Is a lump sum distribution right for me?
Most people think of lottery payments when speaking of the choice of a lump sum vs. an annuity. For some people with pension plans, that decision isn’t just in dreamland though. Both personal and financial factors should be considered when facing that decision.
Which will provide more money in the long run?
To answer this question, one needs to consider longevity risk.
From an actuarial standpoint, the lump sum payout is equivalent to the monthly payouts, based on the average lifespans of retirees. A pension plan continues payouts until death, and it can also provide for survivor benefits (typically a spouse). Those with very long lives end up on the better side of that actuarial curve with the monthly payouts. If you live alone and are likely to have a shorter lifespan because of medical issues, then you may get more from the lump sum. With the lump sum, you also have the potential to leave the unused portion as an inheritance upon death.
Even with a long life, it may be possible that properly invested the lump sum would earn more money overall. Not all pension-plans are indexed for inflation either, making inflation risk a serious concern when it comes to running out of money with monthly payments. Social security will be adjusted for inflation each year, but the rest of the retirement portfolio needs to take inflation into account.
What about spending during retirement?
There can be large expenses during retirement, especially when it comes to health. The debt from these expenses could eat away at retirement resources, but with a lump sum one might be able to cover those expenses right away. On the other hand, having access to all the money at once might encourage overspending in the beginning. Data from Consumer Financial Protection Bureau (CFPB) provide a cautionary tale as they find that:
“Among retirees with a pension, the analysis shows that those who chose a pension cash-out were less able to maintain the same spending level for five years after retiring than those who chose to receive their pension as a monthly payment (73 percent versus 56 percent).”
Are there tax implications to taking the lump sum payment?
Yes.
First and foremost, the money should be rolled into an IRA to maintain its tax-advantaged status. Otherwise, it could all become taxable, all in the same year bringing you into a higher tax bracket. When possible, the best way to do this is with a direct rollover from the plan provider to the new IRA plan provider. The sixty-day rule comes into play with rollovers, so realize that you don’t have until the end of the tax year to move the money.
Should the money not be rolled over, there could also be a 10% penalty for an early withdrawal before age 59½, and once it is moved over, it will fall under the same required minimum distribution rules as other IRAs.
What else might be considered?
Overall, when it comes to taking the lump sum payment it’s not just a question of how many dollars will be received. It’s also a question of addressing the enjoyment within retirement. Are you going to be more comfortable knowing that pension check is coming every month? Even if the business goes bust, the pension benefits are safeguarded by the Pension Benefit Guaranty Corporation up to an annual maximum. Does the pension have cost of living adjustments, or will you need to reduce spending to offset inflation?
Managing the investment side of retirement money is difficult work too, and many talented professionals have skills that don’t involve financial management. Finding a trusted financial professional who will guide you through your retirement can be difficult. At Garden State Trust Company, we hope to make it a little easier by providing a consultation where we look at all the different assets you may have that would affect your retirement picture. We then ask questions to help you create a roadmap of your retirement and make sure to answer any questions about what the usual retirement experience is like. We’re also happy to answer questions that might seem awkward such as how we earn our fees.
