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Lump Sum or Traditional Lifetime Payout—The Big Pension Question

Old-coupleFor those who are lucky enough to have a defined-benefit pension plan, one of the big decisions that comes with retirement is whether or not to take a lump sum payment and mange the money yourself, or receive it in monthly payments.

Before coming to any conclusion on this large financial decision, you need to understand the options, advises Investopedia in the article “Lump Sum vs. Regular Pension Payments: What's the Difference?”

A lump sum distribution is a one-time payment from your pension administrator. Taking a lump sum payment gives you access to a large sum of money that you can spend or invest as you want. You have flexibility.

Once you and your spouse die, the pension payments might stop. However, with a lump sum, you could name a beneficiary to receive money after you and your spouse are gone, if any money is remaining.

The income from pensions is taxable, but if you roll over that lump sum into your IRA, you’ll have much more control over when you take out the funds and pay the income tax on them. You’ll have to take required minimum distributions from your IRA at age 70½.

A regular pension payment is a set monthly payment retirees get until death. Some pensions continue with the surviving spouse at that point, but some don’t.

A lump sum requires careful asset management, and with a lump sum, there’s no guarantee that your money will last a lifetime. You also need to think about health insurance because in some situations, company-sponsored coverage ends if an employee takes the lump sum payout. Therefore, you may need to include the extra cost of health insurance in your calculations.

A downside of pensions is that an employer could go bankrupt and find itself unable to pay retirees. Benefits are safeguarded by the Pension Benefit Guaranty Corporation (PBGC). This is a government entity that collects insurance premiums from employers sponsoring insured pension plans. The PBGC only covers defined-benefit plans (stated payments) and doesn’t cover defined-contribution plans (like 401(k) plans). It earns money from investments and receives funds from the pension plans it takes over. The maximum pension benefit guaranteed by PBGC is set by law and adjusted yearly.

Think about why your company would even want you to cash you out of your pension plan. Employers may use it as an incentive for older, higher-cost workers to retire early. They may make the offer because eliminating pension payments gives them accounting gains that increases corporate income.

If you take the lump sum, your company won’t have to pay the administrative expenses and insurance premiums on your plan.

From an actuarial standpoint, the typical recipient receives about the same amount of money from the lump sum or the lifetime payout. There’s no way to game the system to get more from your pension. If your health is poor, you may do better with the lump sum, as long as it is managed carefully. Another strategy is to take a lump sum and put part of it into an annuity to provide lifelong income, and invest another part of it to hopefully enjoy market gains. However, if you’re worried about Wall Street and enjoy good health, you may want to stay with a stable monthly payment.

Reference: Investopedia (April 14, 2019) “Lump Sum vs. Regular Pension Payments: What's the Difference?”