Should I take my pension as lump sum or monthly payment (or both)?

James Pope | May 15, 2019

Retirement coming soon?

Retirement is on its way, there’s no denying it. So you clear off the cobwebs one day and open up your retirement benefits booklet.

There is a 100% lump sum option that you have already heard about and understand. This is relatively intuitive. However, there are also several pension election options that are not as straightforward and we’ll be going over those in this article as well.

Should I take my pension as lump sum or monthly payment?

With no further ado, let’s get to the bottom of this question you may be asking yourself.

In a 100% lump sum option, the employee can take the entire benefit amount upfront at one time. Why would it make sense to choose the lump sum option instead of monthly payment?

The lump sum may be the right option for you if you:

Are confronted with a heavy need for the cash upfront (example: have to pay for daughter or son’s wedding, have to pay off huge medical debt)
Are worried about the company or municipality going bankrupt and not being able to provide you with the money owed in the coming decades
Anticipate yourself having short life expectancy
Want to control your money
Want investment flexibility and responsibility
Want the option that money may be used for kids/grandkids future inheritance
Need flexibility for other reasons not related to the above

Keep in mind everyone is unique. Some retirees pension choice represents 80% of their retirement savings making this a huge decision meanwhile others pension may only represent 20% of their retirement saving where this decision doesn’t have nearly the same influence. Notably some company plans have changed allowing their employees to take “Partial Lump Sum” options such as 25%, 50%, or 75% where the remaining amount goes toward the monthly pension payment selected.

The monthly pension may be the right option for you if you:

Want to protect you and your spouse from longevity risk
Need help to prevent excessive withdrawals
Don’t have a temperament that accepts investment fluctuation
Use a partial pension plus social security that provides enough monthly fixed income so that you can invest the remaining retirement assets

If you do opt for the monthly payment option, in many company pension plans, there are options to receive regular pension payments each month until death. Some scenarios give you the right to pass on your pension to a spouse while others do not. It’s here we see a lot of moving parts that is less intuitive than a “lump Sum”.

Let’s take a look at the joint life options first. Here you can name your spouse as a joint annuitant. Then we’ll consider single life options.

Pension election JOINT life options

A joint annuity means you will receive an annuity payment each month for the rest of your life. Upon your death, your designated joint annuitant will continue to receive a monthly benefit based the option you selected. There are two very important concepts to understand that shape the option selected. They are the (1) percentage of payment selected and the (2) period certain.

Let’s look at how this could potentially play out in the hypothetical company pension plan options below.

100% Joint Annuity with 5-Year Certain option

One of the first options that you may be looking at within a pension plan is the 100% Joint Annuity with 5-Year Certain option. 100% joint annuity means that it’s going to help not only the employee, but also the joint annuitant which is very often a husband or wife.

What that means is that if something were to happen to you, then your spouse (joint annuitant) would receive that same 100% monthly benefit amount for the rest of their life. In this case maximum payments received is not known but they will last for the life of both people.

The 5-year period certain is important because that explains the minimum that can be paid out. As the name implies, 5-years’ worth of payments will be paid out regardless if both annuitants pass in year two or three. However, if both annuitants pass in year six or any time after 5-years then it’s all over and payments will stop.

75%, 50% & 25% Joint Annuity with 5-Year Certain option

In this pension plan payout option, you receive an annuity payment each month for the rest of your life. Upon your death, your designated joint annuitant will continue to receive a monthly benefit. if your death occurs within the initial 5-year period, your joint annuitant will receive the same monthly amount you are receiving until the end of the 5-year period. After the period certain expires, your joint annuitant will receive either (75%, 50%, 25%) of the amount you were receiving based on the continuation percentage method you selected at commencement. That’s a potential reduction for the surviving spouse.

Again, in a 5-year period certain if you were to both pass together in year six, it’s over. If it were a 10-year period certain or 20-Year period certain the same concept applies. The time period is just longer. In general, the longer you guarantee the payments the smaller your monthly payment will be.

Pension election SINGLE life options

There are great pension plan payout options for single life. Many retirees are not married. As you contemplate the question of “Should I take my pension as a lump sum or monthly payment”, the best thing to do is to figure them into how that works in conjunction with your other retirement assets, income, and tax strategy.

5-Year Certain and Life Annuity

This pension plan option covers your life no matter how long you shall live. Again, that’s your life only and no one else. If you die within five years from the time these monthly payments start, your beneficiary receives the same monthly pension amount for the balance of the five-year period certain. If you die in year six then it is over and payments cease.

10-Year & 20-Year Extended Period Certain Annuity

It’s the same concept as the 5-year certain above except in this case the company is on the hook to payout that same monthly pension amount for a minimum of 10 or 20 years to either you or your designated beneficiary.

Should I take my pension as a lump sum or monthly payment?

Let’s say that you have accrued a lump sum benefit amount of $812,268. Again, you ask yourself, “should I take my pension as a lump sum or monthly payment?”

Joint annuity

Let’s say you took the 100% Joint Annuity with 5-year certain option discussed above. This would pay out $3,196.59 per month for at least five years. That minimum comes out to be about $191k.

But the maximum in this case would be both of your lives. Let’s say that one person passes in year three but the other lives 30 or 40 years more. That’s $1,150,772 or $1,534,363 of payments received. In that case, the survivor stays protected over his or her entire life.

Single annuity

Now, let’s say you had taken the 5-Year Certain and Life Annuity option. Remember this is a single life option, not a joint life option. The maximum amount that could be paid would be the monthly payment of $3,543 over the life of one person.

But what about the minimum? It comes about to be about $212k. It’s a little bit more than for the joint life option we just covered.

The breakeven

You may be curious to know about how long you would need to get paid out before your principal of $812k gets returned to you.

In the case of the joint annuity, it would take you about 21.3 years.
In the case of the single annuity, it would take you 19.2 years as the monthly payout is a little higher.

Now, the above scenarios were calculated for a 57-year-old male. But what if you’re older? With less life expectancy, your principal gets returned to you in fewer years. And of course, this is a reminder that your situation is going to be different – you are unique!

Our Suggestion

Our suggestion is to first make sure you understand the pension choices that exist within your plan. Then carefully consider whether you want to take the (1) pension or the (2) lump sum or a (3) partial lump sum choice if available. Don’t do what’s right for your neighbor or what your co-worker did. Spend the time to understand and do what’s right for you and your family. Integrate the pension vs. lump sum portion of your puzzle within your big picture including but not limited to your health, age, investment risk tolerance, spouse’s desires, taxes, other retirement assets, IRS rules, and future beneficiaries.

You could crunch your own numbers and figure out these different types of angles, but there are a lot of nuances and it’s easy to miss something important. You don’t have to climb this mountain alone! Email me here with questions– it’s shane@advisor.investments