If you’re like me, you hate decisions that you can’t change. It’s a perfect opportunity for Monday morning second-guessing. Evaluating lump sum from pensions and pension buyouts have become an increasingly popular opportunity for employees to evaluate. Your company simply may call your options a lump sum or take the annuity option.
Lump sum pension or payments?
The first question I would ask is whether or not your pension has a cost-of-living increase. If it does, you have to think can I take the money and then create a situation where my income guaranteed increases annually. Some increases are based upon consumer price indexes and others are based upon a simple straight percentage increase, typically 3%.
If you’re like many people I know they are concerned about running out of money in retirement. Likely in the day of 5% returns in savings accounts, they felt that they would definitely get 5% on their money and wouldn’t have to adjust their spending habits. Those days are long gone and we don’t know when they may return. Taking the money and expecting to do better is likely not wise. I believe one should put themselves in a situation to make sure that their monthly expenses are covered by some source of guaranteed income. If you agree, continue to read on.
If your expenses rise, will your retirement income?
I’ve looked at pensions that do not have a cost-of-living increase. Prices in the future are likely to be higher than they are today. Would you be able to live confidently on the paycheck you earned 20 years ago? While the current payout may look attractive today, will it still look that way 10, 20 or 30 years from now?
You likely are unaware that a pension is guaranteed by the Pension Benefit Guarantee Corporation (PBGC). However, your pension may not be truly be guaranteed. If you go their website, you will find that the guarantee has a cap should your company go out of business. One cannot predict the future viability of any company. Just think of Bear Stearns, Lehman Brothers and Hostess.
Lump sum vs. annuity
You may find that rolling your money into a single premium immediate annuity, fixed annuity with a 3% guaranteed annual increase may be just the ticket for your lump sum money. Similar to a pension, it provides for a stream of lifetime income. Rather than being based upon the guarantee of the PBGC, it’s based upon state insurance regulations. This gives you the ability to diversify your money among several different insurance companies to diversify the potential insolvency risk that you might face with putting all of your money in one company. You may find that based upon your retirement income needs, you could take the lump sum and invest only the portion that you need to cover monthly expenses. You could then use the balance for discretionary income.
If you have a spouse or partner you can also evaluate a joint and survivor benefit. Many pensions only cover a spouse. If you are in a partner relationship, this can be a bonus to your retirement income.
Time for a financial planner and a financial plan?
Because this is such an important decision, I recommend that you look for a financial planner that can do what if scenarios on your entire personal situation. It may show that you have opportunities that you were not aware of to better leverage the opportunity of this lump sum pension opportunity. I believe this person should charge a fee for their work. That way, their decision is a solely based upon what decision you actually make. You certainly don’t want to find out Monday morning that there was a better decision you could have made.
Note: Guarantees are based upon the claims paying ability of the issuing insurance company. This is a hypothetical example for general information only. It is not intended to provide specific advice or recommendations for any individual.
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Fixed annuities are long-term investment vehicles designed for retirement purposes. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Withdrawals made prior to age 59 are subject to a 10% IRS penalty tax and surrender charges may apply.