Do you take it all at once or in portions over time? That’s a question that many workers face as they near retirement. Specifically, are they better off taking their pension as a lump sum or in monthly payments?
“These programs tend to be popular with eligible participants,” said Matt McDaniel, a senior consultant at Mercer, a consulting firm. “When they offer a lump sum, people tend to take it.”
By law, he said, pension plans “have to offer you an annuity” that provides fixed periodic payments. “They may or may not offer you a lump sum.”
Richard and Sonya Brown of Arlington have decided to take an annuity over a lump sum.
Richard, 65, is a technician for a large telecommunications company. He’s considering retiring in January, when he turns 66.
Richard said when he retires, he will take his pension as an annuity because he doesn’t want the worries that come with investing a lump sum himself.
“We have friends who took the lump (sum), and they’re consumed every day by the newspaper and do they have enough money,” he said. “I don’t want those worries on me in retirement. I would rather make enough or work long enough so that my guaranteed amount would be sufficient to take care of my expenses.”
The annuity options can include:
• Life annuity –This pays a monthly payment for as long as the pension plan participant lives but stops immediately when he or she dies.
• Life annuity with survivor benefits – Also known as a “joint-and-survivor annuity,” it continues to pay a monthly payment to the survivor after the plan participant dies.
• Life annuity with period certain – This pays as long as the participant lives or for a set period of time, whichever is longer.
“For example, life and 10 years certain would pay for lifetime or 10 years, whichever is longer,” said Tom Murphy, certified financial planner at Murphy & Sylvest LLC in Dallas. “If the participant dies in the first 10 years, the remaining payments go to the designated beneficiary.”
In addition, there are numerous combinations of the annuity options, he said.
“Each option has a different monthly payment,” Murphy said. “Life-only is almost always the largest monthly payment, with the amounts decreasing as survivor and period certain are added.”
Weighing the options
So how do you decide which is the better option for you?
“The two things that are critically important for a participant in deciding whether to take this lump sum are how long they’re going to live and how much they would earn in investments if they were to take a lump sum and invest it,” McDaniel said.
Of course, you can’t know precisely how long you will live, but you can get an idea by looking at your parents’ longevity and your family’s health history.
“Participants who are in good health and have a history in the family of longevity – they might be better off holding out and taking the annuity because then the lifetime payment nature of that annuity would become valuable for them,” McDaniel said.
For example, if you chose an annuity, retired at 65 but then died at 68, “then you got three years’ worth of payments, which is typically going to be less than the value of a lump sum equivalent you might have gotten,” McDaniel said.
But if you lived until you were 95 “you would have received 30 years of payments, in which case the value of that annuity is probably better than whatever lump sum you would have gotten.”
Murphy said, “If you are married and at least one of you is in good health, life and survivor is most likely the best option.”
However, if you’re not in good health, a lump sum might be better suited for you. “At your early demise, the rest of the money can go to your heirs,” Murphy said.
The other factor to consider is how good an investor are you?
“From a decision-making perspective, participants need to ask themselves how comfortable are they managing a large pot of money and how confident do they feel about their ability to earn a good return on that money over their investment horizon,” McDaniel said.
“If you take the lump sum and invest it well and earn a strong return on your assets – everything else being equal – you would be better off taking the lump sum,” he said. “But if you invest it very conservatively or invest poorly and lose money, you would have been better off with a fixed annuity payment.”
Richard Brown described himself as a conservative investor and said he’s not experienced enough to be a good stock picker.
So he chose a joint and survivor annuity so his wife, Sonya, would be provided for when he dies. He said that will reduce his monthly benefit by about $200.
“I want my wife to have survivor benefits,” Richard said. “Basically, you’re buying an insurance policy to cover your wife that’s costing you $200 a month.”
Financial planner Alan Goldfarb said if you choose an annuity, make sure you get the biggest bang for your buck.
“You might want to check whether your lump sum could buy yourself a better annuity product than the company’s offering,” said Goldfarb, managing director at Financial Strategies Group LLC in Dallas. “If you’re going to compare an annuity to a lump sum, you want to make sure whatever annuity you pick is going to be the highest payout annuity.”
One factor that you don’t need to consider is the financial well-being of your employer.
“The stability of the employer is not usually a significant factor as a retiree considers whether or not to take a lump sum payment,” McDaniel said. “Most retirees should instead consider this offer based on their own personal needs.”
That’s because pension plan assets are held in a separate fund that the company cannot tap, he said. Further protection also is offered by the Pension Benefit Guaranty Corp., which stands behind monthly pension payments if a plan goes into default.
Before pulling the trigger on this critical decision, it’s a good idea to consult a financial professional.
“As with many financial issues, there is not one answer applying to all,” Murphy said. “Deciding which option to take is one of the most important retirement decisions you will make, and once decided, generally cannot be changed.”