your decision.
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