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SMART INSIGHTS FROM PROFESSIONAL ADVISERS

Pension Possibilities: IRA Rollover? Buy an Annuity? Or Take the Payout?

Making your decision on the type of payout you receive in retirement requires considering these four factors.

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Pension decisions aren’t clear-cut, and they can have serious consequences for you and your family.

SEE ALSO: Lower Your Expectations on Pension-Plan Promises

Take some clients of mine, for example. The husband, age 65, wanted the highest monthly payout he could get, so he chose a 100% single life option of $2,100 per month. With that type of payout, the payments would end when he died. The joint life option he could have chosen would have paid only $1,800 per month. But although the payments were lower, his wife would have received the same amount once he passed away (and keep her quality of life).

A year and a half later, he was diagnosed with terminal cancer.

If you’re contemplating retirement, it’s in your best interest to be proactive and research the different benefit payout scenarios available to you. According to the Employee Benefit Research Institute, only 2% of employees participate in a pension as of 2014 (compared to 28% in 1979). If you’re one of the fortunate, you could receive a stable, consistent amount of income per month for your entire life as well as a spouse’s.

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On the other hand, several employers offer a lump sum option instead of lifetime payments, which might be a wiser option for some retirees (more on that in a bit).

Some people choose to take a lump sum and roll it into an IRA, managing the investments on their own terms. Others may take a lump sum and use it to buy an annuity held within an IRA. They receive a lifetime of guaranteed payments, similar to the lifetime payments that a pension could offer, but with more flexibility and control since you can choose from a plethora of companies. Of course, before going that route, you’d want to compare how much lifetime income the annuity you could buy from an insurer would compare to the lifetime income from your employer's pension.

4 Areas to Consider When Making Your Choice

To determine which path to take — whether you opt to take a lump sum and invest it yourself in an IRA or decide to take lifetime payments, either through your employer’s pension or by taking a lump sum and buying your own annuity instead — here are a few considerations to guide you:

  • What is the overall financial strength of the company providing you guarantees? Annuities and bonds are rated through large credit-rating agencies, such as Standard & Poor's, Moody's, and Fitch Group. Ratings range from “AAA” (highest grade) all the way to “C” or “D” (considered junk). Weigh the ratings for the company your pension plan uses against those of the companies available to you on the open market if you were to take a lump sum and buy an annuity on your own.
  • What is your health (and your spouse’s health) currently?
  • How does the option you’re considering help your spouse or other heirs? For annuities and pension lifetime payouts, for example, typically, you'll get higher payouts with a life-only option. However, your payments would stop when you die, and your spouse would get nothing. Your payments would be lower if you opt to have them continue for your spouse, but spousal payouts are important for many married couples.
  • What are the potential tax implications (e.g., will your Social Security benefits become taxable?) with a guaranteed income stream?

See Also: Why Working Past 65 Can Be Doubly Rewarding

Lump sum considerations

There are several reasons why people might opt for a lump sum. If you can foresee a shorter retirement due to illness, it may suit you to manage a lump sum on your own, vs. taking a guaranteed lifetime income over a diminished lifespan. If you’re not married, then you should consider an IRA instead of a pension since there is more flexibility to pass the remainder to another family member or a charity.

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In addition, if you’re confident in your nest egg and just want more control, a lump sum could be for you. For example, I have a 62-year-old client who is single and well-prepared for retirement. His benefit statement shows that at age 65 he could get a $1,200-per-month benefit, or he could take a lump sum of about $165,000. He is choosing the lump sum, because although the lifetime payout amount could be significantly higher over time, he doesn’t need the income and would rather have more flexibility and manage when he takes withdrawals.

On the other hand, a lump sum transfer to an IRA most likely will come with market risks, depending on what you do with it and who you choose to manage it. Considering the recent stock market fluctuations, managing a portfolio might not be a great idea. Not to mention that choosing this option can jeopardize a spouse’s lifetime benefit in comparison to other plan options.

Thoughts on annuities

If your main concern is a reliable income stream, then you may be better suited for the lifetime payments, whether from your company’s pension plan or by taking a lump sum and buying your own annuity. Certain annuities (e.g., fixed, fixed-indexed and immediate annuities) give retirees the opportunity to relax and not stress over daily market instabilities, and benefits can pass to a chosen spouse or heir. The main concern is their ability to keep pace with inflation.

Here’s how one client of mine came to his decision to buy an annuity. This man, who is married, has a pension through his employer with a single life option of $1,560 per month, a joint life option of $1,236 per month and a lump sum option of $250,000. His objective is to not only pass the same monthly benefit to his wife but potentially leave a remainder benefit to either his children or grandchildren. By transferring the $250,000 lump sum to an IRA and purchasing his own annuity, it will provide $1,004 per month ($232 per month less than his employer’s pension), but after he and his wife both pass away, their children or grandchildren will receive the remainder of their accumulated value. This scenario provides flexibility and possibly a benefit for their heirs.

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As you can see, there are many moving parts to consider, and sometimes getting creative by involving other financial vehicles, such as life insurance, can increase your options or avoid future problems. For example, if couples want to go with a 100% single life option, they also could purchase a life insurance policy for the difference. Had my client who later discovered he had terminal cancer opted for this, his wife would’ve received a $150,000 death benefit.

In conclusion

So, the bottom line is that a suitable candidate for a lump sum would be someone who has all their income needs met for retirement and who wants to effectively plan for lower taxes in the future. On the other hand, a likely candidate to take the lifetime payments of a pension would be someone who will need the income to supplement Social Security or who anticipates the lifetime payout being higher vs. transferring and self-managing it.

The advice from a competent financial adviser will help you properly assess if a lump sum option is the right fit. Don’t forget to evaluate your goals, health, heirs, tax consequences and the plan for the unexpected.

See Also: 4 Telltale Signs You're Ready to Quit the Rat Race

Carlos Dias Jr. is a wealth manager and founder of Excel Tax & Wealth Group, an advisory firm offering strategic financial planning services to high-net-worth individuals, business owners, executives and retirees. He maintains a highly personal approach by accounting for the distinct needs that his clients have at different points in their financial lives. Dias is a contributor for Forbes, the Huffington Post, Kiplinger and MarketWatch.

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This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.