The age old question: Should you take a monthly annuity or a lump-sum payout from your employer’s defined-benefit pension plan? It’s a simple question without a simple answer.
For some employees, taking the lump sum makes the most sense, but others are better off with the annuity. Your decision should be based on a number of factors, including your life expectancy, health status, marital status, investment experience and tax issues.
You should also factor in what other assets you have designated for retirement, your other sources of guaranteed retirement income, the amount of the benefit or lump sum, your company’s pension plan and ability to meet long-term financial obligations, and the types of annuity guarantees you’re being offered.
When weighing the private annuity vs. lump sum dilemma, the three main questions you should ask yourself are as follows: What are my current and long-term life circumstances? What are my choices? How will I decipher what to do?
Health and marital status, life expectancy:
If both you and your spouse are in good health and expect to have many years ahead of you, perhaps you should consider requesting a monthly pension benefit for the duration of your life. You can also take a joint-and-survivor option for both you and your spouse that will extend through the duration of your spouse’s life as well.
On the flip side, if you are in poor health and have no surviving spouse that can receive continuing benefits, the better option may be to take the lump sum, in order to maximize the sum of money you will be given.
Taking a lump sum can also provide more flexibility, especially when it comes to the rising costs of healthcare. You have the freedom of purchasing an annuity on your own at any point in time, and then managing the remainder of the funds on your own. A lump sum will also leave you the opportunity to leave sums of money to various beneficiaries.
Lump sum responsibilities:
Taking a lump sum comes with the responsibility of managing that sum of money and making it last a lifetime — or trusting a professional to do it for you. If you’re uncomfortable with the risk of losing money in the market, or possibly outliving your savings, then perhaps this isn’t the best option for you.
While putting a lump sum into a diverse array of stocks can produce substantial fruit, some people simply feel uneasy about the risk involved in investing an unpredictable and ever-changing market, as well as the hassle involved in managing those funds.
It may seem more appealing to you to go the annuity route, which provides you with a lifetime income the same way a pension plan was designed to provide.
Map out a plan: Before you decide to take a lump sum or the annuity, figure out which one makes the most financial sense. Calculate the amount of income you’ll receive from the lump sum, and weigh it against the amount of annuity income from the plan.
You may be able to generate a higher amount of income by investing the the lump sum. An adviser can help you decipher these possibilities and help you make the choice that’s best for your situation.
Tax considerations: If you take a lump sum and don’t immediately roll it into an IRA or another plan, the lump sum will be considered income, and you’ll be faced with a 10% penalty tax if you’re under the age of 59 1/2.
I’ve discussed the ways to avoid that 10% tax if you’re under that age in previous blogs. One exception is if you’re age 55 and retired. The other is if you sign up to take the lump sum in substantially equal payments.
Other funding, number of plans, amount of benefit: If you have designated other assets or accounts for your retirement nest egg and you’d like immediate access to a portion of your money, consider the lump sum.
Especially if it isn’t a large sum of money and you have several other accounts to manage, rolling it over into another plan could save you a headache on the amount of plans you have to track down the road.
The above method probably isn’t right for you if you and your spouse don’t have another source of guaranteed lifetime income besides Social Security.
Company status: If you’re concerned about the financial wellbeing of your company and fear it may not endure for many more years, consider taking the buyout offer of a lump sum of annuity. Similarly, if you’re worried the plan is underfunded and won’t last, you may want to go ahead and receive your pension. You should note, however, that just because a company is derisking its pension doesn’t necessarily mean its in trouble of folding.
Guarantees: If a pension plan fails, your benefit is guaranteed to a specified limit, by the Pension Benefit Guaranty Corp. But once you take a lump sum from your pension, all guarantees are off the table.
Most financial professionals feel there’s little reason to worry about the placing of your retirement funds with a private insurer, however. The reason is because employers are required by law to choose a ultra-safe insurer.
One major advantage that life insurance companies do have over pension funds is the ability to leverage the mortality risk over several different product lines. Profits on life insurance increase as as mortality extends, while profits on annuities reduce as mortality extends.