If you’re like me, you hate decisions that you can’t change. They invite way too much second-guessing. Unfortunately, what you do with your employee pension is one such decision. Companies sometimes ask employees to consider a pension buyout. This usually entitles a lump sum payment now in lieu of monthly payments for life. So if your employer asks if you want to take a lump sum buyout, should you say yes? Here’s how to evaluate that decision.

Lump sum versus payments

The first question to ask is whether or not your pension has a cost-of-living increase built into the monthly-payment option. If it does, you can take the money and create a situation where your income is guaranteed to increase annually. Some cost-of-living increases are based on metrics like the consumer price index, while others feature a straight percentage increase, typically 3 percent.

If your monthly payments include this type of increase, the only reason to take the lump sum would be if you envision a situation where you could invest the money in some type of account that would generate returns greater than the cost-of-living increase. Unfortunately, the days of 5 percent return on a savings account are long past. So in my opinion, taking the lump payment and expecting to do better is likely not wise. I believe it’s better to build a situation where your monthly expenses are covered by some source of guaranteed income in retirement.

If you agree, continue to read on.

Will your pension provide enough income in retirement?

I’ve looked at pensions that do not have a cost-of-living increase with concern. Prices in the future are likely to be higher than they are today. And most of us couldn’t live today on the paycheck we received 20 years ago. So why would we expect to be able to live 20 years from now on today’s paycheck?

Plus, pensions are not guaranteed. We often think they are. And they’re technically guaranteed by the Pension Benefit Guarantee Corporation (PBGC). But there’s a bit of a loophole. Often, PBGC only guarantees pensions up to a certain amount if the company goes out of business. And even the most secure-seeming companies have failed historically. Just look at Lehman Brothers, Hostess or Sears.

If either of these two factors apply to or worry you, consider taking the lump sum. If your employer were to go bankrupt, you’ve already received your payout. And even if the company is around for years to come, the buyout option can help you create a cost-of-living increase.

When the lump sum makes sense

If you take the lump sum payment, you may be able to roll that money into a fixed annuity with a 3 percent guaranteed increase in annual income. Doing this can simulate a pension by providing a stream of income for life. And by using the lump sum payout to buy an annuity with a cost of living increase, you’ve solved for inflation. Plus, like pensions, annuities are guaranteed. Only that guarantee comes from state insurance regulations not the PBGC.

In theory, you could purchase several annuities with different insurance companies and diversify your potential risk if one company were to become insolvent. Consider how much income you may be able to generate from reinvesting a lump sum payment in different annuities. You may find that that the lump sum provides more than enough to cover the initial investment into the annuities, leaving you with a 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.

Ask for help if you need to

If this decision confuses you, or if you’re unsure what to do, I recommend going to a professional for help. This is such an important decision that it can pay off big time down the road to have a professional help you evaluate all of your different options, so you don’t end up second-guessing your call down the road. Just be sure to ask any financial advisor if they are a fiduciary, or legally obligated to act in your best interest.

If possible, work with a fee-only financial planner. If the advisor charges you a fee for the work, you know that they are not also receiving commissions from products. That means when they recommend a product, you can feel confident it’s because it’s the best product for you, and not because the product pays the advisor a commission for the recommendation.

Envision Wealth is a fiduciary firm. For questions about your pension, you can always contact us for a free introductory call.

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