Pension Decision: Lump Sum or Lifetime Payments?

It is an age-old financial planning dilemma: Take the big sexy pot of money or the monthly payments for life? This question, of course, assumes that you are fortunate enough to have a pension and your pension offers a lump sum option.

What if your former employer goes bankrupt?

Some people like the idea of the lump sum because they worry that their former employer could go bankrupt during their retirement. It is important to understand that pension assets are held (and invested) separately from a company’s general assets. Most pensions are also guaranteed by the Pension Benefit Guarantee Association (PBGC). Click HERE to see whether your pension is covered by the PBGC and HERE to find out your coverage limit, which varies by age.

Pension decision: Is a lump sum even an option?

A pension plan must be at least 80% funded in order for a company to offer participants a lump sum. Pension plans frequently offer lump sums in order to eliminate administrative costs, PBGC insurance costs, and longevity risk.

A client recently asked me for advice; should he take the lump sum or monthly payments? This client was inclined to take the lump sum because monthly payments meant there would not be a death benefit to pass on to his heirs. You might think I would also be inclined to recommend the lump sum. The team here at Planning Great Retirements is confident in our ability to generate competitive returns if given the chance to manage the lump sum. However, we recommended the lifetime monthly payments for this particular client.

Pension decision:  Why would we recommend monthly payments?

  1. Today’s low interest rates result in a larger lump sum payout. If interest rates rise, a smaller lump sum will be required to generate the same monthly benefit.
  2. Social Security only covered approximately 40% of this client’s retirement living expenses. Ideally, we like to see at least 60-80% of core living expenses guaranteed.
  3. We looked at his financial plan’s probability of supporting his and his wife’s lifestyle for a range of life expectancies and portfolio rates of return. The lifetime payments generated a higher probability of success compared to taking the lump sum in almost every scenario.
  4. The pension only represented 1/3 of the client’s investible assets. Therefore, the client will still have sufficient investments to provide liquidity, the ability to keep pace with inflation, and a potential source of funds to leave to his kids.

Naturally, our advice may have been different for another retiree with different circumstances.

Have a great week.