Many of you are blessed to be employed at a cooperative that offers a defined benefit pension plan that provides you with a lump sum payment or a monthly pension payment for life when you retire. Congratulations! Such plans are uncommon today. Most employers have opted for higher matching contributions to 401K plans and defined benefit pension plans are going the way of the dinosaur. This means most workers have to rely on their own savings and investments to supplement Social Security and other sources of retirement income.
Many of you will face a challenging decision at retirement: Should you take the lump sum payout or should you take the monthly annuity payment for the rest of your life and, in some cases, the life of your spouse and beneficiaries as well?
This is a tough decision for most, but one you are lucky to get to make.
Should you take the annuity option from your cooperative?
- Single life payment: This typically pays the highest monthly amount.
- Single life with term certain: You receive a little less each month, but if you die before the specified term is over, payments continue to your beneficiaries for a preset number of years.
- 50% joint and survivor: You receive a lower monthly payment to make sure your surviving spouse gets monthly payments for his or her life that are equal to 50% of your original annuity.
- 100% joint and survivor: You receive an even lower monthly payment, but in return, your surviving spouse gets 100% of your annuity in monthly payments for his or her life.
To see a complete list of your annuity payment options in plain English click here.
With the annuity option you must consider factors such as life expectancy, retirement income needs, credit quality, inflation, convenience, taxes, estate planning and you need to run a full cost comparison with the lump sum option.
Should you take the lump sum option from your cooperative?
- Current Income Needs- Maybe your monthly income needs are met and you could invest that lump sum for future use or for your family's legacy?
- Taxes-If you opt for a lump-sum payout, one option could be to roll it over to a traditional IRA and continue to defer taxes. If you take a lump sum and don’t roll it over, you’ll pay a large, single tax bill.
- Health-If you choose an annuity, you’re choosing a lifetime cash flow. If you choose a lump sum, you generally will have more control over the asset, but not the promise of a lifetime cash flow. Balance annuity payments with other savings and resources, though. If you have a single, large expense, like a health-care event, you may need money to pay for large expenses or bills in excess of Social Security and annuity payments.
- Risk-Ask yourself, how much of your retirement income will depend on markets, and how much is insured (e.g. provided from Social Security, pension or annuity)? Do you feel comfortable with this balance? If not, consider the annuity. If so, consider the lump sum.
- Inflation-Unless the annuity payment carries a cost-of-living adjustment, you’ll lose purchasing power over time. A lump sum could be invested to include a prudent allocation of equities to help assets have a better chance of keeping up with inflation.
- Gift and Estate Planning-Unless you choose a term certain or survivor benefit option, your annuity payments die when you die. A lump sum could be passed on to heirs, if a balance remains. Be sure to factor your gift and estate planning goals into any lump sum versus annuity decision, along with the additional factors above.
What about both?
You might choose to take a portion of the lump sum and one of your annuity payment options. Your approach may be to aim to cover as much of your essential, fixed expenses as possible from the annuity payments, Social Security or other forms of predictable and, if possible, guaranteed income sources and invest the portion of the lump sum for future use. For many retirees, this can increase comfort and confidence and help in managing other investments more flexibly, with a baseline of income in place. Consider your situation, however, and tolerance for managing market, longevity and other retirement risks.
Your choice can have major financial impacts, so it's best to make a careful decision and seek a second opinion from a trusted financial adviser. At 80/20 Financial Services we are here if you need a second opinion.
You Need A Plan
A goal of retiring - without a plan to get there - is simply a plan to run out of money. Retirement isn't some magical age. It's a dollar amount and a strategy to increase that dollar amount over time. If you're age 50 or over and still in the accumulation phase (pre-retirement) we can help you figure out where you need to go and how to get there. If you are retired or nearing retirement, we can create a plan which will outpace inflation and possibly leave a legacy to your family. The consultation is free and without obligation. Contact us to set up a consultation.
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80/20 Financial Services is an independent Registered Investment Advisory Firm. We help clients age 50 and over plan their retirement income and investment strategies. Contact us today for help with your retirement needs.
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