In recent years more and more employers are offering lump sum payouts to their pensioners, as opposed to a monthly benefit. Should you take it? Consumer advocates and pension industry experts say it’s risky for most people.
There may be some advantages to taking a lump sum payout. But keep in mind, you will be responsible for managing your own money, and that’s a big job. This includes future investment choices, a task which previously was handled through your employer. Are you up for the task? You’ll need to be on your toes and diligent.
According to the Consumer Finance Protection Bureau (cfpb.gov) your risk increases when you handle your funds yourself. If you make bad choices or if the bottom falls out of the stock market, you may find yourself living solely on Social Security. Of course, recent years have taught us that sometimes employers and their plan administrators can make bad choices too.
Before you decide, consider these points:
- Where will you be if you lose the money in your pension? Can you still live in reasonable comfort? In general, taking your money in monthly payments reduces your risk. But a lump sum makes sense for two groups of people:
- Those who already have enough income to cover all their basic living expenses. If that’s you, you may do well to take your lump sum and invest it aggressively. You could end up building a much nicer nest egg for your survivors.
- Those whose health issues are likely to result in shorter life spans.
If you don’t fall into either of those categories, be cautious about taking a lump sum. Will you get back what you paid in? For many people who take the lump sum option, the reasoning is that they fear they will pass away before they get what they’ve accumulated. Some fear that the pension plan they’ve diligently paid into will go broke due to the economy or gross mismanagement. Depending on the details of your plan, your spouse and other beneficiaries may be eligible to receive the remainder of your pension, or a portion of it. However, don’t take this for granted. While there’s time, ask your plan administrator to verify this for you. Also ask him or her to check that you have done the necessary paperwork to funnel your benefits where you want them to go. If you aren’t in touch with your plan administrator, you should be. Ask your employer how to make contact.
As for pension plan mismanagement (or in the event your employer goes belly-up and can’t make the pension payments) there’s a good chance your plan is protected by the Pension Benefit Guaranty Corporation (PBGC). The PBGC covers plans that have at least 26 workers, and guarantees your payments, up to a point.
The coverage can be up to $5,000 per month, but you’ll need to verify that if you’re concerned. You can check your “funded status” at www.pbgc.gov. If the funded status is around 80% or below, that’s worrisome. If that’s the case, talk to a qualified financial advisor who isn’t connected to your pension plan or your employer.
- What creditor protection do you have on a lump sum of funds compared to money in your pension plan? You should know, money that remains in your pension plan is protected from creditor claims. Nolo.com, which provides answers to everyday legal and business questions, verifies that qualified pension plans cannot be touched, even if you file for bankruptcy, regardless of how much money is in the account. On the other hand, retirement funds that are paid to you as benefits can be partially tapped to pay creditors.
Money that you may place in a traditional or Roth IRA (such as money taken out of a pension plan in a lump sum and rolled into an IRA), does have an upper limit of protection, but it’s pretty generous, in excess of $1.24 million for all combined IRAs.- Do you have the investment skills and the energy to handle this task? While your money is with your employer’s plan, the plan managers handle the decisions, and deal with the fluctuation in the stock market. As you’ve already seen in early 2016 the fluctuation can be considerable. The plan also can calculate how much you should withdraw monthly, once benefits begin, in order to stretch your money.
If you are a skilled money manager, disciplined in your spending, and willing to monitor your money carefully, you might prefer the flexibility of taking a lump sum. You can also enlist the help of a trusted financial advisor. He or she may advise you that if you want to take a lump sum, you could roll it into a traditional IRA to avoid a big tax bill. Money can later be taken out of an IRA in smaller withdrawals, without a harsh tax hit. Just keep in mind, as noted above, a well-funded IRA has limited protection from credit claims.
- Are you considering taking a lump sum and buying a private annuity? If so, make this decision fully armed with facts. A high-quality private annuity will provide you with regular guaranteed monthly payments, but probably similar to what you’ve already got. Plus you will likely have to pay commissions to the salesperson, so there might be no real point in switching, according to the CPFB. In some cases, you will receive less.
David Blanchett is the director of retirement research for Morningstar. He was quoted on Time.com with this example: With the goal of making your money last another 20 years, you were getting a monthly pension check of $1,500. Then you took your money out in a lump sum. Still hoping for 20 years of payments, you might only get a monthly check of $1,213. Why? Because now you’re on your own, and not receiving the benefit that group participation can allow. In a group plan, payments are averaged out based on the life spans of all the people in the plan, which generally means more generous payouts for people with normal life expectancies. To be blunt, in a group setting, people who pass away early subsidize those who live longer.
Whatever you decide, tread carefully. Taking a lump sum might be best for you, but be prepared to work at managing your money. If that’s not your idea of a relaxing retirement, talk it over with a professional to get some alternatives.
Teresa Ambord is a former accountant and Enrolled Agent with the IRS. Now she writes full time from her home, mostly for business, and about family when the inspiration strikes.