In Your 50s? Find Your Way to Best Benefits

BOSTON ( TheStreet) -- For those of us who are directionally challenged, recent technology in the form of mobile apps, GPS devices and Google Maps have made life easier by providing clear directions to where we need to go. They even alert you when there's heavy traffic or changes in street patterns that may affect your route and redirect you accordingly so you can reach your destination.

If only we had a similar device to help us navigate the labyrinth of factors we must consider when deciding how and when to take our pension benefits at retirement. While fewer and fewer companies offer traditional defined-benefit plans, people fortunate enough to have a pension must weigh several factors -- such as life expectancy, income needs and current interest rates -- to determine whether it's more beneficial to choose a one-time lump sum distribution or annuitize the benefits over a lifetime.

Even without a GPS, you can find your way to a good answer to pension benefits.

Complicating matters is the fact legislation is changing constantly and may tip the balance to one option over the other. The climate seems to have changed recently, making monthly income payments more attractive than a lump sum distribution.

Why annuitize?
Passed Aug. 17, 2006, the Pension Protection Act was the most sweeping pension legislation in more than 30 years and included a number of significant reforms affecting pension owners. For example, it changed the benchmark interest rate used to calculate lump sum benefits for all pension plans. Rather than being based on 30-year Treasury yields, the act stipulated that plans use a higher composite corporate bond rate for benefit calculations. This change has been phased in, beginning in 2008, and will be fully implemented in 2012.

Generally speaking, for every 1 percentage point increase in interest rates, there is a 10% drop in the value of the lump sum payment -- and, as noted, the corporate bond rate is much higher than the 30-year Treasury yields. For participants retiring next year and beyond, the result will be a lower lump sum benefit compared with what they would have received without the law (assuming all other factors, such as retirement age remained equal), making annuitizing more attractive.

In addition, the PPA passed several reforms that required all plans to get 100% funded over a certain period. This helped alleviate some concerns from those wanting to elect an annuity option but who feared what would happen if their company faced bankruptcy or other financial hardship that would threaten their future benefits.

Even without the recent legislation, there are inherent advantages to annuitizing over receiving a lump sum. There is a certain level of assurance in knowing you will enjoy a fixed monthly income through retirement without the worry and risk of market performance. For women, there is an additional benefit to annuitizing: benefits for lump sum payments are calculated using actuarial tables that combine the life expectancies of men and women, yet women on average tend to outlive men by about four years. Therefore, women who elect lump sum benefits get a smaller benefit than they would otherwise based solely on their expected lifespan.

Bird in the Hand ...
Of course, nothing is ever as black and white as we might want, and there are many other reasons why someone would prefer taking a lump sum. Even though annuitizing has become safer due to the recent PPA reforms, as well as the Pension Benefit Guarantee Corporation insuring most private plans, there is no true iron-clad guarantee that one's pension benefits will be there come 2025 (or whenever you happen to retire). Some people would rather have the "bird in the hand" in the form of an immediate lump sum distribution than the intangible promise of monthly income payments down the road. In addition, you may want to use the larger sum for another immediate purpose, such as the payoff of a loan or for traveling, or simply want to manage the investments on your own rather than through your former employer.

A possible compromise might be to take a lump sum benefit but roll it immediately into an IRA (thus avoiding taxation). A portion of that money could be used to buy an annuity from an insurance company. In this scenario, you might get the best of both worlds: the peace of mind of a steady income stream and the peace of mind of having a larger investment you can control and direct however you choose.

Defined-benefit plans and their retirement options can be confusing. Even without a GPS to guide you, though, you can find your way by keeping yourself up to date on changing legislation, identifying your objectives and carefully understanding the different routes you can take.

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Greg Plechner is a CFP and a principal at Modera Wealth Management LLC, based in Westwood, N.J., and Boston and a member of NAPFA, the National Association of Personal Financial Advisors.

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