Should You Take a Lump-Sum Payout?
Should you take a pension lump sum when you retire from your company or a monthly pension check for life?
A growing number of employees, who are covered by pensions, are facing this question as more companies promote the lump-sum option. Corporations are offering lump-sum buyouts as a way to shrink the size of their pension obligations. There are many factors involved in determining whether you should take a lump sum or stick with a lifetime of monthly pension checks. You should consult with a CPA or other financial professional, who is familiar with pension issues, before making this irrevocable decision.
Weigh Your Options
Here are some factors to consider:
Is the company financially stable?
Collecting monthly payments for your lifetime will depend on the employer’s ability to issue them. Many companies have underfunded their pension plans and if they get into trouble and can’t meet their obligations, pension checks could shrink. That’s because the Pension Benefit Guaranty Corporation will routinely only step in to pay a portion of each monthly check. The maximum guaranteed benefit was recently $4,943 for most people retiring at age 65.
Assuming the financial risk.
If you accept a lump sum, you will take the risk, rather than your former employer, that you can make the payout last for the rest of your life. Are you confident in your investing skills? Unfortunately many people overestimate their investing prowess. Or do you have a financial firm that you can trust to invest the money wisely?
What is the lump sum?
You’ll want to examine closely just what you would be getting. The Pension Protection Act of 2006 dictates how a lump sum is to be calculated. Current interest rates are a significant factor in what the payout would be. A lower interest-rate environment will result in higher payouts and the reverse is true when interest rates are higher.
Selecting the lifetime of payments for you and possibly a spouse means that you won’t have access to a large pot of money if there is an unexpected large expense. There also wouldn't be money left to give to heirs when those covered by the pension payments die.
Handling a Pension Payout
If you decide to opt for the cash payout, move this money into an IRA rollover account. It’s best to make this move through a direct trustee-to-trustee transfer. That means the money, rather than being sent to you directly, will be moved from the employer to an IRA with a financial institution. Moving the money into an IRA will mean the lump sum will not be subject to taxes and it will remain protected in a tax-deferred account. If you take the cash instead, the money will be subject to federal taxes and state taxes (if applicable) and you may also get hit with a 10% early withdrawal fee if you are under 59 ½.
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