I’m retiring at 60 should I take a $500,000 Lump Sum or pension option? | Retirement Income Planning


Which Option is for Me?

Jessica Cannella: Should I take the lump sum or pension option?

This is an issue that’s best addressed with your financial advisor or ideally a retirement planner.

For now, I’m going to cover some basics to get you pointed in the right direction. This is a hot topic here in Houston, especially when you consider we are home to a tremendous number of medical companies and oil and gas corporations, many of which offer pension plans to their employees.

If you’re one of those lucky people, this is an important question that you’re going to want to ask sooner than later. Your decision could have a huge impact on your retirement. I want you to think of your pension as income.

I’m Jessica Cannella, Co-founder and President of Oak Harvest Financial Group, and today we’re going to discuss the benefits and considerations when it comes time to make the important decision around electing your lump sum payout or taking that pension income.

If you’re fortunate enough to have worked for in the private sector and your employer provides a defined benefit pension plan as part of your overall compensation, then you probably know that this is a form of income in retirement. Pension is income.

You should view your pension always through the lens of income in retirement. It’s similar to taking withdrawals from your portfolio, including retirement accounts such as IRAs, 401(k)s, and it can be likened to the same income that your social security payments might provide.

A pension is a stream of income, social security is a stream of income, rental income is a stream of income, and any distributions that you take from your portfolio are streams of income.

Your pension payments will begin once you request them after retiring. They’ll be paid out for life through an annuity that’s purchased on your behalf, but through your employer’s pension plan.

For some of you, an estimated about 25%, your employer may offer the option of taking a one-time pension lump sum payout upon your retirement, of course, versus receiving those lifetime annuity payments. If you are considering the lump sum pension payout or taking the pension payments, you need to understand the difference between the annuity payments or the value of the lump sum payment.

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Also, there’s a lot of different solutions that are offered through the private insurance sector where you can pick your own annuity if you love the way that lifetime income sounds. This can be determined by consulting with an investment advisor. There’s calculations and analysis that we can look through and give you clear confidence on which option makes the best sense for your
unique situation.

That said, there are many other considerations that you’re going to want to explore before deciding which option will best serve you in retirement.

One of the biggest considerations is that your decision is irrevocable, you must live with it. The decision whether or not to take the lump sum payout or the pension payments is a big one that will impact your retirement significantly. It’s also very personal.

Given the importance you want to have that conversation and understand all of your options with a retirement planner. It’s best to do so well in well in advance of your planned retirement, especially with what interest rates are doing right now.

It is causing lump sum pension payouts to decrease. Many of my clients have decided to retire earlier than they had originally planned because the interest rate environment is affecting their lump sum payout. It is going down. They’re pulling the trigger on an early retirement because they want to retain that lump sum amount. That’s an important consideration that is very relevant to what’s going on in the economy today.

To make the best choice for your particular situation, you need to take a comprehensive, holistic approach, and that includes factoring in your retirement goals, needs, as well as examining a number of key considerations. As part of this process, you’ll need to review the benefits and risks of both options so that you have a clearer understanding of how they can potentially impact your retirement.

I believe that clarity begets confidence, so start there. Understand your options. There are more than one ways to build a plan. You want to understand in the context and through the lens of income when does it make sense for you to take the pension payments or to elect the lump sum.

Do you want to take the lump sum and create a steady stream of income in a private market, or does the annuity offered by your employer make the most sense financially for you? Again, that’s a quick annuity calculator assessment or a full analysis of your pension options with a retirement planner.

After completing this assessment, either on your own, not recommended, or with the help of your financial advisor, the answer to the question of a lump sum or pension should become much clearer.

Let’s discuss some payout options. Both the lump sum and the pension options come with positive elements and some considerations that might be less beneficial for you and your unique situation. We’ll start by reviewing the key benefits and then we’ll go into the consideration in order to gain a better understanding of each.

The number one benefit of electing the annuity payout or the pension option, where you get that monthly check, is just that. It’s the guaranteed lifetime income on your life, and potentially, your spouse’s. There is not a death benefit when you have the pension option and you make that decision to get that monthly paycheck using the use of an annuity through your employer. There is no death benefit. That is not true if you look at the private pension market, we call it the life insurance industry.

They offer plenty of annuities that could be suited to your goals. Again, have a conversation with a respected professional to understand your options. Here’s a consideration. When you’re looking at receiving the pension option, you lose flexibility that you would otherwise have in taking the lump sum. The payments that you receive, they’re set in advance.

They’re not going to adjust for cost of living or inflation. Hot topic again, talking to you in 2022. We want to be cognizant that there are going to be other income needs that arise in retirement. Life is going to happen. We’re talking about a 20, 30, even 40-year time horizon from the point in time that your earned paychecks stop and your pension payments begin through the end of your life. Let’s say your pension is $5,000 a month.

$5,000 today will not have the same purchasing power 10 years from now, 15 years from now, much less 30 or 40 years from now. Having the flexibility to maintain your own income choices and not be held to that fixed amount could be an option for you if it makes sense. Another major consideration you’re going to want to consider is that your company might not be able to make the payment or they could go bust.

I’ve seen it firsthand, you’ve seen it firsthand, think Enron. In which case, your pension could be jeopardized. This is a serious risk, especially if you have a public sector or a religious entity employer. If you’re in the private sector, the intrinsic risk is that you could be under questionable financial condition, the company that you worked for, you could be in a volatile industry.

A pension is as good as its ability to be funded. Now we’ll discuss the benefits of taking a lump sum payout versus those fixed payments from your pension. The number one benefit of taking a one time lump sum payout when you retire is the fact that you will gain flexibility to do whatever you want with that money within the context of taxes. Your pension is IRA money. It has not been tax, it has grown tax deferred.

If you make a distribution or a withdrawal or you think to yourself, “Hmm, I could buy that dream house now that I’m in retirement,” or take that dream vacation, please talk to your CPA or your financial advisor first. Anytime you touch that pension money in the context of taking it as a lump sum, you want to be very cognizant of the tax implications.

It is taxed as regular earned income tax. If you’re looking at a lump sum payout of $500,000, you’re going to be taxed if you take it all at once on $500,000 income tax. Very important thing to note there is a consideration, but let’s get back to the benefits. One of the benefits in having flexibility with the lump sum payout is the ability to invest that lump sum in an IRA, into whatever you want.

You can do some more conservative low-risk options like bonds or real estate, publicly traded real estate, as in REITs, annuities, and have the flexibility to choose where your funds go.

If you have a larger appetite for risk, you may consider taking that lump sum pension payout and investing it in a traditional sense, in stocks, mutual funds, and so on and so forth in your investments portfolio, but kept in an IRA to avoid a tax event. Having this flexibility can help you keep pace with inflation, taxes and even increase the value of your overall retirement portfolio.

Let’s chat a little bit more on some of the tax implications. Pension money, be it lump sum or the pension option, is income. It is taxed as income in the eyes of the IRS. We want to be very cognizant of what are we taking out of those funds. It’s IRA money.

It can not only cause you a huge income tax bill in the year that you’re taking a large distribution, or if you are taking those monthly pension options, this is something that you want to be very aware of. When you have income on your return, it is taxed at income tax rates.

That said, whatever your income tax rate is going to affect how much your social security tax check is taxed, how much your medical care premiums are. It is a wide range, and so you want to be very careful to always look at when you’re making a decision as large as this one, that you’re looking at it through the lens of income and you want to tie a bow on it with the tax conversation.

Again, please don’t go it on your own. Please call a licensed professional in preferably the retirement space so that they can help to lay out some of your options, especially under the umbrella of tax.

Now that we’ve discussed some of the basic benefits and considerations on the lump sum payout or the pension option, let’s discuss a couple of other considerations that you’re going to want to factor into your decision. Age, the younger you are when you retire, the longer you’re going to have income coming in, in retirement, in which case the annuity option might make more sense.

An older individual might be better served with a pension lump sum payout. Health is another major consideration. It fits hand in hand with your age. We’re talking about time horizon and longevity.

Think of it this way, you’re in good health the longer you’re going to live. It might be more attractive to you to take a consistent monthly paycheck in the form of your pension. If you’re retiring at age 72, and it’s unlikely that you’re going to live to age 80 or 85, the lump sum payout might make more sense.

One thing that should never be overlooked when electing your pension payout is the ability to elect a spousal benefit.

This is an election that is on your own account, and it’s important that you go over the options. Generally, what it looks like is that instead of electing the full amount of your pension, let’s say with my example from earlier, you’re receiving a $5,000 monthly pension, and that’s on a single life.

If you determine that you want to elect to have the spousal benefit, your $5,000 will go down to say $4,500. What it means is that the check at a lower amount, $4,500 versus $5,000 will continue onto your spouse.

I have seen so many situations, especially in working with single women, where their husband was receiving a pension and there was no spousal benefit elected. What happens then?

The pension dies when he did. This is something that is very important to get ahead of. Sometimes it doesn’t make sense to take a spousal election. Again, please have the conversation with a professional retirement planner.

For more insight and information on how to be proactive for the eventual death of a spouse, be it yourself or your spouse, you’re going to want to click on the description box where we’ve linked our playlist to our Survivorship series. In that series, we make an offer to have our Survivors Guide mailed to your home or sent digitally to you, and it addresses things like electing a spousal pension.

As I noted earlier, once both spouses are passed away, and assuming you’ve elected the spousal benefit, I want you to keep in mind that that’s the end of the road. If you do end up passing away, notebook-style holding hands, prematurely, your beneficiaries are not going to receive the benefits that you were in receiving that pension. The money is gone. You are both passed away, end of the story.

That can be considered a benefit to taking the lump sum payout, is that, you can still have all of those funds readily accessible depending on how they’re built into your financial plan. You can create a plan to have that legacy or money passed on to the next generation. Payment risk is another consideration. We talked about it a little bit earlier, I’m going to reiterate it now.

The inability of an employer to make pension payments is not uncommon. This is often due to issues ranging from underfunding, mismanagement, bankruptcy, and legal exemptions. If you’re uncertain as to your employer’s ability to make payments or their solvency, or you’re in fear that they might go bankrupt, and many are in this situation, a lump sum payout is going to be additional peace of mind to you because you get your money upfront.

If you prefer or need to take the pension option and that sounds attractive to you, I do want to remind you that if you’re in a private pension plan, the Pension Benefit Guaranty Corporation, or PBGC, will make the payment in the event that your company declares bankruptcy or can’t make its payments. The PBGC guarantees your payments up to a certain amount based on your age and some other variables.

The maximum payout is set by the law. For a 65-year-old individual in 2022, the maximum payout is approximately $74,000. You can see how that might be disappointing in my example of your initial payment if you had taken the lump sum payout it was going to be $500,000. Pretty disappointing, $500,000 versus the maximum protection is $74,000.

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If you don’t need to take the pension option right away, let’s say your social security is covering some of your income needs, you’re taking distributions from your investment account because you’ve had this discussion with your advisor, that might be some fodder for considering taking a lump sum, because if you go ahead and you start taking these pension payments, it’s going to affect your income taxes as we discussed earlier.

On the flip side of that coin, if the pension is your only source of income, hopefully, you also have social security, it might make minimal sense for you to take the monthly annuity guaranteed lifetime income.

I discussed it a little bit earlier but we also have the ability to create private pension customization. What does that mean? That means you take the lump sum payout and you repurpose it and if a guaranteed income sounds attractive to you, you explore what options are available to you in the private market. What am I speaking about in plain English? Well, there’s a life insurance industry.

The life insurance industry offers tools called a fixed indexed annuity or a fixed annuity that provide, you guessed, guaranteed lifetime income. 9 times out of 10, shopping in the private market, with the exception of government pensions, you can get more income with your lump sum payment than you would get through your employer-selected annuity with your pension payments.

That is something that we incorporate as part of our analysis. If a client comes in and they love the idea, a peace of mind in retirement, having a guaranteed paycheck that comes in, maybe they don’t need to take the pension or that paycheck right away because they’ve got other sources of income.

We’re exploring where can we put that lump sum amount or a portion thereof and still get some guaranteed income? I’m not going to go too much into detail about that. If you’re interested in learning more about a fixed index annuity, we’ll put a link to Choice series on the fixed index annuity.

If you’re somebody that hates the A-word, annuities, then maybe you want to take a portion of your lump sum payout and put it toward your investment account. Again, it could be in stocks, bonds, mutual funds, a blend of all of that, or publicly traded real estate investment trusts.

Whatever the case may be, we want to look at our lump sum payout as an eventual stream of income, a pension payout as a stream of income in retirement, and we want to have the conversation with a retirement planner or financial advisor. If you don’t already have an advisor or you want a second opinion, please contact us.

We can quickly perform a very thorough pension analysis and help you get on the right track. Always remember that a pension is income. A customized income plan can be tailor-suited to your unique income needs.