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Pension Lump Sum or Annuity?

If you have a company sponsored pension plan and are separating from service (i.e. retirement, layoff, early buyout, etc.), you may be looking for answers or guidance as to whether you “should elect the Lump Sum or one of the Annuity options?” There is not a one-size-fits-all answer to that question. What is best for you will depend on several factors. Fortunately, my Group and I have helped many with this decision and are here to help you!

In general, if you have spent many years with a particular company who offers a pension plan, there is a good chance that it makes up a significant portion of your retirement assets/income. Consequently, deciding which option is best is probably one of the most important irrevocable financial decisions you will make in your lifetime. In my opinion, the key to making the right decision is to not just focus on the pension itself, but to determine and understand how the pension fits into your overall financial picture.

Let’s start with some of the basics…

Annuity option: by electing the annuity, you’re choosing to leave the lump sum amount with your employer. They will “annuitize” the monies, providing you with a fixed monthly benefit. In many instances, you can choose between a single life annuity payment, a 50% joint and survivor annuity, and a 100% joint and survivor annuity.

The single life annuity gives the highest dollar amount per month, but the payments cease at your death. The 100% joint and survivor annuity option provides the lowest dollar amount per month, but provides your surviving spouse with the same continuing benefit upon your death. Depending on the credit rating of the annuity provider or pension fund, you can argue the benefits are guaranteed. Typically, the Federal Pension Benefit Guarantee Corporation (PBGC) insures pension annuity payments, up to a certain amount per month.

Market fluctuations will not affect the payments. However, by leaving the monies with your employer to be annuitized, you are giving up control. If you think about it, no matter which annuity option is taken (survivor benefit or not), upon the deaths of both you, the retiree and spouse, the annuity payments typically end. Also, other than a few (i.e. FERS), most benefits do not provide inflation protection. In other words, your fixed monthly benefit will buy you less as time passes.

Lump sum option: choosing the pension lump sum distribution option and then transferring the account balance into an Individual Retirement Account (IRA) allows you to choose exactly where and how the money will be invested – you have control. The lump sum option provides for a potential inheritance to heirs, because unlike the annuity option, the money can continue on post-death. A lump sum also allows your retirement benefits to keep up with, or outpace, inflation through proper investment decisions. However, taking the lump sum payment brings with it market risk (“no guarantees”). You are responsible for making the funds last for your lifetime. Furthermore, pension lump sums are not insured by the PBGC.

Guiding questions: In addition to being familiar with the basic pros/cons to help with the task of determining and understanding how the pension fits into your overall financial picture, I propose being able to answer the following general questions:

– What are your short-term and long-term goals?

– What assets do you have? What liabilities do you have?

– What income do you have? What is your spending need?

– How is your health? Longevity?

– Single? Married? Kids?

Other considerations: have you reviewed current interest rates? What is a realistic expected rate of return if you invested the lump sum? Have you calculated rates of return for the annuity options assuming you live to age 80, 85, 90 and so on? What about inflation rate assumptions? Have you looked into the credit rating of the annuity provider or pension plan if you elect the annuity option? Have you reviewed service, investment options and costs of managing the lump sum? The list goes on…

Feeling overwhelmed yet? Don’t be, we’re here to help!

What is my Group’s process? How can we assist? 

The first step is simply to reach out – give me a call or send me an email. We would schedule an initial meeting/call to get to know one another. The goal is to learn about your situation, goals, objectives, gather the details and answer any questions you may have for me.

The next three tasks would involve bringing it all together.

1. We would create a one-page Net Worth listing all of your assets and liabilities, providing a snapshot of your financial situation today…a starting point.

2. We would create a retirement analysis, which depicts year-by-year cash flow. This type of illustration will help determine whether or not your accumulated assets and expected income sources (i.e. Social Security, pension, etc.) will be adequate to meet your retirement income needs. It will also help determine whether or not your current spending is sustainable and what changes may be necessary in your portfolio, if any.

3. We would also isolate and focus on the lump sum and annuity options by putting together a pension analysis – calculate rates of return and present values – crunch the numbers. Consider all strategies (i.e. pension maximization if it makes sense).

The final step would be the presentation meeting/call. We would review the analyses, revisit the pension options as well as provide our recommendations.

Another option would be to walk through our MASTERPLAN® approach (comprehensive financial plan) as it would cover all of what I mentioned above and much more.

In summary: if you need to decide which pension option is best, it is extremely important to have a well thought out plan prior to making a final decision. Once a decision is made, it typically cannot be “undone.” It is true that each pension plan has its own unique features, but we are very familiar with most of the pension plans offered in our region and are more than happy to dig deeper in order to provide additional details that may be specific to your plan.

If you would rather not tackle this decision on your own and are interested in utilizing our expertise, please reach out to me directly! Again, I cannot emphasize how we are here to help you make an informed decision and gain peace of mind!

DISCLAIMER: Past performance does not predict future results. This report is based on data obtained from sources we believe to be reliable. Hefren-Tillotson does not, nor any other party, guarantee the accuracy or completeness of this report or make any warranties regarding results obtained from its usage. All opinions and estimates included in this report constitute the firms judgment as of the date of this report and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation to buy or sell the securities herein mentioned.

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