Should your trade your pension for a lump sun?

{via Wall Street Journal}

Deciding whether to take a pension in a lump sum or monthly payment can be a combination of self-analysis (“How much risk can I stand?”) and prognostication (“When will I die?”). But there are clues in one’s own behavior that can help make the choice easier.

The question received a burst of attention earlier this year, when more than 140,000 salaried retirees at General Motors GM +3.42% and Ford Motor F +1.94% were told they could trade in their lifetime of monthly checks in exchange for a one-time payment.

In the past, companies offered lump sums to older workers to entice them to retire early, and because in some situations, the payouts don’t have to include the full value of the pension.

Today, many companies are offering lump sums because they can calculate the payout using a higher interest rate than they have in the past, which reduces the size of the payouts.

Though lump-sum payouts transfer all the risk—investment, inflation, interest rate and longevity—to the retirees, many nonetheless find the prospect of receiving a large sum of money seductive, and are tempted to forfeit what is essentially a guaranteed monthly paycheck they and their spouse can’t outlive.

Others may succumb to the importuning of investment advisers eager to earn commissions and fees for managing the assets, or to the heady temptation of buying a sandwich franchise.

You can’t know what the future holds. But you can get a good idea of how well you’d be able to manage a lump sum by asking yourself the following questions. The more often you answer “yes,” the more likely you are to do better by sticking with your monthly pension plan.
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Investment management. Do you believe you can earn more managing the money yourself? Then take a look at your 401(k). How well did it withstand the market crash? Did you lose 30% and then move your savings to a money-market fund, thus missing the subsequent market rally that would have erased your losses? If your lump-sum account also lost 30%, would you bail?

Portfolio management. Can you say “no”? Choosing prudent investments is crucial. But if your investment portfolio contains variable annuities, life-insurance policies or investments you don’t understand, it demonstrates you can be talked into buying all sorts of potentially unsuitable, high-commission investments.

Any idea how much you pay in annual fees for your 401(k)? Probably not, and even if you do, you would be paying retail rates for investment management fees, not the institutional rates a pension plan would pay.

Asset preservation. A big part of managing your pension portfolio includes knowing how much you can withdraw each year and having the discipline to stick with the plan. Have you ever taken a loan from your 401(k), made a hardship withdrawal or withdrawn money from an IRA prematurely to pay for medical bills, tuition, a mortgage or a surprise expense?

Unexpected demands on your retirement income won’t vanish, and if you’ve always had trouble budgeting and have dipped into your retirement savings to pay current expenses, you’re going to find it even harder to stick with a budget when you don’t have the predictability of a monthly pension check.

Creating a legacy. Are you taking a lump sum because you want to leave money to your family? Perhaps you worry that if you elect a monthly pension and get hit by a meteorite the night of your retirement party, your family will get none of the pension money.

But don’t forget that, in most cases, your spouse will continue to receive the pension. What’s more, the odds of dying young are pretty slim, and the chances both you and your spouse will die prematurely are even longer. You’re far more likely to live too long and run out of money than you are to die young, and a monthly pension is insurance that you won’t end up sleeping in your kid’s dining room when you’re 92.

Protecting a spouse. Perhaps you are counting on your employer-provided life insurance to protect your spouse if you have taken a lump sum. Well, have you ever been surprised by your employer’s decision to cut benefits? If so, you may not see the blow coming when your employer rescinds its retiree life insurance, which most can do at will. In recent years, for example, GM has slashed both retiree health coverage and life-insurance benefits for white-collar retirees.

Self-defense. You might be inclined to take a lump sum because you don’t trust your employer. While it is common for companies to cut pension benefits while you’re working, they can’t cut them after you retire. Even if an employer goes bankrupt and dumps its obligations on the Pension Benefit Guaranty Corp., current retirees continue to receive their monthly payments, and most future retirees receive 100% of what they had earned.

After all this, if you’re still set on taking a lump sum, any attempt to dissuade you may be futile. But don’t say you weren’t warned.

About thebenefitblog

Eric is a Producer at Lockton Insurance Brokers, Inc., the world’s largest privately held commercial broker. Eric has over 23 years of experience in the insurance industry and has spent the last 11 years with Lockton. Eric specializes in Health & Welfare Benefits, Retirement Planning, and Executive Benefits. Eric's clients utilize his expertise in the areas of Plan Due Diligence, Transaction Structure, Fiduciary Oversight, Investment Design, Compliance and Vendor negotiation to improve the operational & financial outcome for each client. The Benefit Blog is a place to share that expertise and industry news.
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