If you are one of a select few whose organization still offers a Defined Benefit Plan you will be asked to make a very important decision when you “call it quits” and it is time to exercise your benefit.
A Defined Benefit Plan is a type of pension plan in which an employer/sponsor promises a specified monthly benefit in retirement. Most companies offer you the option of either receiving lifetime monthly income (also called an annuity) or a lump-sum payment.
Choosing the monthly payment ensures that you will receive a steady income for the rest of your life. You may also be able to provide a lifetime income to your spouse or another beneficiary.
Choosing the lump sum payment gives you flexibility. You can choose to pay off large expenses and remove debt, invest the money on your own, or choose any of the other options that open up when you receive a large cash sum.
You may want to step back and look at the big picture. What do you want in retirement? Do you want the security of a steady check that could last 30 years or more? Or, do you want access to a large sum of cash that you control at the onset of your retirement?
Next, consider the following factors as they relate to your specific situation:
- Your health and your spouse/partner’s health
The lump sum may help if you think you might need cash on hand to pay medical bills. It may also be the right option if you have concerns about your longevity.
- Investment knowledge (and your spouse/partner’s), and how this may change as you get older
The lump sum may be the right option if you are confident investing and feel secure in your ability to grow and maintain the funds for as long as you need them to thrive in retirement.
- Living expenses (current and future)
The annuity option might be right if your living expenses are typically fixed. Don’t forget yearly expenses and incidentals such as property taxes or car and house maintenance. Your carefully planned monthly budget will help to make sure you are aware of all expenses.
- Debt (mortgage, car, credit cards, student loans, child support payments)
Consider the lump sum as a way to pay down big debts. Consider the annuity if your debt incurs little or no interest and you can pay it as part of your monthly expenses.
Make sure that you fully understand how you will be taxed on your pension payment and how those taxes will change depending on the payout option you choose.
- Savings, reserves, and other guaranteed income (social security, pensions from past employers).
Think about your savings and other sources of retirement income. Factor this into your retirement budget planning.
- Assets to beneficiaries
Both options may offer you the opportunity to leave money or assets to your heirs. Again, the lump sum offers flexibility while the annuity offers stability. Make sure you fully understand if or how each option can live on as your legacy.
- Financial health of your company
Future payments that you receive depend upon your company’s ability to make those payments. Be sure to find out what happens to your annuity payments if your company experiences difficulty or failure. Pensions have a certain level of protection granted by the federal agency, the Pension Benefit Guaranty Corporation (PBGC), which will pay a portion of the payments up to a certain limit. The pension could also be turned over to an insurance company that would manage payments.
Help and Advice
The tradeoffs between taking pension payments or a lump sum payment should be very carefully and thoughtfully examined as this critical decision cannot be undone.
If you find you need assistance with making an informed decision, contact Gene Hilliard (firstname.lastname@example.org) at Emerge Financial Group.