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The Big Pension Debate: To Lump Sum or Not To Lump Sum

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Whether retiring soon, or you got a letter from an old employer, many are forced to make “the big pension decision.” Do you accept a one-time, lump sum option, or keep the pension as a monthly annuity payment?

Every year, this topic arises with clients. Therefore, I thought it’s time to share the thought process which generally transpires.

Understanding the basics.

Before you can actually decide what’s right for you, it’s important that you understand your choices. Most companies don’t want these archaic pensions bogging down their books for the next 30 years. That’s why many give the option to remove their responsibility and put it onto you.

There are two options in the basic offer.

Option 1:

You can collect (either now or in the future) a monthly paycheck for the rest of you and your beneficiary’s life.

Option 2:

You can forgo the monthly payments and receive a lump sum payment. These dollars then can be rolled into an IRA to avoid current taxes.

I want to preface the following sections with “there is no one right decision for everyone.” Every client’s situation is unique. Therefore, when we at Diversified discuss these, we take a neutral position and discuss the pros and cons of each.

The pros of taking the pension as a monthly payment:

To many, the monthly payment means security. You’ll know the markets won’t disrupt your ability to collect your lifelong, predetermined monthly payment. It becomes stress free money and allows you peace of mind in planning future finances.

Another upside is usually some form of spousal benefit. This insures your significant other some portion of your pension, if you should predecease him or her. This is pretty standard and most people end up taking advantage of this feature.

The pros of taking the lump sum payment:

Conversely the biggest perk of taking the lump sum is control and flexibility. When taking the lump sum you now have virtually unlimited options on what to do with these funds. Generally, putting them in an IRA (for tax purposes) is recommended. From there, you have the capability of investing as you choose (or as you and your financial advisor deem appropriate). Many like this option, as it gives flexibility (both while living and at death) as to what happens with their funds.

With every pro comes a con, hence what makes the pension decision so difficult. Quite frankly, this is why we spend so many hours going through the options. This collaboration allows for making an informed decision.

The cons of taking the pension as a monthly payment:

There are a few major cons of taking the monthly pension payment. The biggest is inflexibility. Once you collect, you get that payment for life (and usually not a cent more). You can’t change once you’ve started, and generally there is no inflation rider. Also, to give your significant other a survivor payment, it reduces your eligible amount. The greater the survivor amount, the less the primary collector will receive at the onset. The biggest concern is if both die prematurely, there will be no funds for their children or heirs.

Additionally, if one has a private, non-government pension there may be concerns about their company’s ability to continue to pay. The good news is these pensions are insured by Pension Benefit Guaranty Corporation. The bad news is the limit to how much they will cover. For 2019, the maximum covered by the PBGC is $5,047.16 for a 65 year old collecting a 50% joint and survivor benefit. Thus, any dollars over that amount wouldn’t be covered if the company no longer could fund their requirements.

Related: 8 Actionable Items for Your 2019 Finances

The cons of taking the lump sum payment:

Where you have flexibility you usually have uncertainty. What if the markets go down or up, what are you going to do with those funds? Do you have a plan for not spending those dollars too quickly? Unlike the pension payment, these dollars can eventually run out. This is the biggest concern of people taking the lump sum option. If going this route, I highly recommend working with a financial planner. They can assist in structuring your investments to best combat market volatility. That said, that’s the risk you takes when the funds are under your control.

Recommended steps to take.

If (or when) faced with this decision, sit down with your financial planner and focus on clarifying your financial situation. Make your wants and needs for the rest of your life crystal clear. Then, see how these two options would play into those plans.

Ask your advisor to run some breakeven analysis with different rates of return. This help’s see at what age you would be better off collecting the pension vs. taking the lump sum offering. Often times, this information can be quite enlightening and helps make the decision for you. Remember, once you select to take the pension, this decision is irreversible.

Regardless know that we here at Diversified, LLC are well equipped to help you make these decisions.

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