Making Your Money Last

Pension Payments or Lump Sum? Take Your Time to Get It Right

The choice you make today will affect your retirement for years to come.

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.

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:

  1. How is my health and my spouse’s health? In other words, how long might I live?
  2. How much do I want to leave my beneficiaries (children, grandchildren, charity, etc.)?
  3. Am I concerned about the strength of the company offering the pension?
  4. 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.
  5. 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.

About the Author

Richard W. Paul, CFP, RFC, Investment Adviser

President, Richard Paul and Associates, LLC

Richard W. Paul is the president of Richard W. Paul & Associates, LLC, and the author of "The Baby Boomers' Retirement Survival Guide: How to Navigate Through the Turbulent Times Ahead." He holds life and health insurance licenses in Michigan and Florida and is a Certified Financial Planner, Registered Financial Consultant, Investment Adviser Representative and insurance professional.

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