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7 Ideas to Consider before taking your Pension as a Lump Sum

Updated: Mar 22

Workers with substantial pension benefits are becoming the white whales of the retirement planning community. Since the dawn of defined contribution plans, aka 401k plans, there has been a steady decrease in the number of workers covered by a traditional defined benefit pension. For those workers who are covered by a pension, the vast majority of them elect to receive the lump sum benefits rather that choose an annuity option.

There are many different factors to consider when making this decision, and in this post, I will discuss seven specific ideas to consider. However, for me personally, I believe that one of the leading reasons people elect to have their pension paid to them in a lump sum comes down to psychology. Since a pension lump sum payout can easily be the largest check a retiring worker ever receives, cashing out is an offer that’s too good to refuse…. or is it?

Here are 7 steps you can take to determine if choosing the lump sum buyout is right for you:

1) Consider all of the payout options in the proper context. Since the idea behind a pension benefit is to replace a portion of an employee’s income, the first thing they should look at is the available annuity payout options. These plans usually offer a variety of options, so it is important that you understand how each of them works. Three common choices are: single life annuity, a single life annuity with a 50% survivor option, or a single life annuity with 100% survivor option.

A single life annuity is just that—a payment stream that will last as long as you live, with the payments ceasing at death. If you are married, you will not be able to elect this option without your spouse’s consent. This type of payment choice could be a good option if you are single and have no plans to marry in the future. For the 50% survivorship option, the pension will pay the stated value every year until the death of the participant; and if their spouse survives them, the spouse will continue to receive 50% of the original amount until they die. The 100% option functions the same way, except the surviving spouse would have no reduction in the payments.

Key Questions:

Are you single or married? How important is leaving a legacy to your loved ones? Is there someone who will be dependent upon you for economic support during your retirement years?

2) Run the numbers.

As mentioned above, pension plans by their very nature are designed to offer the annuity income payments to participants when they retirement. To determine how your benefit is going to be calculated, you should be able to locate the formulas inside of your plan documents. Many plans will calculate their payout factors using various benchmarks (a common benchmark is corporate bonds).

Since participants may not be educated on how annuities price their income payouts or the applicable discount rates to use, they may have a difficult time determining if the payouts being offered are a wise move or not. This makes the decision seem overly complex, and thus, they opt for the simple option—the lump sum. However, in today’s low-interest rate environment, pension plans may offer a much stronger payout than clients can receive if they were to take their lump sum and reinvest it into a private annuity. One way to compare the payout options is to work with a professional advisor who has access to multiple top-rated insurance companies. Working together, you can research the different types of payout options and amounts from various carriers.

Key Point: When you get into your retirement years, guaranteed paychecks are king. It’s imperative to know how your pension payout options can compare with the marketplace.

3) Clients should consider both their health and the health of their spouse. Pensions use actuarial tables as part of their life expectancy, so if you believe your life expectancy may be shorter than average due to health issues, it’s important to consider the impact of a shortened life expectancy of you or your spouse. If both spouses have health issues, a lump sum option may be favorable because the unused assets could be transferred to their heirs.

Key Questions: How is your heath? How is the health of my spouse?

4) Evaluate different tax and income strategies.

Client’s that have other assets such as a 401k, cash value life insurance, IRAs, and or ROTH IRA accounts have the opportunity to put together comprehensive financial strategy during their retirement years. The pension needs to be considered in context of a true plan–both on its impact for guaranteed income and for its investment potential as a lump sum. Again, some clients may assume or may be advised that they can “do better” by investing the pension lump sum, but this decision should be taken on a case-by-case basis and never as a rule of thumb. Some clients may also fail to consider the impact of taxes during their retirement years–especially after the death of a spouse. I believe it’s critical to make this decision in the context of an overall plan b/c there are many different planning techniques and strategies that may be a greater benefit to them.

Key Questions: How will this decision impact my overall retirement income plan? Do I actually have a retirement income plan?

5) How healthy is your company?

Employers that offer pension plans are required to fund these plans; and if a client is concerned that their employer could have challenges in the future, this is a valid consideration when determining a pension decision. Pension plans assume the risk when clients elect to take the annuity payments b/c they are essentially promising to pay those amounts. If someone retires and believes their employer may have trouble in the future, or if they know firsthand from the plan communications that the plan could be facing a funding shortfall, they may certainly opt for a lump sum if it brings them peace of mind.

6) Inflation.

Pension payouts are almost always level, which means that their purchasing power erodes over time. I personally believe that many pensions have strong enough guaranteed payments that the benefits usually outweigh the lump-sum decision. Many times when I hear a client telling me about advice they’ve received to roll the pension into some type of investment portfolio, the inflation talking points are usually the script I’m given as justification. Make no mistake—inflation is serious business. However, there are other considerations that come into play if one chooses to invest their pension funds.

Key Questions: How are the funds going to be invested?

Will they be principally protected or subjected to market risk?

What is the projected Real Rate of Return (after accounting for inflation)?

What fees will be charged against the account?

Can your advisors give you reasons both for and against this type of decision?

7) Work with a professional that you can meet with face-to-face.

Workers with a pension have a tremendous benefit, yet few may know how to understand its value. I would encourage every worker who has a pension to consult with a qualified financial planner–preferably someone who has at least earned a CFP® designation. Pensions are benefits that need to be protected first. If the opportunity exists to enhance the benefits offered by a pension through planning, then that’s an added bonus. I am of the opinion that a client should only consider moving the funds out in a lump sum if they genuinely believe they can enhance their overall financial position. Working with a financial planner who is held to a fiduciary standard of care (such as a CFP®) should be the first step in this decision-making process. I would also encourage the worker to get full disclosure from the financial professional on how they are compensated because you will want to know if there are any conflicts of interest that may be underpinning their advice.

Obviously, as more and more people move into retirement, there will be increased interest in this topic. A brief Google search already returns many different articles and talking points for the pros and cons of a pension rollover. Unfortunately, information isn’t enough…people need genuine insight into their personal situation. Do your research, gather your data, and then engage with a CERTIFIED FINANCIAL PLANNER™ that specializes in Retirement Income Planning to help you.


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