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Should you take a lump-sum pension payment?

Created date

January 23rd, 2014

Traditionally, if you have a pension, upon your retirement you begin receiving regular monthly payments for the rest of your life. However, many employers are increasingly offering employees the option to take lump-sum payouts in lieu of annuitized payments. Some companies are even offering former employees who have been retired for several years and already receiving pension payments the option to switch to a lump-sum payment.

California financial advisor Tom Chandler (hansonmcclain.com) conducts workshops to help people decide whether to take lump-sum payouts. He says stock market losses in recent years have left many pension plans underfunded. That, combined with today’s low interest rates, makes lump-sum pension payouts attractive for companies.

“Right now, they can borrow money quite cheaply to pay out these lump sums versus having to know the cost to pay retirees in the future,” Chandler says. “When a retiree takes the lump sum, the employer no longer has to worry about interest rate fluctuations or returns.”

Pros and cons

While the benefits of lump-sum pension payouts for employers are clear, for retirees the choice between a one-time payment and a traditional pension isn’t as cut and dry. Chandler says people should consider their age and spending habits because once you take the payout, it’s up to you to make it last.

“You have to ask yourself whether you are disciplined enough to stick with a spending plan because when you get that lump sum, it can look like a lot of money,” Chandler says. “Someone age 62 could be looking at needing income for a 30-year timeframe.” 

However, in many cases, lump-sum payouts can be advantageous because they put you in control of the money. Chandler says if you take that lump sum and invest it wisely, you may be able to generate even more income than you would have received from monthly pension payments. Chandler says your financial advisor can help you determine the rate of return you’d need to earn on that investment in order to make the lump sum more advantageous than a traditional pension.

“There’s no way you can guarantee an 8% internal rate of return,” Chandler says. “Around 5% to 6% is the pivot point—if you’d need to earn a higher return than that, you are generally better off taking the monthly payment.”

Connecticut wealth manager Sean Dowling (thedowlinggroup.com) reminds retirees opting for lump-sum payouts to put proceeds into a qualified account like an IRA. Otherwise, Uncle Sam could end up with a big chunk of your nest egg.

“If you are talking about a $1 million or $500,000 payout and you don’t facilitate a transfer to another qualified account, you’re looking at 40% tax bill,” Dowling says. “It happens to people all of the time—you’d be amazed.”

Lump-sum pension payouts may appeal to some retirees who have fears that their former employers aren’t financially stable enough to make good on pension payments for the next several decades. Ohio financial planner Adam Koos (libertaswealthmanagement.com) says those concerns are real and should be taken into consideration. But, he says you shouldn’t base your decision solely on that fear.

“The vast majority of pensions, even if the company were to go belly up, are covered by the Pension Benefit Guarantee Corporation,” Koos says. “Think of it like ‘pension insurance’ companies are required to keep.”

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