There was a time when most people had three sources of income in retirement. One was their savings, the second was Social Security and the third was their pension from work. Today, very few workers enjoy the security of a pension and retirement income is dependent on each person’s ability to save.
For those remaining workers who have pensions, at some point a decision must be made whether to take their pensions over time or to receive the accrued value as a lump sum. A pension can be a stable stream of income in retirement, or it could be a lump sum that is invested. There are pros and cons to both.
Investopedia’s recent article, “Pension Planning: Lump Sum Versus Monthly Payments,” says that the pension provider takes the risk of both sub-par market returns and the possibility that the retiree will live longer than expected. The article raises several thoughts to consider when making the decision:
Implied Return on Pension. Calculate the return on the pension by assuming the lump-sum you could take was invested and generated a stream of income. The longer the pension pays out (the longer the retiree lives), the higher the implied return. Compare that return to the long-term return one would expect from investing in a diversified portfolio. This is heavily influenced by the amount of the lump-sum and varies greatly by person.
Impact on Retirement Plan. A retirement plan should be designed to fully fund the retiree’s spending needs through the balance of his or her life. If the plan includes an investment portfolio, the portfolio is usually a key source of income—but it’s an uncertain source of income, because returns will vary. The pension, however, is a steady stream of income that won’t vary, and usually won’t even adjust for inflation. For some plans, this is okay, since the static nature of the return is more important than the fact that the income doesn’t grow. In other situations, growth is needed.
Spending Habits. If spending is variable or if there’s uncertainty in spending needs, use caution. This may not mean going with the lump sum, or it could simply require delaying the pension decision. The more complete the information, the easier it is to decide.
Fiscal Health of the Pension and Trustee. There are instances where pensions are underfunded, and trustees encounter financial problems that lead to the loss or reduction of pension payments. In most cases, the Pension Benefit Guarantee Corporation (PBGC) may assume responsibility for payments. The problem is, PBGC itself is underfunded, and there’s no way to know for sure what its own health will be in the future.
Pensions are another example where knowledge is power. Do the research to find out as much as you can about the financial viability of the pension fund, the trustee and all related institutions. That should factor into any decisions about how to take your pension payouts.
Reference: Investopedia (November 15, 2018) “Pension Planning: Lump Sum Versus Monthly Payments”