The Pension Question – Lump Sum or Annuity?

You’ve worked your whole life and retirement is in sight. You’re one of the lucky ones, you have a pension option. Maybe you work for the state or one of the many private companies in town such as PG&E or AT&T. It’s time to kick back and enjoy your hard earned savings.

Now you have a decision to make… perhaps the most important decision of your life!

The quality of your golden years will be monumentally affected by how you choose to receive money from your pension. Should you take a lump sum or in a monthly annuity? Maybe you can do a combination of the two? It’s a critical decision and you only get one shot at it. Once you make your decision, you’ll have to live with it the rest of your life.

When interest rates were higher some 20 years ago, the lump sum accounts earned more and the payouts were higher. However, with today’s low interest rates, if you choose the annuity option, you’ll be locking in low rates for life. In addition, lump-sum payments have been reduced because the Pension Protection Act of 2006 changed the type of interest rates that plans use in calculations.

I have found that most people are far better off taking the lump sum option for these simple reasons:

  1. You can usually beat the pension payout by investing it in your own portfolio, either in a tactically managed portfolio or a guaranteed option.
  2. You can have access to all the money at any time when you roll it into an IRA. For example, If your lump sum payout is $2,000,000, you have access to all $2,000,000. If you take the monthly payout, that’s all you get, ever.
  3. There are no taxes or fees to roll the lump sum into your IRA.
  4. Your beneficiaries will get all the money that is left over when you die. Typically that is substantial! With the monthly payout, you lose what’s left. Of course if you have a spousal option, your spouse will get their share when you pass, but when they die, it’s gone.
  5. With some pension alternative investments, you can also get long-term care benefits.

There is one thing to be aware of. If by taking a lump sum option you lose your health benefits, you may not want to do this. This situation is very rare, but I have come across it.

According to a recent Vanguard Group study “73% of employees ages 55 and over chose a lump-sum payment over an annuity in a traditional pension. The study found that people like the flexibility of having money at hand rather than locked up for a long time. They also want to leave something for their heirs. Certainly, the recent demise of big banks and bankruptcies of major automakers have made people more wary of leaving their money with their employer.”

Not all plans have the lump sum option for their retirees, they simply don’t offer it. Furthermore, if a plan is less than 60% funded it is prohibited from paying lump sums. If the plan is between 60% and 80% funded, the lump sum can equal only half of a retiree’s benefit or the amount the retiree is entitled to under the PBGC, whichever is less, the rest is annuitized. Pension sponsors in bankruptcy cannot pay lump sums unless the plans are fully funded.

As you can see, the decision is not always that simple and requires detailed planning. If you need help, don’t be afraid to ask. It’s what we do for our clients every day!

Cheers -Keith
916-715-4607




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