Pension payouts: Look before you leap
Joel Dresang: Isabelle, from time to time, you have retirees ask you to help them figure out their pension payouts. But that doesn’t always happen. So you actually wrote an article about it for our website. Why is this a big deal?
Isabelle Denton: Well, it’s so important because this decision is a one-time decision you can’t go back and change once you’ve decided. So when you’re talking about such a large part of someone’s retirement savings potentially, you want to make sure you’re getting it right.
Joel: And the way I understand it, essentially you have a choice between a lump sum payout and steady monthly payments. Let’s talk about both of those. Let’s talk about the monthly payments first.
Isabelle: With the monthly payout option, your company is going to tell you what your benefit is. They come to that number by using how long you’ve been with the company, what your average salary was, among other things. And that benefit they provide for you, you can expect to receive for the remainder of your life. And once you pass away, all benefits stop.
Joel: And sometimes they have provisions for spouses as well?
Isabelle: That’s right. A lot of times, there will also be benefits that cover not only the retiree’s life but also the spouse’s. And that benefit will be at a certain percentage, whether it’s 50%, 75% or 100%. And in exchange for covering not only one life but both lives, typically the payment will be smaller than the single-life option.
Joel: What about the lump-sum payouts?
Isabelle: So, when the company tells you what your benefit could be for the monthly payments, they’ll also tell you what you could take right now as a larger lump sum. With that, you’d be able to move it into an account of your own. And you would be taking over control of the funds. So you’d be able to control how it’s invested and when and how you take the money out.
Joel: So on the one hand, you’ve got something that you can kind of count on month to month, and the other is more flexibility but more uncertainty maybe.
Isabelle: That’s absolutely right. You can take the money out when you want, but there’s more uncertainty with how the account will do.
Joel: What other sorts of considerations should retirees make in deciding how to take their pension payouts?
Isabelle: So, first and foremost, you want to think about your health. If you’re in poor health, and you anticipate maybe some large medical bills, or if you just think your life expectancy might be a little shorter, you might want to think about the lump sum because you’d be taking control, and you could take the funds out when needed.
On the other hand, if you are anticipating maybe a long life expectancy and perhaps concerned that you could outlive your financial resources, the pension payments could be good to alleviate that risk because you never have to worry about that payment not coming.
Joel: How do you value one over the other?
Isabelle: So the math can get a little complicated. But basically what you want to find is what the implied interest rate is on those pension payments. You do that by comparing the lump sum amount versus what you would receive monthly, and you use your life expectancy to determine what that implied interest rate is. Once you know that, you can compare it with what you could reasonably expect to make in your own account, and you can determine which one is better from there.
Joel: And you said it’s a one-time decision.
Isabelle: That’s right. And you want to look at your entire retirement picture when making the decision. You want to think about how much income you’re going to need in retirement and where that money is coming from. It could be a savings account, other investment accounts, Social Security, or any other income. And when you think about the whole picture, it might help make the decision clearer on which one is better for you.
Joel:And your article on this is on Landaas.com. And it also has some links for some useful resources.
To learn more about pension payouts from the Financial Industry Regulatory Authority, please click here. For tips from the Pension Benefit Guaranty Corp., please click here.
Isabelle Denton is a registered representative and investment advisor at Landaas & Company.
Joel Dresang is vice president-communications at Landaas & Company.
Money Talk Video by Peter May
(initially posted March 12, 2015)
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