As retirement approaches, you might be facing the choice of accepting a lumpsum pension payout or a lifelong stream of pension checks. What factors should you consider when making this decision?
A lump-sum payout is usually the present value of your pension benefits discounted over your life expectancy. A lifelong annuity is a set of payments, usually a fixed amount, that lasts until you and/ or your spouse pass away. Both have important merits and risks.
Lump-sum payments put you in control. You can use the lump sum as you wish, including investing it in ways that may help you keep up with inflation. You can avoid immediate taxation by rolling the payment into an IRA (if you are younger than 70½) and postpone taxes until you withdraw money. If rolled over, you must eventually take required minimum distributions, although you can withdraw more if you wish.
Lump-sum payments put you at risk. The chief risk is that you’ll outlive your money. If you invest in a low-risk investment such as Treasury debt, you might not be able to stay ahead of inflation. Invest in riskier assets, and you could lose value in a bear market. One solution is to use the payout to purchase a qualified immediate annuity with the features you might want, such as inflation protection and survivor benefits. However, you’ll bear the risk that the annuity issuer will default, and even government guarantees are limited. Furthermore, these extra benefits will reduce the size of the annuity payments.
You won’t outlive lifetime payments. If your other sources of retirement income aren’t enough to support your post-retirement lifestyle, you might prefer to take the lifetime payments option. However, unless you opted for survivor benefits, your spouse will receive nothing after you die. Furthermore, unless your pension features inflation protection, your payments can lose their buying power over time. Of course, you face the same default risk you would if you bought an annuity with a lump-sum payout.
Life expectancy plays an important role. Does your family history show a pattern of longevity? At a certain age, the benefits from lifetime checks will exceed the value of the lump-sum payment. On the other hand, if your health or other factors don’t support a long life expectancy, you might prefer the lump sum. Of course, if you can invest a portion of your periodic payments, you might be able to rebuild a nest-egg with some protection against inflation.
Seek advice from your financial advisor. I can help you review which course of action makes the most sense for your unique situation. Don’t go it alone—call or email me today and together we’ll work out a plan to help you get the most value from your pension payout.
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