The Case for a Lump Sum Pension Distribution

The stability of monthly payments may sound reassuring, but what are you giving up if you go that route?

(Image credit: KaraGrubis)

Large corporations, like Pfizer and Bristol-Myers, have long extolled the benefits of their defined benefit pension plans. However, in 2017, Pfizer finally pulled the plug on its defined benefit plan in favor of a more company-friendly 401(k) employer match. Bristol-Myers announced it would follow suit in 2019. These two corporations are some of the latest examples of a trend that has become more prevalent in the private sector in recent years: the extinction of defined benefit plans.

As an alternative, more and more corporations are electing to “freeze” or discontinue defined benefit plans and replace them with employer-matched 401(k) plans. These plans are much easier and cheaper for corporations to administer.

What motivates the move away from defined benefit plans?

In a defined benefit plan, corporations are on the hook for the performance and funding of its plan. If the underlying investments underperform, as was the case during the last financial crisis, it can become cost-prohibitive for the sponsor company to maintain adequate funding in order to meet current and future pension obligations. Furthermore, rising life expectancies mean employees may collect a pension for decades.

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Unlike government plans, private pension plans can't run on a pay-as-you-go basis. They are legally required to keep those plans funded. Should the pension plans fail, these companies will suffer massive legal liability. These factors have contributed to the growing trend of large U.S. corporations opting for 401(k)s over pensions.

Now, employees of companies discontinuing their defined-benefit plans, as well as those retiring from companies that maintain a plan, face a choice: To take a lump sum distribution now, which can be rolled into an IRA, or take an annuity that pays a level amount each month upon retirement.

Trade-offs to consider

The lump sum option carries with it more investment risk borne by the employee, but it also provides much more growth opportunity and flexible distribution options. The annuity option, while more stable and predictable, severely restricts the pensioner’s ability to adjust to a rising cost of living in retirement.

You should make the decision based on what’s best for your individual financial goals, but the lump sum option does provide several important advantages over an annuity election:

  • A lump sum affords complete control of your funds.
  • It avoids dependence on the company's solvency.
  • It also offers many distribution options.
  • It gives the investor more control over their tax liability.
  • And it allows you the ability to pass to your heirs the remaining account balance upon death, which can be an incredibly valuable wealth-building tool for a family.

A lump sum rollover into an IRA also “quarantines” the employee’s funds, thereby mitigating the risk of a reduction in pension benefit, which may occur in the event of a company’s bankruptcy. In the wake of the 2008 financial crisis, a number of longstanding companies were forced to file for bankruptcy protection, and many pension members were left to rely on the Pension Benefit Guaranty Corporation with reductions in their pension benefits, like having their recent pension increases prorated. With the lump sum option, your funds are segregated in the IRA, which eliminates the risk of this potential impact.

The flaw of opting for monthly payments upon retirement

The lump sum plan puts the money in your control right away. With the monthly payment option, the plan member passes before retirement or soon after electing payments in retirement, those funds can be lost.

Members can opt for a smaller payment so that benefits continue if they predecease their spouses. However, the pensioner may be leaving substantial money on the table if their spouse dies before them or if both spouses pass away within a short timeframe of one another.

Many times, employees don't realize they have a lump sum option or lack the discipline and expertise to properly manage those funds. With some proper planning in concert with the advice from an experienced CERTIFIED FINANCIAL PLANNER™, oftentimes electing a lump sum distribution can be the most advantageous and flexible option available.

How to take the lump sum

Rolling the lump sum into an IRA preserves the tax-deferred nature of the funds and provides flexibility with future withdrawals. As the IRA owner, you own the account and therefore control the distributions.

Unlike options available in a defined benefit plan, through an IRA, you can choose the frequency, size and starting date for future withdrawals. You can also stop and start withdrawals as often as you’d like, which provides you with much more freedom in managing your taxable income in retirement.

Managing the IRA involves more risk than simply taking part in a pension plan. The shift toward more employer-matched 401(k) plans has also shifted the risk of managing those funds to the employee. Less-experienced investors would be wise to work with a trusted, CERTIFIED FINANCIAL PLANNER™ to establish retirement planning goals and help manage their assets to accomplish those goals. Experienced financial professionals work with clients to manage investments, control tax liability and help clients prepare for a secure retirement.

A word of caution: When deciding between an annuity and lump sum payment option, it is important to understand that lump sum payment amounts are determined not only by an employee’s years of service and earnings history, but also by the level of current market interest rates.

As rates go up, the outcome of the lump sum payment calculation will decline. This is true because, much like the lump sum election for lottery winners, the amount is calculated by discounting all expected future payments to a current present value amount.

If you are an employee whose company recently announced plans to discontinue its defined benefit plan or an approaching retiree facing the same pension distribution decision, I would encourage you to do your due diligence. Electing the wrong option may have permanent and expensive ramifications. Speak with a knowledgeable and experienced CERTIFIED FINANCIAL PLANNER™ who can help you understand your options and guide you in making a suitable decision.

Securities offered through Kalos Capital, Inc., and investment advisory services offered through Kalos Management, Inc., ("Kalos") both at 11525 Park Woods Circle, Alpharetta, Georgia 30005. Caliber Financial Partners, LLC, is not an affiliate or subsidiary of Kalos Capital, Inc. and Kalos Management, Inc. Member FINRA/SIPC.


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.

Patrick B. Healey, CFP® MBA
Founder & President, Caliber Financial Partners

Patrick Healey is the founder and president of Caliber Financial Partners and has over 20 years of experience in the financial services industry.