Sorting through pension options
By Isabelle Wiemero
When presented with their pension benefit options, what retirees must determine boils down to one question: Should you keep your money with the pension plan and receive a fixed monthly payment for life, or should you take a lump sum and roll it over into an IRA of your own?
On the one hand, there’s a promise for steady monthly income, on the other is flexibility with your finances. It’s important to get this decision right because once you choose your payout method, you cannot change it.
Unfortunately, there is no-one-size-fits-all answer. Deciding what is best for you depends on your full retirement picture and what your family needs. Talk with your family about how you envision your retirement, and work with a professional to sort through the mathematical implications of each option.
Here are some considerations when deciding which option works best for you.
Steady monthly payments
If you are concerned that you may outlive your financial assets, taking the pension in set monthly payments can be attractive. Married couples often get the option of joint and survivor benefits. In exchange for a smaller monthly benefit, the pension would continue to pay some percentage of benefits to the surviving spouse for the remainder of that spouse’s life.
One potential risk of staying with the pension plan is that your employer may not be able to support your benefits throughout your retirement. Last year, the Pension Benefit Guaranty Corp. covered payments to nearly 813,000 retirees whose employer pension plans failed. The coverage is limited and not available to all workers. Even so, the insurance-funded federal agency has reported a funding deficit in all but six of its 40 years.
Another drawback, for those who wish to leave something to their heirs, is that payments end at the death of the owner (or the surviving spouse, if choosing the joint option).
The most common concern, however, is the risk of inflation. Most pensions offer a fixed dollar amount for life, which means over time the benefits lose buying power. Without adjustment for inflation, the fixed payments can look much less attractive years down the road.
For instance, if someone retired in 1995 with monthly pension payments of $850, their payments would need to have risen to $1,320.38 now in order to keep up with inflation.
Foremost with this option, you won’t have to worry about your employer failing to make your steady payments because you would be bringing the funds under your own control.
You also have the flexibility to invest your benefit at the risk level you find comfortable, with the opportunity to outpace inflation. Furthermore, you are giving yourself control over how the money is used, with the flexibility of varying the income stream from year to year.
And, unlike the monthly pension payments, anything in your IRA not spent in your lifetime will be passed to your beneficiaries.
Of course, there is a tradeoff. By choosing the lump sum and leaving the pension plan, you are essentially giving up the certainty of fixed monthly payments for the uncertainty of managing your own retirement account elsewhere.
To help understand what your specific needs are, start by asking yourself the following questions:
Am I concerned about the financial health of my company?
Taking the lump sum pension benefit and rolling it into an IRA should ease any concern that your employer might not be able to fulfill its obligations throughout your retirement.
How is my health?
If you are concerned about outlasting your financial resources, monthly pension payments offer the promise of steady income as long as you live. If, however, you anticipate having high health care costs, a lump sum rollover could provide flexibility for taking withdrawals when needed as you are not bound by a set amount at a set schedule.
What is the rate of return the pension benefit will give me? Could I do better in an IRA?
Where interest rates are today, the return rate of pension benefits is relatively low. Determine how much risk you would want to take if investing this money on your own, and compare to see if you could reasonably expect to do better than the pension’s fixed rate.
Example: A 65-year-old man has been offered a pension benefit of either $500 monthly for life or a lump sum of $100,000. According to life expectancy estimates from the Internal Revenue Service, that man has a 21-year life expectancy. Using all of this information we are able to solve for the implied rate of return that the pension is offering, which in this case is 2.2%.
There are instances in which the pension plan offers a fixed payment with a generous implied rate of return. Be sure to work with your advisor and go through the math to find the best option.
Do I want to provide for my heirs?
Monthly pension benefits stop at your death, or after your spouse’s death if choosing the joint and survivor option. In an IRA, any money that is left over when you pass away will pass on to your designated beneficiaries.
If choosing the monthly payments: Do I need to also cover my spouse?
In most cases, the answer is yes since most couples want to be sure the surviving spouse will be financially set. Statistically, if a husband and wife are the same age, the wife tends to live about six years longer. The monthly payments will typically be lower than a single life payment, but there is the added benefit of the payments covering two lives.
Pension benefits are just one piece of your entire retirement picture. But your decision on how to take the payout is a one-time deal, so it is crucial that you consider all your options before signing on the dotted line. Be sure you ask yourself all of these questions and talk with your financial advisor in advance.
Isabelle Wiemero is a registered representative and investment advisor with Landaas & Company.
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.
(initially posted Feb. 26, 2015; updated Jan. 2017)