May 4, 2015
by Michelle Perry Higgins
Second only to the decision about when to retire is the decision to either take either a lump sum or a pension annuity for your retirement benefit—that is, if you are one of the fortunate ones to still have a defined-benefit retirement plan.
The decision is especially difficult because the two options are very different in nature. There are, however, a number of qualitative differences that you should carefully consider even if they cannot be exactly quantified.
1. Pass to heirs: The pension annuity will end with the death of the retiree or their spouse, if the spouse outlives them. The lump sum can survive the death of both, thus providing a legacy to leave to heirs.
2. Ability to invest: The lump sum, once it is rolled over to an IRA, can be invested in accordance with the overall portfolio allocation of the participant based on their time horizon and risk tolerance.
3. Keep up with inflation: The pension annuity payment may not be adjusted for inflation. The ability to invest the lump sum, on the other hand, allows the participant to counter an inflationary environment by allocating some of the lump sum to stocks or inflation-protected fixed-income securities.
4. Control: With the lump sum the retiree has the ability to control distributions. If, for example, the retiree plans to do some consulting after retirement, and doesn’t need the income from the pension annuity for some years, taking the lump sum may result in tax savings during those years.
1. Longevity insurance: As long as the company stays solvent, the retiree will not outlive the income stream provided by the pension annuity. This is a powerful argument in favor of taking the pension annuity, especially if the retiree has longevity in their family and has had trouble controlling expenses prior to retirement. While there is credit risk if the company goes bankrupt, the Pension Benefit Guaranty Corporation generally insures against this risk up to a level that will cover many annuity recipients.
2. Stock-market risk: The income stream is not dependent on the ups and downs of the stock market. This can be an important benefit for conservative retirees who are particularly risk averse.
3. Spousal benefits: According to the Retirement Equity Act of 1984, with some exceptions, the pension annuity must include a spousal benefit in the event that the retiree predeceases their spouse. This benefit can only be changed by written approval of the spouse. A retiree can be assured that even with their death, their spouse will be provided a benefit that they cannot outlive or outspend.