Are you getting ready to retire and deciding what to do with your pension? Making the wrong decision can be costly, especially considering that, most likely, you won’t be able to change it. Plus, the impact of these decisions is usually 20 years or longer. Many of our clients nowadays are taking the lump sum option. Let's talk you through the pros and cons of doing so to see what can make the most sense for you.
Note that all pensions are unique, so it’s important to examine the numbers in detail to determine which option is best. With our clients, we might run multiple scenarios to truly understand their situations and goals before we make decisions. As you will see, two people with the same pension options may choose different option depending on their situation.
Reasons you should take the lump sum
With many of our clients, when we run the analysis, we find investment options that can do the same thing as the pension but provide more features and flexibility. For example, many pensions do not allow you to leave the money to a beneficiary if you pass away. This means you get the payments only for your lifetime.
Let's put some numbers to this. We had a client who had a $600,000 lump sum pension. If they did not take the lump sum, then they would receive $3,000 a month for the rest of their life but would pass nothing on to a beneficiary. If you truly want that lifetime income option, then you could shop the marketplace to find an insurance company that could provide you, for example, $4,000 per month for the rest of your life. And, when you pass, the beneficiary would get whatever remains of the $600,000. In my mind, this would make sense for most people in this scenario.
There are many other options beyond using an insurance company to get income for life. There are other vehicles and investments out there that may better fit your situation, so keep an open mind when you look at your options. The income annuity is just a good example to illustrate how there are other options that could work, depending on what your goals are.
If you are doing survivor planning and trying to ensure that your spouse has enough money in their pocket if you are no longer here, then this can be another good reason to take the lump sum option. While many pensions have the option of continuing payments for your spouse for the rest of their life as well, this usually comes at a price, where you receive a lower pension amount while you are living in exchange for the extra benefit for your spouse. If your goal is to pass money to your kids, this may not be an option unless you take the lump sum payout.
Another consideration is not knowing what that future pension will look like. Depending on where the pension is coming from, it could be underfunded because people are living longer, and not enough people are paying into the system. If you take the lump sum, that money you've worked so hard for is now in your control and can be used for what you want.
Tax planning
Many of our clients have preferred the lump sum pension option so they can have more control when it comes to tax planning. If you take the monthly payout for life, you are stuck with that, and it is hard to efficiently manage your tax plans in the future, knowing that you will have Social Security and required minimum distributions (RMDs) from your tax-deferred investments at either 73 or 75.
If you take the lump sum now, we have more opportunities to employ strategies, such as Roth conversions, and have more flexibility to take the money out when we want to vs being told when to take the money out via RMDs.
Reasons you should not take the lump sum
Some pensions may have a great monthly payout for your lifetime. If that's the case, then you may want to consider taking that. If you could not find another investment vehicle that can provide you that type of ongoing monthly income, then you could have a great option by taking the pension payout each month for life.
Also, if you are younger, that could be a good reason to take the monthly payout for life. The longer you live, the more payments you will be getting for the rest of your life. Of course, as I mentioned before, the lump sum option may still be preferable because the money could be put into an investment vehicle that gives you higher income over your lifetime while still allowing you to leave the money to a beneficiary.
In the end, for most of our clients, we recommend they take the lump sum pension option. That’s not always the case, so I want to make it very clear that you should do your due diligence. If you are unsure what to do and need guidance, work with a financial planner who specializes in planning with pensions.
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