Trying to figure out which is better, Pension Lump Sum vs Traditional Annuity can be tricky. If you have worked most of your life where you have earned a pension benefit you may have a couple of options. Taking your benefit as a Lump Sum where you would roll it over into a an IRA and invest it. The other option is the most traditional where you take the monthly Annuity check sent to you by your Pension plan.
Taking the pension annuity or lump sum was the difficult decision I had to make in analyzing what was the best option for me. I had to consider the Pension Lump Sum vs Traditional Annuity choice when I retired the first time. There are many factors to consider. I found it best to seek profession help from my fiduciary CFP Planner.
If there is any question in your mind then you should seek professional guidance too. It is a major financial move. Its best to understand all the variables that must be weighed in your decision.
Pension Lump Sum vs Traditional Annuity Decision Variables
The list of factors will be different for everyone. There are two key sides to the Pension Lump Sum vs Traditional Annuity equation. Pension Health and You. You, as in your unique financial, physical health, longevity, etc. that needs to be considered.
Pension plan funding status can become the biggest variable in your decision. If the funding level is below 80% then Lump Sums will be restricted. Pension plans are usually insured by the PBGC. But there are limits to what they will payout depending on your age at default and the severity of the under-funding.
My Pension’s health Issue
In my case my pension plan was underfunded but still just above 80%. Lump Sums were still on the table. Another issue is how your company talks about the pension plan. The company I worked for was taken over by a non-pension benefit providing company. The new company depleted the plan over several years. They did this by paying severance for tens of thousands of laid off employees. How they got the Fed’s blessing to do that is beyond me.
A few years later the company CEO advised that they were freezing the plan. The pension fund was underfunded hundreds of millions of dollars. He laid it all out there. They had no intentions of adding another dime to the pension plan they had severely depleted. The attitude to me was that they would let it default if it came to it. They could care less about their retirees.
I didn’t really want to be tied to it wondering year to year through my retirement what might happen. If you want to check your Pension plan health see my page, Can You Depend on Your Pension for details.
The Lump Sum Offered
Pension payouts have complicated and sometimes unknown calculation used to come up with your annuity’s lump sum equivalent. Many Pension annuities are based on a 7% to 8% return which we know isn’t realistic today. The Lump Sum should be an amount that would allow you to buy your own annuity for the same monthly payment as the pension annuity. That said, the lump sum may be tied to the interest rate of the US Treasury Bond rate.
The amount of lump sum being offered is usually for the companies benefit. They are offering an amount that they believe will save them money. Not a gratuitous amount out of the kindness of their heart and love for you. The amount offered compared to the monthly payment amount needs to be completely analyzed. Analyzed to determine the Lump Sum’s value to annuity percentage. If the Lump Sum’s value to Annuity is low you might be looking at a poor lump sum offer.
Some Pension plan annuities have cost-of-living increases tied to yearly inflation. Some offer that as an option but it comes with a lower monthly payment. Most have no cost-of-living benefit. If you choose to take the annuity and there is no cost-of-living increases you must consider that in your decision. That is becasue over time your pension’s spending power will be diminished.
Make sure you will have enough in your other funds to counter the negative impact of inflation on your annuity income. In 1996 my buddy retired and his annuity was $1800 a month. That was before medical insurance and taxes. He would clear $1400 and that wasn’t too bad in 1996. Health Insurance certainly has gone up taking more from the total. That annuity certainly doesn’t go as far today.
A lump sum may offer inflation protection if invested. Especially when combined with all your 401K and IRA amounts. Then by using the 4% safe withdrawal strategy with yearly inflation increases you could take care of inflation and spending power. But there are no guarantees on investment returns. The 4% withdrawal strategy may have to be adjusted downward during bad market investment years.
The younger you are when you retire the more negative variables there are for both the Annuity and Lump Sum option. If the pension is at risk of default then look at the PBGC payout graph. You will see the younger you are the more they cut from your payment for the rest of your life.
If you take the lump sum you must consider there are more years of investment uncertainty that you will have to live through and self-fund.
Your Health and Longevity
Most annuities end when you die. If your family history is short-lived or you are now in poor health then the lump sum may be the way to go.
If you are married and have the survivor pension benefit available then you should also consider your spouse’s health and longevity. Having a short projected life longevity may make the annuity with a survivor benefit for a spouse having longevity on their side more appropriate.
The Lump Sum isn’t necessary out of the decision here with longevity being a factor. It just means be aware that there is more risk of investment volatility that must be considered.
Your Financial Situation
For making the choice between pension annuity or lump sum look at your total financial picture. Add your lump sum value to all of your other savings. Look at your total and ask yourself, will you be able to live your retirement lifestyle with a 4% to 5% withdrawal rate?
If you take the annuity and with adding to it a 4% to 5% withdrawal rate from your other savings total. Does it come out higher than the lump sum with all savings calculation? The idea here is to look at what provides the best monthly income over the long haul.
Your Risk Tolerance
If you have no risk tolerance and can’t sleep when the stock and bond markets are rolling up and down. Then the annuity may just be the better bet. If you can tolerate market volatility and your investment portfolio can generate decent returns. Then the lump sum may be your choice.
I am sure that there are more considerations when looking at the Pension Lump Sum vs Traditional Annuity. These above issues were the things I was going through for my decision.
For me another issue was emotional. I just did not want to be connected for life to the company I no longer recognized nor agreed with. That gave weight to my cutting ties as much as possible when I elected to take the Lump Sum.
However had my company pension plan been better funded and my company was at least somewhat committed to its retirees I would have went with the annuity. It carried a higher value over the lump sum amount that was offered.
If you plan on living the “Retire Early and Often” lifestyle like I do. Then the lump sum may be of more value because you can roll it over to an IRA to invest it. You can then let it ride while living off of your Next Act Encore Career earnings.
The annuity would also work in this way as you just live off of your annuity and invest all of your wages. Basically you can retire early and increase your wealth by putting your pension to work for you.
Hopefully you have found some considerations here to include in your Pension Lump Sum vs Traditional Annuity analysis. Please give consideration to seeking guidance from a fiduciary CFP professional. This is one of most important decisions you have to make in your life.
“Disclaimer: This content is not provided or commissioned by any investment company or financial adviser firm. Opinions expressed here are author’s alone and are there as examples for readers to research and investigate their own best pension strategy. As the author is not a financial adviser, there is no implied recommendation being made on a professional level and readers shall choose between Pension Lump Sum or Annuity payout at their own risk”.