Why You Shouldn't Take A Lump Sum Of Your Pension

Chris Reddick |

I often get asked whether you should take a lump or partial lump sum on your defined benefit pension plan. As we know, the private sector has essentially abandoned pension plans in favor of defined contribution plans such as 401(k) plans. This is in response to the high cost of administering pension plans and the added liabilities for these corporations. But many educators and public service workers still have pension plans, which are a great option to save for retirement.

Who would not like to get a fixed monthly income stream in retirement? Something predictable and not dependent upon markets can reduce the stress of running out of money in retirement. Isn't this the major worry for retirees? But the problem is that we get complacent and rely on the pension. This is a significant problem.

You can use various online calculators to predict if you take a lump sum from your pension and invest the money to get a better return. Of course, you might be so lucky and be able to beat what you get for your pension annuity, but why would you want to take away a fixed income stream?

There is a breakeven point of how long you would have to get to break even from the pension. This could be ten years of monthly income, and you would get what you could in a lump sum payment. If you live longer, your returns increase, and you essentially make a profit.

Pensions are designed knowing that some participants will live longer and some shorter, and those that live shorter will not benefit as much, essentially subsidizing the longer-lived participants. This risk pooling works well in that you can offer an annuity based on the level of survivorship in the pool. But some participants worry that if they die a few years after they start collecting the pension, they will not get the full benefit. This is not the point of an annuity since it reduces your risk of running out of money in retirement. You can, of course, have a survivor benefit for your spouse, which makes sense if you pass away early.

Maybe a better approach I advocate for is to save money in addition to the pension in a 403(b) or 457 plan if available in your government or school district. This can supplement what you get in your pension and provide you with additional money to fulfill your retirement goals. The standard pension will only provide a proportion of your income, in some cases, if you are lucky less than 2/3rds or perhaps half of what you made while working.

So saving in another retirement plan along with the pension makes sense. If you don't have good options at your workplace, why not save in a Roth IRA and have your money come out tax-free in retirement? There are many good options to save beyond your pension in retirement that you can take advantage of. It would be best if you had a strategy and a financial plan to put it together.

I encourage you to talk to a financial planner to determine how to save beyond your pension for retirement. Contact me on the contact page below if I can be of service.


*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 to avoid federal tax penalties. Individuals are encouraged to seek advice from their 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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