So you're on the verge of retirement and you're faced with a difficult choice regarding your company-sponsored retirement plan: should you accept the traditional, lifetime monthly payments or take a lump sum distribution? Understandably, you might be tempted to go with the lump sum. After all, it may be the largest single disbursement of money you'll ever receive. Plus, you may like the idea of having more control over your investments. Employees about to retire face this dilemma all the time. Before you make an irrevocable decision about your future, take the time to understand what it might mean to you and your family.

SEE: Which Retirement Plan Is Best?

Why Employers Offer the Choice
First, you should ask yourself why your company would even want to cash you out of your pension plan. Employers have various reasons for offering the lump sum payment. Your employer may use it as an incentive for older, higher-cost workers to retire early. Or it may make the offer because eliminating pension payments generates accounting gains that boost corporate income. Furthermore, if you take the lump sum, your employer will not have to pay the administrative expenses and insurance on your money.


Understanding the Guarantees
Like many retirees, you may find it comforting to know that you can get a check every month for the rest of your life. But suppose your employer is in financial trouble - what assurance do you have that the check will always be there?


The Pension Benefit Guaranty Corporation (PBGC) is the government entity that collects insurance premiums from employers sponsoring insured pension plans. The PBGC only covers defined-benefit plans (stated payments) and does not cover defined-contribution plans. It earns money from investments and receives funds from the pension plans it takes over. The maximum pension benefit guaranteed by PBGC is set by law and adjusted yearly. The guarantee is lower for those who retire early or when the plan involves a benefit for a survivor. And the guarantee is increased for those who retire after age 65. Therefore, as long as your pension is less than the figures above, you can be reasonably sure your income will continue if the company goes bankrupt.

Why You Should Take the Lump Sum
The average rate of inflation is about 3% per year. Yet the cost of health care has gone up 5.5% during the same period. Does your pension include cost-of-living increases? What are the increases based on, and will they reflect the actual amount you'll need to meet your expenses down the road?


For example, something that costs $1,000 today will cost $1,344 in 10 years, assuming 3% inflation. But what if your $1,000 in prescription drugs goes up 5.5%? You'll need $1,708 to pay the same bill in 10 years, and your pension might not have kept up. The pension fund manager's primary concern is making enough money to send you the required check each month. In many cases, the pension fund payments are not indexed to inflation, meaning they will not rise with inflation. But if you handled the portfolio, you could rebalance the assets based on inflationary trends and possibly have a better chance of boosting your income as the years go by.

SEE: The Consumer Price Index

Do you want to leave something to loved ones upon your death? Once you and your spouse die, the pension payments will stop. On the other hand, with a lump sum distribution, you could name a beneficiary to receive money after you and your spouse are gone.

Income from pensions is taxable. However, if you rollover that lump sum into your IRA, you'll have much more control over when you remove the funds and pay the income tax. This could be a big benefit when you start receiving Social Security checks and want to keep that income from becoming taxable.

Why You Should Take the Pension
What about your spouse? If you opt for the pension, you can make sure that he or she will receive a steady income if something happens to you. But if you take the lump sum, will there be enough money to provide for your survivor? And will he or she be able to manage the funds as well as you?


You also need to think about health insurance. In some cases, company-sponsored coverage stops if an employee takes the lump sum payout. If this is the case with your employer, you'll need to include the extra cost of health insurance in your calculations.

SEE: Buying Private Health Insurance

How To Evaluate the Offer
Many employers don't provide side-by-side comparisons of the lump sum and pension payments options and fall short of giving the information you need to make an informed decision. Therefore, it's your responsibility to find out what the numbers mean. Here are some key questions you'll want to ask:


1. Is the value of the lump sum equal to the monthly pension payments over your estimated life expectancy?

2. Did your employer remove any early-retirement subsidies in calculating the lump sum offer? Typically, these subsidies are added to the value of pension benefits as incentives to entice workers to retire early, and they could be worth tens of thousands of dollars. If that amount is stripped out of the lump sum payment, you could be missing out on a lot of money.

3. Could you get a better return than the pension fund managers earn? Calculate how much you would need to earn using your lump sum payment to equal the benefits of the pension payments. For example, suppose you were offered $400,000 in lieu of a $2,500 per month pension. The breakeven point if you earned 0% on the lump sum would be 13 years ($400,000 / $2,500 = 160 payments / 12 = 13.3 years). But if you could earn 5% each year on your lump sum of $400,000, the money would last 22 years, assuming you spent $30,000 ($2,500 x 12) annually. But would this be long enough?

Conclusion
Putting the numbers aside, when you make your choice between the lump sum and the monthly pension payments, it should come down to this crucial question: How confident are you that you'll make the right decisions to convert that lump sum into a stream of income that will last the rest of your life? Moreover, do you have the self-discipline to manage this money, or will you end up using it to buy a new car, go on vacations or pay down debts? Are you willing to give up the security of regular pension payments for yourself and your spouse in exchange for the greater financial control of the lump sum payment? Ask questions, do your research and crunch the numbers - only then will you have the satisfaction of knowing you've made the right decision.




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