Making a complex pension decision is not a concern for most Americans. But for those who have worked in the public sector or for a large old established company, this may be something you have to deal with. For most, the decisions you have to make concerning a pension can be overwhelming.
Pension payment options usually go like this; You have the option to take a lump-sum amount of money or convert that lump-sum payment into a monthly income stream. Most plans will default you into a monthly income stream.
The pension industry is heavily regulated. This heavy regulatory burden causes most providers to offer a fair package when comparing the options of the lump-sum payment and the monthly income stream. This makes the decision between the two options even harder. Financial calculations can help analyze this issue, but the biggest drivers of this decision is your specific situation.
The answer to the question of whether you should take the lump-sum payment or the monthly income stream lies in an old Egyptian inscription that states “know thyself.” In this article, we will go through some of the most significant factors you have to analyze when making a pension decision. Before we do that, we will go into more details of the different attributes between the two options.
Taking the Lump-sum Payment
If you take the lump-sum payment, you will have the maximum amount of control of your money. Taking a lump-sum means the pension company will write you a check for a predetermined amount. Typically, you will roll that amount over into a Rollover IRA to prevent incurring ordinary income taxes.
For most who opt for this option, they will try to replicate the income stream the pension originally offered by investing the money. A plus for taking the lump-sum payment is that you can withdraw a lot of money in some years and a little money in other years.
For example, you can do a lot of home repairs one year by taking a more substantial withdrawal from your IRA. Then in other years, you will take a smaller withdrawal when your income needs are relatively low. You can even convert some of the money into a ROTH IRA to manage your future tax liability better. This control of the money is a key reason a lot of people opt for the lump-sum payment option.
Things to consider
It will be your responsibility to manage the money – When a pension fund provides the monthly stream of income, they take responsibility for ensuring your payments will last for a predetermined time. When you take the lump-sum payment option, it is your responsibility to manage the money. You can either do it on your own or hire a financial planner to do this for you. This can be a major concern if you have not done well with your money in the past.
Tax Planning – When you take the lump sum payment, you decide when to withdraw the money. Keep in mind when you make withdrawals, there will be tax consequences.
Social Security & Medicare – If you find yourself needing government assistance, you will have to strategize how taking the lump-sum payment will affect the services that are available to you.
Living Longer than expected – The longer you live, the less beneficial it is for you to take the lump-sum payment. The longer you live the monthly income stream offered by the pension company becomes considerably more valuable.
Selecting the Monthly Income Stream
The terms of your pension plan will determine the monthly income stream you are entitled to. In most cases, the insurance company will provide you with more than one option of how you can take your monthly stream of income. Some will even offer payments to your beneficiaries if they outlive you.
I find a lot of individuals are okay with taking the monthly income stream because it resembles earning a paycheck every month. With the monthly income stream, anticipating major expenses and cash flow management is done on a monthly basis vs. a yearly basis. The monthly income stream compared to the lump sum payment is usually easier for a lot of families to get their head around.
Also, it is common that one spouse is more financially savvy than the other spouse. If the financially savvy spouse were to pass, it can be a tall order to ask them to manage a $500,000 portfolio vs. a $3,000/month income stream.
Things to consider
Sudden Death – To earn a pension from a company, it usually requires multiple years of service to that company. The risk of opting in for the monthly income stream is that if you pass early, you may not be able to maximize the benefits you have earned.
Lack of Flexibility – Once you set your monthly income stream, there are few options to change it. If you need more money in a given month, you will have to dig into your savings or use credit.
Poor ROI – Most pension funds invest conservatively as a result of the regulatory burden. They will focus most of their investments in fixed income securities. Historically stocks have outperformed fixed income products. The idea of an individual obtaining a higher ROI for their money taking than lump-sum options is not uncommon.
‘Know thy Self’ Factors
You could write a book on the scenarios and factors that affect how you should elect to take your pension. To simplify this decision, we have provided a few key factors and explain how those factors may affect your decision.
Financial Condition / Financial Responsibility
The stronger your financial condition is, the more likely you will opt for the lump-sum payment. The more your financial affairs are in order, the more you will prioritize increasing the value of your estate. If your affairs are not in the best shape, this increases the odds a guaranteed monthly income stream would fit your risk profile.
With over 70% of Americans living paycheck to paycheck, asking the average America to be responsible with a pile of money is a tall order for most. The average person would not know where to begin or even where to seek help if they were asked to manage a large sum of money.
Life Expectancy / Health
The longer you expect to live and the healthier you are makes taking the monthly income stream a better option. The best predictor of how long you will live is your current health status and the average longevity of your family members.
If you are dealing with current health issues that may limit your expected longevity, a shorter life expectancy causes the lump-sum payment to maximize the benefits you have earned through your pension.
Financial Health of the Company Providing the Guarantee
The guaranteed payment is only as good as the one guaranteeing the payment. If you are planning to take the monthly income stream, you should review the financial health of the guaranteeing company. If the company that holds your pension falls on hard times, this can put your monthly income stream in jeopardy. If you find the financial condition of your pension company is poor, I would opt for taking the lump-sum payment and looking for other options to produce income.
Based on the information above you can see why so many people have trouble making their pension decision. There are a lot of factors to take into account. If you need help making these decisions, please give me a call by utilizing the contact information below.
Randall Avery
Financial Advisor │ Author │ Public Speaker
R.S.A. Deasil Advisors, LLC
Office: 531-333-2745
Email: Deasil@rsadeasil.com
Website: www.rsadeasil.com
P.S. If you would like me to speak at your next event, please click HERE
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