Should You Take the Pension Or a Lump Sum?

Should You Take the Pension Or a Lump Sum?

Lauterbrunnen, Switzerland – visited in 2003

For those that are lucky enough to have a pension, this is always a popular question. For those without a pension of any sort, this is one to skip. Given that I’ve gotten this question a few times over the past couple months, I wanted to provide some thoughts on this topic.

When it comes time to retire, if you are offered a pension, you will likely be offered one of two scenarios:

Scenario One:

The option to choose: a monthly paycheck from the company for the rest of your life OR a lump sum of cash to rollover into an IRA.

Scenario Two:

In some cases, you may be offered a combination – meaning you will get a pension plus the option to choose: to roll your own pension contributions over to an IRA OR trade your contributions in to receive a higher monthly payout.

In either case, the choice you make can have a significant impact on your short-term and long-term retirement scenario. Let’s talk through these together. In both cases, you’re faced with one primary question:

Do you need the income?

Do you need the income the monthly pension would provide? Or are your other incomes (Social Security, etc) enough to cover your core living expenses?

If you do not need the income:

If your Social Security payments (and any other incomes you may have) are sufficient to cover your core living expenses, then the choice is yours to make. You may prefer the additional income security associated with the pension or you may prefer the flexibility associated with rolling the funds over to an IRA. It would still be advised that you seek professional guidance to ensure you aren’t overlooking anything. But in a general sense, you certainly have more flexibility than those that need the income.

If you do need the income:

If you need the income the pension can provide, the answer is pretty clear – it is probably prudent to take the pension.[1]

But you believe you can manage the money better…

In some cases, people believe they (or their advisor) can manage the funds better via their investment strategy and withdraw funds as they need them. I’d be extremely cautious with this idea. In most of the cases that I see, pensions offer the equivalent of a 6% withdrawal rate as compared to the rule-of-thumb withdrawal rate of 4% outside of the pension. So, it’s nothing against you; I don’t think I (nor anyone else) can do it either. It is purely an arithmetic issue with regard to sustainability.

The pension can offer that withdrawal rate with a higher level of sustainability because they can spread the risk among the entire group of pensioners, thereby also spreading the risk over various market cycles, longevities, and continue to fund it (in most cases) by the current employees. Whereas you are just one person. So, the pension has more safety nets than you/I/we have. Lastly, if you choose the pension, you eliminate the risk of overspending which is often an overlooked issue for many people.

In closing, for whatever it’s worth, in over a decade of providing retirement advice, I have yet to find a pension where it makes sense to withdraw the lump sum if the retiree is in need of income. Most of the time, the benefits of the pension outweigh the alternatives and the pension comes without the risk of paperwork mishaps and behavioral issues. That said, it’s always a good idea to explore your options. If you do, please take the time to educate yourself on the pros and cons of each scenario.

[1] I should note that there is one additional option – that is the potential to roll the funds into a private annuity. There are potential reasons to forego the company pension and utilize a private annuity. These can include personal reasons, corporate financial risk and the potential for a higher payout. In my experience though, these instances are very rare but highlight another reason to consider seeking professional guidance.

Related Article: Should You Buy An Annuity for Retirement?

Thanks for reading!
-Ashby Daniels

If you’re looking for a retirement planner to help you make a comfortable transition into retirement and want to see if we’re a good fit, reach out to me here.

Disclaimer: Any opinions are those of Ashby Daniels and not necessarily those of Raymond James. Any information provided is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation.

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