All About Pensions

Should I take a lump sum?

That’s a question I hear often from those fortunate few with pensions. The answer is not always cut and dry. There are several factors to weigh if you’ve been offered a lump sum on your pension.

To illustrate:

Joe is retiring from a Fortune 100 company that offers a pension plan (also referred to as a defined benefit plan). He and his wife plan to enjoy using some of their pension income to travel. However, they recently received a letter from Joe’s employer with an offer to pay a one-time lump sum amount to Joe in lieu of receiving the pension income for the remainder of his life. Should they take the lump sum or receive the monthly income?

If you are in a similar situation, we hope you find the following information useful.

Which pension option is best for you?

While each person’s situation is unique. There are generally some areas to think through before deciding on accepting or rejecting a lump sum offer. They include:

  • Marital Status. Pensions provide a guaranteed lifetime income at retirement and, if elected, an income to your surviving spouse.
  • Longevity. Your life expectancy is a major factor in this decision. If you are in ill health or have a family history of short life expectancy, taking a lump-sum may be an attractive offer versus the income from the pension.
  • Age. Your current age is important in considering whether to take the lump sum. The earlier you are in your career and/or tenure with the company, the smaller your pension lump sum might be. If it is a small amount; you may want to consider taking the lump sum offer and investing it for the future.
  • Money management. A pension is a fixed income stream. Although the income is guaranteed, you have limited flexibility in withdrawing additional funds. Receiving a lump sum gives you access to the funds. However, you’ll need to manage the money to provide the needed cash flow in your retirement years.
  • Legacy. With pension income, generally nothing remains for your heirs after you and your spouse pass away.
  • Tax considerations. Pension income is taxed as ordinary income. A lump sum amount can be rolled over to an IRA and avoid taxation when you receive the lump sum amount. However, any distributions from the IRA will be taxes as ordinary income.

Questions to ask yourself:

  • If you took a lump sum, what is your expected future return on the investment and what income could that generate versus the income received from the pension?
  • Are you willing to take the risk that is involved with taking the lump sum?
  • Are you and your spouse set on handling the investments or will you let someone else manage your investments?
  • What other guaranteed income streams will be available to you?
  • What other assets do you have to meet your income needs?

In summary, there are many factors to consider before deciding whether to accept a lump sum pension buyout offer. Before deciding, I encourage you to meet your financial advisor and tax professional to ensure you fully understand which option is best of you.