When you first enter the workforce you have many decisions to make in regards to how you will fund your retirement years.
After years of earning an income, soon-to-be retirees also have some major decisions to make regarding how their retirement funds will be distributed once they are no longer in the workforce.
For individuals who have a pension plan in place, the decision of how they will take their pension is an important one with significant consequences.
Lately, I have met with several clients who are faced with a very important question,
“Should I roll my pension into an IRA or take the lifetime payments?”
See, pension plans can be distributed in one of two ways;
- Through regular installment payments received throughout your retirement years or
- Through one lump sum payment (which can be rolled into an IRA)
There are benefits and drawbacks to each option, therefore it is important to weigh each option carefully before making your final decision. Here we evaluate the pros and cons whether you should or should not take the lump sum option on your pension.
Control of the Pension Distribution
One of the potential benefits of opting for the lump sum is the additional control you have over pension funds. This can be beneficial in that most pension plans do not account for inflation when establishing what your monthly annuity payment will be in the years to come. When you choose the lump sum option, you have control over your pension funds and can invest them as you see fit, which can result in additional growth throughout your retirement years.
Control is the largest driving force that have led to most of my clients choosing to roll their pension money over. Most recently, I had a client that said, “I’ve worked for the company 31 years on their terms, now I want to take my money on mine.” Could not have said it better myself.
When you roll it over, you decide when you want your money on your terms. If you want a little extra to spoil your grand-kids on a trip to Disney World, you have the power to do it.
Having control does come with its risks.
You have to be careful to not go on a spending spree and run the risk of spending down your retirement too soon. By choosing the annuity method, you have a guaranteed paycheck for the rest of your life and possibly your spouse if your pension plan allows for it. For some that have a harder time managing money, not being able to have access to the principal may be a good thing.
I have had cases where the client opted to take the lump sum option thinking they could control their spending. Alas, they could not and blew through their entire savings in a short amount of time. Now they have little savings and only Social Security to depend on during retirement.
Security of the Pension
Choosing to get your pension in one lump sum payment, eliminates the security of receiving a monthly check for the remainder of your life, however you do know exactly how much money you are getting. Consider for example, if the company funding your pension annuity payments finds themselves in financial trouble, this may result in problems with your pension payments. There is a Federal agency; the Pension Benefit Guaranty Corp) that may make up for companies that file for bankruptcy, however there are limits to how much money you will receive.
More from GFC, Below
As of 2009, the PBGC has insured pensions up to $54,000 for those that retire at the age of 65. If you’re pension is for more than that and your company goes bankrupt, you might be regretting that you hadn’t taken the lump sum.
As I mentioned above, security of having all your money up front can be reassuring, but; if you mismanage it, you can go through it quickly leaving you with no security in retirement. It’s important to do a self assessment of yourself and your spending habits to make sure you don’t make this mistake.
Estate planning: Don’t Forget the Kids
Annuity payments will cease once you and your spouse have departed. By choosing to receive your pension in a lump sum payment, you can plan your estate to include beneficiaries of retirement funds that are unused during the lifetime of you or your spouse.
In essence that means that if you unexpectedly passed away and your spouse wasn’t too far behind you, all the money that you had paid into your pension goes back to the company.
Another Example of When You Don’t Take the Lump Sum
As mentioned in the first point, it can be attractive to have control of your money when you want it. I had a client meeting years ago that with a gentleman who was a state employee. He was nearing retirement, but still had a few years left. In an effort to entice some of the employees to retire early, the state was offering early buyouts to those that would retire immediately. In his case, the offer was in the neighborhood of $180,000.
At the time, he was dealing with credit card debt and some medical bills, so the offer was enticing. I reminded him that he takes the check, that he would be giving up his guaranteed paycheck in retirement. If he worked just a few more years till age 55, he and his wife were guaranteed around $2,500 per month with the pension. Just a quick calculation using simple interest revealed that in about 6 more years would be the break even point for taking the monthly payments.
Otherwise stated, that after 6 years, he was in far better shape taking the lifetime annuity payment for he and his wife. No question. In this case, taking the lump sum was not the right decision.
Should You Choose the Lump Sum?
The decision as to how you will receive your pension is one that should not be taken lightly. There are several factors to consider and the decision you make today will outline your quality of life for your remaining years. The benefits listed here could also be considered drawbacks if handled incorrectly, therefore be certain you are capable of managing your lump sum payment to ensure you will have financial security in the years to come.
If you feel you cannot properly manage your funds or simply don't want the hassle of dealing with investments and long term planning, annuity payments might be the better option for you and your family. What is beneficial to one family may not be perceived the same for another, so make sure your decision is based on your unique situation and future needs. If you’re still not sure, be sure to meet with a qualified financial planner to asses your needs and see what direction is best for you.