With over 10,000 baby boomers reaching retirement age every single day, many are faced with the decision to take a lump sum dollar amount or an annuity payment from their employer. I receive calls every day from people in this situation that have questions like, “Is it worth taking a pension lump sum?” or “Is it better to take a lump sum or the annuity?” or “Is it better to take the lump sum or the monthly payments?”
All good questions, with no perfect answers. It all comes down to what you are trying to achieve with your specific situation and financial objectives, so you need to weigh both the pros and cons as part of your overall retirement planning goals.
This is a demographic tidal wave of money decisions that will have to be made by many retiring American workers.
Lump Sum or Lifetime Income?
Regardless of what your financial advisor or agent recommends, your “lump sum vs annuity” decision really comes down to if you need a lifetime income stream or not. If you do, then that monthly pension amount hitting your bank account can combine with your Social Security payments to create your guaranteed income floor. The guaranteed income floor is the amount of money that comes in monthly and is not affected by the stock market or political types events. It’s an income stream that’s going to happen and that you will never outlive.
If you don’t need income, then that lump sum payment or lump sum distribution can be rolled into an IRA so you can invest the money as you see fit. That transfer is a non-taxable event, but you need to connect with your HR department or plan administrator to make sure that you are fully aware of the lump sum pension payout rules for your specific company retirement plan. You should also connect with a qualified tax professional, tax lawyer, or CPA to make sure you understand pension lump sum tax rules as well. Never take tax advice from an agent or advisor, unless they meet those qualification standards. This is a huge decision, so be pragmatic and thorough about it and take your time.
So...lump sum or annuity? It depends on what you need and what you are trying to achieve. In other words, it’s your money. It’s about you and your family, not someone trying to sell you something or charge you a fee.
80% of the time...or more
If you are leaning toward taking the lifetime income pension offer from your company, you need to shop those payment guarantees against what is offered on “the street.” You need to find an honest agent or advisor to quote all carriers for a Single Premium Immediate Annuity (SPIA) to make sure that the offer from your company is better than what you would get from a private annuity company. It just makes sense to do this because annuity payments are a commodity, and should always be shopped for the highest contractual guarantees available.
A Single Premium Immediate Annuity (SPIA) is a fixed annuity that is issued by a life insurance company and regulated at the state level. SPIAs are commodities that need to be shopped using an annuity calculator connected to all carriers in order to find the highest guaranteed number. It has to be an “apples to apples” quote comparison using the same contract parameters of the pension payments offered by your company. There are over 30 ways to contractually structure a SPIA payout, so make sure the comparison quote is exact. This is very important.
In my decades of experience in the financial services industry, I find that the private company will ususally have the highest “pension fund” lifetime income stream guarantees when shopped against annuity companies. Over 80% of the time, your company will win that lifetime income quote.
That might be surprising, until you really think about it from your company’s standpoint. They want to keep the money instead of coming up with the lump sum amount to send to you, so their lifetime income quote will typically be very competitive in order to keep the money. Makes sense from the company’s view.
Single Life or Joint Life?
If you choose the guaranteed income option from your employer, you need to decide whether to set up those payments single life or joint life with your spouse/partner. If it’s on your life only, then the payments will primarily be based on your life expectancy at the time you start the income. If you set it up for joint life, then the payments will be based on both of your life expectancies at the time the guaranteed income starts. Interest rates play a secondary pricing role with both single life or joint life with life expectancy at the time payments start being the main factor in pricing. Either way, the income guarantee is for the rest of your life regardless of how long you live.
Annuity companies look at the average life expectancy of your age group, and primarily base that pension income on that, with interest rates playing a secondary role. If the income stream is set up joint life, then two life expectancies are covered with the insurance company focusing on the younger of the two. Regardless, single life always has a higher income guarantee than joint life.
I always tell people that lifetime income guarantees are transfer of risk strategies. You are transferring the risk to pay you (or you and your spouse) for the rest of your life/lives. There’s no ROI (Return on Investment) calculation until you die. Up until that time it’s a pure transfer of risk. If you choose your company to provide that lifetime income stream, then they are shouldering that risk. If you take the lump sum and transfer it to a life insurance company to buy a SPIA, then that carrier is shouldering the risk to pay for life.
Claims Paying Ability
It’s important to point out that if you choose to stay with your company and have them provide the retirement income pension payout, you need to make sure that company can back up those claims. You need to do your homework to make sure they are financially secure enough to pay. There is a Pension Benefits Guaranty Corporation (PBGC) that is somewhat of a safety net if something goes wrong with your company, but this is not a perfect solution. The PBGC is a government entity, and should not be part of your consideration to go with your company offer.
Your previous employer is going to back up that lifetime income stream. Are they going to be around that long? Are they stable? Does your gut feel tell you that everything is good? Do you trust current leadership? All of these questions should factor into your decision. If you feel uneasy about your company’s future, you certainly do not want to have them be on the hook for your lifetime pension income stream payment. If this is the case and you still need income, then it might make sense to take the lump sum and move it to an highly rated annuity carrier.
If you choose to receive a lump sum payout and buy a SPIA in the open market because it provided a higher guarantee, then you have to do your homework on that issuing life insurance company because they will be the ones backing up that income guarantee.
So should you take a lump sum pension or monthly payments or should you take a lump-sum pension offer? It all comes down to your personal goals, so listen to your gut instincts and make the decision on your terms and on your time frame.