Home  >  Financial Articles and Q&A  >  Pension payout options?

Pension payout options?

In deciding between lump sum and lifetime payments, what are the most important things to consider?

Jun 21, 2012 by Francisca from Brookfield, WI in  |  Flag
5 Answers  |  7 Followers
Follow Question
13 votes

Hi Francisca, I think your question is going to be more and more common as companies and state/local governments consider reducing pension benefits due to revenue/expense problems. There are pros and cons to both of the approaches you mention.

On the lump sum side, tax is an immediate concern. Usually the easy way around that problem is to simply roll your lump sum distribution to an IRA. From there (assuming you're past age 59 1/2), you can tap into the IRA as needed, convert part or all of it to an immediate annuity (thus creating your own personal "pension"), or just let it continue to grow. You typically have more beneficiary options with an IRA than a pension distribution, so that may be another reason to roll it to an IRA. One challenge of taking a lump sum distribution though is that you have to make the investment decisions. If you roll to an IRA, for instance, and do not convert some of it to an immediate annuity, then you will not have lifetime guaranteed income as you would by taking lifetime payments.

On the lifetime payment side, a big plus is guaranteed lifetime income (assuming your company/state government doesn't ever reduce your benefits--that's happened several times with corporations in the past and I read a story earlier this month of some county/city governments in CA that are now reducing pension benefits). Another big plus is you don't have to worry about managing the money that's generating your lifetime payments. Inflation can also be a concern for lifetime payments that are not adjusted for inflation; over a couple decades in retirement, inflation of even 3-4% can cut your purchasing power in half. And as I mentioned, taking lifetime payments through your employer (corporate or government) may expose you to the risk of reduced benefits sometime in your retirement.

Hopefully these ideas will give you some food for thought! Mike

Comment   |  Flag   |  Jun 21, 2012 from Orland, IN

1|600 characters needed characters left
8 votes

Hi Francisca; All the answers above are all excellent, so I won't re-plow that ground other than to say my biggest concern might be inflation. Most people are living much longer; and, if you're married, retirement might mean two lives over three decades - what did a stamp cost in 1982? Considering the debt this country has been piling up, the odds are pretty high (I think) that the government will be printing money to pay if off for some time to come... and we may see the consequences of that for a good many years. When you take a lifetime income, the benefits (cited above) are great provided a dollar continues to buy what it used to; but you are giving up control and the ability to adjust later... and thirty years is a long time.

Comment   |  Flag   |  Jun 21, 2012 from Moorpark, CA

1|600 characters needed characters left
7 votes

Francisca - adding to Evan's answer - consider your intentions for the assets beyond your lifetime - do you want to leave a legacy for your heirs (family members, charities, etc)? Which option gives you the most control of the assets with regard to that goal?

Comment   |  Flag   |  Jun 21, 2012 from Clinton, NJ

1|600 characters needed characters left
7 votes

Sit down with a pen and paper (or spreadsheet; I'm a little old fashioned) and play with the numbers. How much in annual income does your current pension promise? What rate of return would you have to generate on your investments to equal that payout?

You basically have two options if you take the lump sum.

  1. You can invest it (with or without a professional advisor) in a portfolio of stocks, bonds, REITs, and other income producing assets. If the income portion is enough to meet your current needs along with Social Security, you can let the principal grow, untouched. (This may not be possible, depending on the size of the lump sum and your current needs).

  2. Annuitize the lump sum with an insurance company and guarantee yourself a given income for life. This only makes sense if the annuity company is offering a higher payout than your original pension, taking into consideration any inflation guarantees.

The first option gives you maximum control and allows you the most flexibility to leave an inheritance to your heirs. But, again, you may require more income than this option can provide, and if you take regular portfolio drawdowns you risk outliving your money.

Comment   |  Flag   |  Jun 21, 2012 from Dallas, TX

1|600 characters needed characters left
2 votes

Your goals for your retirement and estate , the health of you and spouse, your other assets and investments, your comfort with volatility ( ups and downs of investments)...and more. Good luck!

Comment   |  Flag   |  Jun 21, 2012 from Port Washington, NY

1|600 characters needed characters left