There are few times in financial planning when the advice of “taking a lump sum” is the recommended course of action; however, when it comes to pension benefits, taking a lump sum payout may be worth some serious consideration.
Pensions are qualified employer-sponsored plans, where the employer sets aside money for the employees’ retirement. The plan’s focus is on a guaranteed benefit, as the plans are generally designed to provide a certain percentage of the employees’ salary in retirement. Generally, employee contributions are not allowed. The benefit is not taxable to the employee until distributions are taken.
With a pension, there are generally three ways to receive benefits. If you are married, the plan will offer you a qualified joint and survivor annuity, which takes into account both you and your spouse’s life expectancy. The plan will provide you a fixed monthly benefit until you die, and after, your surviving spouse will continue to receive a benefit, which may or may not be reduced, for the remainder of his or her lifetime. You may opt for a single life annuity, where you receive a slightly larger monthly benefit until you die; however, once you pass, no payments are paid to your survivors.
For some investors, there is a security in knowing they will continue to receive payments for life. There is less opportunity to spend all of the money, and there can be peace of mind in knowing your spouse will be taken care of once you die. When choosing the annuity options, you have to put serious consideration into the confidence you have in your company to be around to fulfil their obligation. A pension is a liability on the company’s books. Even if the company is financially strong a downturn in the economy can create a problem. Companies may have to take cash from operations to fund the pension plan, which takes away from company’s profitability. In a difficult economy, it can become a battle between current shareholders and past and current employees. While many pensions are covered by an independent government agency, the Pension Benefit Guaranty Corporation, should a company go bankrupt, plan benefits are only protected up to a certain amount, which may be less than the employee was promised.
The third option is to receive a lump sum of the entire value of your plan with no further payments. Taking a lump sum benefit from your pension does not mean you take it and immediately pay the taxes due. Instead, you’d roll the money into an IRA and take withdrawals as needed, or as required by the IRS, paying the taxes due at the time of withdrawal.
If an investor is working closely with a financial adviser, cash flow projections within the financial plan often show the employee would be better off taking the lump sum. This isn’t as clear-cut as it sounds. This option often assumes full discipline by the investor to follow the plan and spend the amount allowed within the plan. Disciplined investors may also benefit from having the assets professionally managed. Once the money is in an IRA, your investment options are much broader, giving the investor or the money manager more control over the account.
While this is a general overview of typical pension options, choosing how you take your benefit ultimately affects how much you receive in the long run. There are many other strategies that may work best for your situation. If you have questions regarding your pension benefits, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.
Disclosures: This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
