Should I take my pension as a lump sum?

Chris Reddick |

Many pension plans offer an array of options to take your pension when you retire. One option is the lump sum. This is an important decision to make as once it is made, it cannot be changed. Four of the most important factors that you should consider when deciding on a lump sum are discussed. We also discuss after you get a lump sum what you should do with the money.

Do you have health issues?

Health issues or concerns about your life expectancy should be factored into the decision on a lump sum or taking a monthly payment in the form of an annuity. When pension plans derive the monthly income you can get from the pension, they consider the average life expectancy and determine what you should receive based on that actuarial information.

You can use online calculators and plug in your current age, the lump sum amount, when you expect to die, and the monthly payment. These calculators will give you a breakeven of how many years it will take to get paid more than what is offered in the lump sum. If the lump sum's value exceeds the pension's lifetime income, consider taking a lump sum. If the lump sum value does not exceed your lifetime income, you might want to consider the lifetime income.

These are weighty considerations and hard to predict since we don’t actually know when we will die! But consider the relative health of your family members, which may factor into your life expectancy. Also, consider any medical issues that may prevent you from living a long life in retirement. Talking to your doctor would make sense in determining what your life expectancy could be given your current health and family history.

Do you trust the financial health of your pension plan?

One issue to consider is the financial health of the company offering the pension. If there is a significant risk of the company going bankrupt, this could impact your monthly payments. Do you have serious doubts about the pension's viability or what protections are in place, if any, to be offered by the state or the PPGC (guarantees private-sector pensions)? Do your research and determine whether you think the pension plan will be around to pay out the monthly payments and use this to help figure out whether monthly income makes sense. For instance, many state pensions, including teachers' plans, are significantly underfunded; this could impact future payouts if not corrected.

Will you have other sources of income in retirement?

You need to evaluate all of the sources of income that you have in retirement. How much have you saved in your 401(k) plan or IRA? What about Social Security benefits? Consider all sources of income when making a decision on a lump sum versus monthly payments. You can talk to a financial planner, and he/she can determine how all of your income sources will impact your retirement goals. Also, factor in your income tax rate when considering lump sum versus monthly payments. Since pension income is pre-tax, you will pay income tax at your marginal rate when you take distributions.  

Do you need money now or want to pass it onto your children?

By taking a lump sum, you can perhaps pass on money to heirs or use the money to remodel your home, take that dream vacation, or get a new car. You could also use it to pay off your mortgage or any debts.

However, if you tend to overspend, a lump sum may not be a great choice. Or are you worried about outliving your money? A lump sum would also not be a good option. With a lump sum, you have the ability to control the ownership of your assets and the ability to transfer any amount at your death; the pension annuity would not be available.

After taking a lump sum, what should you do?

Say you decide to take the lump sum, what should you do with the money? To defer income taxation, you could roll the lump sum into an IRA or 401(k). Keep in mind that you need to take Required Minimum Distributions (RMD) at age 72. You will also assume all of the investment risks associated with rolling the money over into an IRA or 401(k). If you are not comfortable with investing, this should be of serious consideration.

Another factor to consider is to compare a single-life annuity in which you get the same monthly income until you die to a joint life if married. But with a joint-life, the annuity will get a reduced monthly payment, and your surviving spouse typically receives an annuity either 100% or 50% of what you received. Pensions also can come with income guaranteed for certain periods or monthly payments indexed for inflation. But more bells and whistles usually come with a reduced monthly payment. There could be 15 or more choices to consider! Typically, the most common options taken are a single life if not married or joint life.

Final Thoughts

There are many choices to make when considering a lump sum versus monthly income for your pension. Given the serious nature of these hard choices, you should talk to a financial planner to make sure you make the right choice for your individual circumstances.


*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets.

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