Retirement Planning: Pension Payment Vs. Lump Sum
- Steven G. Scalici, CFP® Treasure Coast Financial
- 2004 3 Dec
Remember the show "Who Wants to be a Millionaire?" Regis Philbin asked a series of questions and if you answered them all correctly, you could win $1 million. If you were stumped, you could choose to take what you had won up to that point and walk out. Of course, there were also the "lifelines" that you could use if you weren't sure of your answer. There was the "fifty/fifty," "phone-a-friend," and "ask the audience."
Many of you are preparing to make one of the most important financial decisions of your life, but there aren't any lifelines, and you can't simply walk away if you get stumped. For those of you nearing retirement and working for a company that offers a pension plan, you may have to decide if you want to take a pension payment for the rest of your life, or if you want to take a lump sum. Before you give your "final answer," there are some things you need to consider, especially since many of you may receive upwards of $1 million or more.
Traditionally, there was no option. You would work for a company for "x" number of years, retire, and they would pay you an income for the rest of your life. The lump-sum option has become more commonplace in recent years as companies look for ways to reduce their obligations. The lump-sum payment that you can choose is determined by calculating the present value of all those future payments you are expected to receive. We recommend if you take the lump-sum option that you utilize a "rollover IRA" to avoid paying taxes and penalties.
The traditional pension payment may seem the "safe" way to go because your pension payment is guaranteed1,2 by the company. And while your payment may never go down, there's a good chance that your payment will never go up either. That $3,000/month benefit might seem nice today, but in 10, 15, even 20 years down the road, reality will set in that $3,000 "just doesn't go as far as it used to." Inflation is the greatest wealth inhibitor on the face of the earth. Make sure your pension payment has a built in inflation adjustment.
Also, consider the possibility that you may need money to buy a car or make a large home improvement at some point. You won't be able to tap your pension plan because you will be limited to a fixed monthly amount. In addition to inflation concerns and the inflexibility of a fixed payment, you also need to consider your extended family (beyond your spouse). Most pensions offer you the opportunity to provide your spouse with a lifetime income in the event of your death. But, should your spouse predecease you or your deaths happen simultaneously, there is no payment made to non-spouse beneficiaries. If, however, you choose to "rollover" your pension to an IRA, your beneficiaries would receive the remaining balance.
Choosing a lump sum can also offer increased flexibility in your living years. Once again, with a traditional pension payment, your amount is fixed. With the lump-sum distribution, you can control your own destiny -- you can take out as much or as little as you want.
Naturally, there are many variables to consider when deciding which option to choose. Use your "phone-a-friend" to contact your financial advisor for help in making the right choice for your situation.
Steve Scalici is the CEO of Treasure Coast Financial, a financial planning firm in Stuart, FL. He is co-host of God's Money which can be heard weekdays at www.oneplace.com. He can also be reached at his website www.tcfin.com.
1Guarantee based on claims-paying ability of the issuer.
2Withdrawals from an IRA prior to age 59 1/2 may be subject to a 10% tax penalty