Historically, pension plans were the go-to retirement option offered by employers until the 1980s. However, times have changed. According to the U.S. Bureau of Labor Statistics, as of March 2022, pension plans are offered in only 15% of the private industry workforce. While defined contribution plans, including 401(k)s, 403(b)s, and 457s, have taken center stage in retirement savings, there remains a substantial group of pre-retirees facing an important decision on how to receive their pension benefits.
The choice between lump sum payments and pension payments is a multifaceted one, influenced by various factors such as marital status, life expectancy, and risk tolerance. In this article, we will delve into how to evaluate which option might be the right fit for your unique circumstances.
Here are some of the most prevalent pension payment options:
- Single Lifetime Payments: With this option, you will receive monthly payments for as long as you live. When the pension recipient passes away, the payments cease. This choice typically yields the highest monthly payments.
- 10-Year Certain: Similar to the single lifetime payment, this option provides lifetime payments. However, if the recipient passes away before ten years have elapsed, the payments continue to their heirs for the remainder of the ten-year period. While the monthly payments may be lower compared to the single lifetime option, it guarantees at least ten years’ worth of payments.
- Joint Lifetime Payments: Designed for married participants, this option ensures payments continue until both spouses have passed away. Monthly payments are generally lower since they are based on the joint lives of two individuals. A common variant is the 50% Survivorship option, where if the principal recipient passes away first, the surviving spouse receives 50% of the monthly benefits.
- Lump Sum: The lump sum option involves a one-time payment received by the recipient, with no further payments. This sum can be rolled over into an Individual Retirement Account (IRA) or another retirement account to defer any tax obligations.
Sample Case Study
In this case study, we examine the financial decision faced by a 59-year-old married client, whose company’s pension plan was suspended some years ago but now offers various payout options. The client has two choices: a lump sum payment of $52,300 or a single lifetime payment of $240 per month. To determine which option is more favorable, we conducted an analysis aimed at achieving a monthly income of $240 from the lump sum for 40 years without running out of funds.
Our analysis was based on a conservative annual return assumption of 4.95%. We also considered an annual withdrawal of $2,880 from the lump sum, equivalent to the $240 monthly payment.
Under these conditions, the client can receive all pension payments for 40 years while still maintaining a modest balance at the end of their life. However, if the returns were lower than 4.95%, it might be wise to consider the monthly payment option. Conversely, if returns were higher or if the client did not live until age 98, the lump sum would be the superior choice. Notably, we did not explore joint lifetime payments with the client’s spouse since, in the event of the client’s passing, the lump sum would transfer to the spouse as the designated beneficiary.
Potential Risks:
- Sequence of Returns: If the returns are lower during the initial years when withdrawals are being made, the client might require higher returns in subsequent years to avoid exhausting the lump sum.
- Longevity: In the scenario where the client lives beyond age 99, the lump sum could be depleted with the current assumptions, necessitating careful consideration.
Potential Benefits:
- Increased Liquidity: Opting for the lump sum provides increased liquidity, allowing the client to access more assets to cover short-term expenses when needed.
- Beneficiaries: Any remaining balance in the lump sum upon the client’s passing can be passed on to beneficiaries, such as the spouse or children, as opposed to the payments ceasing immediately upon the client’s demise.
- Delaying Payments: The client has the flexibility to delay drawing on pension payments until they are needed, avoiding unnecessary income claims until necessary.
While this case study illustrates one specific example, it underscores the importance of clients thoroughly evaluating the advantages and disadvantages of their payment options. Such decisions are typically irreversible and can significantly impact the overall success of one’s retirement plan. It is crucial for individuals to seek professional financial advice and consider their unique circumstances before making a final decision.
Presented by the Financial Planning Committee of Lake Street, an SEC Registered Investment Adviser
The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. Diversification does not ensure a profit or guarantee against a loss. There is no assurance that any investment strategy will be successful. Investing involves risk and you may incur a profit or a loss.
