Employer-sponsored pension plans have become an endangered species, but it wasn’t always this way. Back in the mid-1970s, nearly 90% of workers in the private sector who had access to an employer-sponsored retirement plan had a pension.
Many of those fortunate workers are baby boomers who are now nearing retirement or just entering it, and they have some big decisions to make about their pension payouts. Thus, it’s vital they get sound advice from a qualified adviser if they have the opportunity to choose whether to receive their pension in monthly installments over the rest of their life or to take a one-time lump-sum payment.
Risks of Monthly Payments
A typical scenario might find a couple coming into my office with a pension from a large company such as Ford or General Motors, and they have been offered a one-time lump-sum payment of around $1 million or lifetime payments of $5,000 a month. To see which makes more sense for them, the first step is to determine their retirement needs and goals and how the pension applies to them. For example, let’s say you gave me $1 million and I said I’ll give you $5,000 a month for the rest of your life — but if you and your spouse happen to get run over by a truck, you’re going to agree I can keep the remaining balance.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
That’s what the pension holder’s company is going to do; that’s part of the agreement. Choosing the monthly payments in that worst-case scenario doesn’t turn out to be a good deal for the couple from a legacy standpoint — the amount they can leave to their heirs. It also restricts them on the health side; for example, if they want to dip into the money to help pay for an unexpected long-term care expense.
Risks of a Lump Sum
Of course, the biggest risk with a lump-sum distribution — be it from a pension or 401(k) — is that sometimes it doesn’t last through retirement. People miscalculate their retirement needs or mismanage the money. A survey by MetLife showed that about one-fifth of retirement-plan participants surveyed who received pensions or 401(k)s as lump sums depleted that money in an average of about five years. So, if you are not studious with money, it may be a better option to keep the pension as a monthly payment or put the lump sum into an annuity, which can provide a guaranteed payment stream for life.
Some people put money from their pension lump sum into the stock market, and that can be risky. If the market experiences another decade like the years 2000 to 2009, they’re more likely to run out of money during their lifetime.
Some Factors to Consider
Having a guaranteed source of income that goes alongside Social Security is important, especially because we’re living so much longer now. In deciding how to take a pension — lump sum or monthly distributions — knowing your expenses and your health status is key to the equation.
When you opt for monthly payments, you’re betting on living a long time, and wealth transfer may not be as much of a concern for you, because whatever balance is left over is going to go to the pension company when you pass away. So, if you’re determined to leave your money — your legacy — to your children or grandchildren, you would probably want the lump sum.
With proper planning, you might be able to structure the pension lump sum to provide increasing income to offset inflation, or additional income to help offset future long-term care costs. For example, if you’re allocating a portion of the lump sum into an annuity that provides a guaranteed monthly income, there are features that could enhance that income stream in the event of a long-term care event. With a lump-sum pension distribution, you could have not only a guaranteed source of income but also a chance of customizing this “pension” inside of your plan.
5 Questions to Ask
It’s not every day that you have to make a million-dollar decision. When you receive a pension buyout offer, here are the five critical questions to begin thinking about:
- How is my health and my spouse’s health? In other words, how long might I live?
- How much do I want to leave my beneficiaries (children, grandchildren, charity, etc.)?
- Am I concerned about the strength of the company offering the pension?
- Do I want to customize my pension payments? This could be spending more in the early years of retirement or providing additional income for long-term care as previously mentioned.
- If something were to happen to me, will my spouse have enough income?
Most importantly, as you’re pondering these questions, it’s important not to rush this decision. Seek out professional help. To get true and unbiased advice, we recommend seeking help from a Registered Investment Advisory firm or CERTIFIED FINANCIAL PLANNERTM, as they are required to act in a fiduciary capacity, meaning any recommendations must be in your best interest.
Dan Dunkin contributed to this article.
-
The Fall Garden 'Tax': What to Plant and How to PrepareTax Tips Fall gardening could increase your taxes this season. Here’s what to know while planting in 2025.
-
July CPI Report Boosts Rate-Cut Odds: What the Experts SayThe July CPI report shows that tariffs are having a slight impact on inflation, though not enough to keep the Fed from cutting interest rates.
-
DST Exit Strategies: An Expert Guide to What Happens When the Trust SellsUnderstanding the endgame: How Delaware statutory trust dispositions work, what investors can expect and why the exit is probably more important than the entrance.
-
Think Selling Your Home 'As Is' Means You'll Have No Worries? Think AgainThere are significant risks and legal obligations involved in selling a home 'as is' and by yourself, without a real estate agent.
-
What the OBBB Means for Social Security Taxes and Your Retirement: A Wealth Adviser's GuideFor Americans in lower- and middle-income tax brackets, the enhanced deduction for older people reduces taxable income, shielding most of their Social Security benefits from being taxed.
-
Financial Planner vs Investment Manager: Who's the Better Value for You?When markets are shaky, who do you trust with your money? A recent study provides useful insights into the value that different financial professionals offer.
-
I'm a Financial Adviser: This Is How You Could Be Leaving Six Figures in Social Security on the TableClaiming Social Security is about more than filing paperwork and expecting a check. When you do it and how you do it have huge financial implications that last the rest of your life.
-
The Big Pause: Why Are So Many Americans Afraid to Retire?While new research sheds light on Americans' growing reluctance to quit work in later life, can anything be done to help those with the retirement jitters?
-
Five Under-the-Radar Shifts Investors and Job Seekers Can't Afford to Ignore Under the OBBBBeyond the headlines: The new tax law's true impact for job seekers and investors lies in how it will transform industries and create opportunities in areas such as regional accounting, AI and outsourced business services.
-
I'm a Financial Professional: It's Time to Stop Planning Your Retirement Like It's 1995Today's retirement isn't the same as in your parents' day. You need to be prepared for a much longer time frame and make a plan with purpose in mind.
