Carefully mull your options when deciding how to receive your pension payout. By Deborah Yao, Contributing Writer August 29, 2011 EDITOR'S NOTE: This article was originally published in the March 2011 issue of Kiplinger's Retirement Report. To subscribe, click here.After 40 years of toiling away, you're finally retiring. You can't wait to kick back and enjoy your hard-earned savings. But the quality of your retirement will be greatly affected by how you choose to receive money from your pension. Should you take a lump sum, monthly annuity payout or a combination of the two? It's a critical decision: Once you make your choice, you'll have to live with it the rest of your life. SEE ALSO: A Strategy for a Lifetime of Income Today's low interest rates make the decision tricky. If you choose an annuity, you'll be locking in low rates indefinitely. Even lump-sum payments have been reduced because the Pension Protection Act of 2006 changed the type of interest rates that plans use in calculations. Beyond simple math, you have to take into account your risk tolerance, income from other sources, and your health and the health of your spouse. Advertisement Start by tallying all your income sources. If Social Security payments and income from other retirement plans cover your basic expenses for food, clothing, shelter and medications, you might want to consider a lump sum that you can invest in higher-yielding securities to beat inflation. If you and your spouse need the money urgently for health care or other pressing needs, a lump sum might be right as well. If you think you can match or exceed the defined-benefit plan's monthly payouts, or if you have a multimillion-dollar portfolio, take the money. Roll it into an IRA to defer the tax bill; you'll be taxed as you draw money from the IRA. A 2007 Vanguard Group study shows that 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. But taking a lump sum means you'll be responsible for funding your retirement. "Most studies show that individuals who take the lump sum do worse than those who take the annuity," says Rande Spiegelman, vice-president of financial planning at the Schwab Center for Financial Research. "Most people do a pretty lousy job of saving. How much more difficult would it be to manage a portfolio for sustainable withdrawals over a long time horizon?" Advertisement Annuities Better for Most Retirees Let's say you've hit your retirement age of 65. Your company gives you a choice of a $300,000 lump sum or $2,000 a month in a single-life annuity. If you take the lump sum and expect to live another 18 years, you have to generate a 4.16% return annually to receive $2,000 a month as you draw down the interest and principal, Spiegelman says. A portfolio of 20% stock, 50% bonds and 30% cash should return 4.1% a year on average. But if you think you'll live another 30 years, you'll need a return of 7.31% a year. That's tougher to do without taking on much more risk. Moreover, you have to be able to ride out market volatility. Can you hold back from selling your stocks if the market plunges? With an annuity, you'll get the same payout every month until you die, regardless of market conditions. The tricky part with managing your own money is guessing how long you'll live. People tend to underestimate their life expectancy, says Ethan Kra, chief actuary of benefits consulting firm Mercer. For a married couple, both age 65, the odds are greater for a spouse to reach 100 than for their house to burn down, he says. When you choose a lump sum, you take the risk that your money will run out before you and your spouse die. Advertisement If you are married and go the annuity route, you must choose between payments that end when you die or a joint-and-survivor option that starts with lower payouts but continues payments as long as either you or your spouse is alive. To cover yourself only, your spouse must provide a written consent that is notarized or witnessed by the plan administrator, says Rebecca Davis, legislative counsel at the Pension Rights Center. With the joint-and-survivor option, the spouse must get at least 50% of the monthly payout upon the retiree's death, although plans can boost the survivor benefit to 75%. If you don't trust the health of your employer, consider that annuities from company pensions are insured by the government-backed Pension Benefit Guaranty Corp. (www.pbgc.gov), for up to $54,000 in 2011. About 85% of folks who end up being covered by the PBGC are made whole, says Davis. So in the unlikely event your company goes belly up and the pension is underfunded, the PBGC will give you up to $4,500 a month if you're 65 when you start receiving benefits. The monthly payment will be lower if you retire earlier or elect survivor benefits. With interest rates still low, you could consider delaying your retirement. "The longer you wait, the better the deal," says Steve Utkus, who runs the Vanguard Center for Retirement Research. But if you want to retire on schedule, and your company offers the option, then consider taking your benefits in a combination of a lump sum and annuity payouts. That way, you won't be locking in your entire pension at a low interest rate. If your employer does not offer the combination option, you could take the lump sum and buy annuities with all or part of it later when interest rates are higher. You could ladder your annuity purchases, investing a portion at a time so you'll lock in different interest rates. However, if you decide to buy annuities with part of your lump sum, be aware that buying annuities -- such as from banks, brokerages and insurance companies -- will cost more in fees and commissions than if you choose the annuity option from your company's pension, Utkus says. And the annuity is only as good as the health of the firm that sells it to you. To minimize risk, spread your investments among companies highly rated by A.M. Best, Fitch Ratings, Moody's Investors Service or Standard & Poor's, Spiegelman says. Advertisement Not all retirees get the lump sum option. Some plans simply don't offer it. And, even if the option is spelled out, plans that are less than 60% funded are 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.