With interest rates trending lower in 2019, many companies are once again looking to offload pension liabilities by offering lump-sum pension payouts to employees and former employees. If you, or someone you know, are being given the option to take a lump-sum pension, it can be one of the most important financial decisions of your life. Below are some things to think about if you are confronted with this decision:
Understand the Options Offered
Companies typically give the option to either take a lump sum payout or stay in the pension plan and receive fixed monthly annuity payments. The fixed monthly payouts will typically be calculated based on a single life expectancy, joint life expectancy (income would continue to be received by a spouse in the event the employee pre-deceased the spouse), or a period certain to the employee, or the employee’s estate.
Understand the Benefit Calculations
The companies calculate the lump sum and monthly annuity payouts based on actuarial tables, which predict average life expectancies. If you and/or your spouse are incredibly healthy and have family histories suggesting you will live a long life, then it may make sense to lean towards the annuity payouts. If, however, you and/or your spouse are not in good health it may make sense to look towards the lump sum option.
How to Choose the Best Option?
Just like with any decision of this nature, it is case by case specific! There is no right answer for everyone. To get to the right decision for your particular circumstances, you will need to look at your entire financial situation. Consider the following:
- What other assets do I have outside of the pension? If I choose the monthly pension payouts, which are fixed, will these assets allow me to combat the negative effects of inflation and offer the necessary liquidity needed for unforeseeable expenses?
- What is my risk tolerance? Do I want to take on the investment risk (Lump Sum Option), or do I want the company to take on that risk (Monthly Annuity Option)?
- What are my assumptions for future rates of return on investments? This assumption will help evaluate whether taking the Lump-Sum Option is better long term for your case facts than the Monthly Annuity.
- What are your priorities? Are you primarily concerned with the consistency of income, which may favor the Monthly Annuity, or do you value transferring wealth to your next of kin?
As you can see, the decision to take a Lump Sum Pension buyout vs. a Monthly Annuity can be a difficult one. What makes the decision even more difficult is the pressure to get it right as these decisions are typically irrevocable. If you, or someone you know, are confronted with this complicated and challenging decision make sure to factor in all the necessary variables to get to the best possible decision. If you do not feel comfortable making this decision on your own, do not be afraid to ask a Financial Advisor for help as it could be the most valuable advice you ever receive!
Follow The Welch Group every Tuesday morning on WBRC Fox 6 for the Money Tuesday segment.
Fox 6 Talking Points:
- Understand the Option Offered
- Understand the Benefit Calculations
- How to Choose the Best Option?
Marshall Clay CFP, JD, is a Partner and Senior Advisor at The Welch Group, LLC, which specializes in providing Fee-Only investment management and financial advice to families throughout the United States. Marshall is a graduate of the United States Military Academy in West Point, New York, the Cumberland School of Law in Birmingham, Alabama, and is a CERTIFIED FINANCIAL PLANNER™. In addition, Marshall is a frequent guest on local television stations as an expert on various financial planning matters. More information about The Welch Group and important Disclosures can be found on our website. Investing in securities involves the risk of loss. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy will be profitable or equal any historical performance level(s). Consult your financial advisor before acting on comments in this article.