If you are fortunate enough to be eligible to receive a pension from your employer when you retire, one of the main decisions you will face is whether to accept a lump-sum distribution or lifetime monthly payments. As you approach your retirement date, it’s important to think carefully about this decision, since it is usually irrevocable and can have a significant impact on your family’s financial well-being for years to come. However, there is no clear answer as to which option is more beneficial—the right choice for you will depend on several variables, some of which may be difficult to predict. The following overview highlights the main pros and cons of lump-sum versus lifetime pension payments.
Lump-sum pension payments
Taking your pension as a lump sum means that upon retirement, you will receive a one-time payment from your employer. One of the key advantages of this approach is that it provides you greater flexibility to spend, save, or invest your money as you see fit. For example, rolling the money directly into your IRA or 401(k) will allow you to defer paying taxes on the amount, continue growing your nest egg through investments, and control when you take distributions—and therefore, when you pay income tax. If you choose the lump-sum approach and won’t immediately need the funds to pay for monthly living expenses, rolling the money into a retirement account is recommended—otherwise, you may find yourself in a higher tax bracket in the year you receive your pension.
While taking a lump sum offers more flexibility than lifetime payments, it also carries greater responsibility, as it places the onus on you to ensure that your pension will last long enough to meet your needs and your spouse’s needs for the rest of your lives. If the funds are not properly managed, you face the risk of running out of money to pay for your living expenses. In fact, according to a study by MetLife, one in five retirees who took their pensions as a lump sum depleted the money in less than six years, and an additional 35 percent were concerned that the money would run out. Therefore, before choosing this option, be honest with yourself about your ability to properly budget and invest money and the expenses that you may encounter in the future. In addition, consider that lump-sum pensions are calculated based on average life expectancy estimates, so if you end up living longer than expected, the amount may not be sufficient.
Aside from the benefits of greater flexibility and control over your money, you may consider taking a lump-sum pension payout if you are concerned about your employer’s financial state and their ability to make monthly payments in the future. However, this generally only applies if you work in the public sector, for a religious organization, or you are part of a multi-employer plan. If you work for a private-sector employer that goes bankrupt in the future, the Pension Benefit Guaranty Corporation will likely cover your payments in full up to certain age-based limits (for example, in 2020, the maximum annual benefit is $69,750 for a 65-year-old).
Lifetime pension payments
If you choose lifetime payments, you will receive your pension in regular (usually monthly) payments for the rest of your life—and in many cases, your spouse will continue to receive 50 or 100 percent of the regular payments after your death. Unlike a lump sum, lifetime payments are often indexed for inflation, so they may increase in the future to meet a rising cost of living. Many retirees prefer this option for the peace of mind it provides in knowing that they will have consistent, reliable support for themselves and their spouses. Lifetime payments are probably best if you’ll need your pension soon after retirement to fund your regular living expenses, or if you have spendthrift tendencies or any concerns about your ability to stretch a lump sum for years or decades into the future. After all, a lump-sum pension may be the largest single amount of money that you ever receive, and the temptation to spend it too quickly could be strong.
While lifetime payments ensure that your pension will continue to support you for the remainder of your life, you’ll have less flexibility in determining how to spend or invest the money since you will be receiving far less at a time than you would with a lump-sum payout. Additionally, if you pass away before you’ve reached average life expectancy, you and your heirs may not receive the full amount of your pension. Therefore, your overall health is one factor to consider when approaching this important decision.
If your retirement date is on the horizon and you will be receiving a pension from your employer, working with a trusted financial advisor can help you determine the optimal strategy for making your money last as long as possible. Contact our team of tax and financial experts today for a consultation!
–Stephanie Vance, J.D.
(Sources: https://www.investopedia.com/articles/retirement/05/lumpsumpension.asp, https://www.aarp.org/retirement/planning-for-retirement/info-2020/monthly-pension-vs-lump-sum-payout.html, http://www.pensionrights.org/publications/fact-sheet/should-you-take-your-pension-lump-sum).
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