If you are one of the lucky few who will receive a pension from your employer when you retire, the options can sometimes feel overwhelming. These options may include taking large lump sums up front in exchange for a lower pension payout over time or taking a single-life annuity payments, versus joint and survivor payments. While we often assist clients with the intensive calculations required to make the complicated choice between single-life annuities and joint and survivor options, deciding whether to take a lump sum, if available, can be much more straightforward.
Most pensions with a lump sum option still include a reduced annuity option that will pay out over time. Why would you want to take the lower monthly payment? The reasons have to do with inflation, flexibility, and your legacy.
Most pensions do not rise with inflation. Only Federal and very rare private pensions have a cost-of-living-adjustment, or COLA, in which the monthly benefit grows over time to keep pace with increasing costs. Even when there is a COLA, that adjustment often does not truly keep pace with real inflationary costs. What that means for you is that if you receive $1,500 per month from your pension for the rest of your life, each month you receive that $1,500, your actual buying power is going down. Those dollars are worth less than they were six months ago. Think about how much your grocery bill was in 2002 versus how much the same items cost today. If you plan on pulling from your pension for twenty plus years, you could be facing a similar rise in prices by 2040. That $1,500 will buy you substantially less near the end of your retirement than it will at the beginning.
However, if you take the lump sum option for your pension and roll that into an IRA that is wisely invested, you have a much greater chance of keeping up with inflation. While your monthly pension benefits will not change, the value of the rollover IRA has an opportunity to rise significantly over the course of your retirement. That means you will not suffer the same loss of buying power that you would if you relied solely on the monthly benefit.
Imagine you are six months into retirement when the furnace in your home unexpectedly dies. Suddenly you need to spend $7,000 to replace and install this necessary home component, but your pension is your primary source of retirement income and only pays $1,500 per month. If you had taken the lump sum option, you could have a large pool of liquid assets to draw from to help pay for the considerable, one-time expense of replacing your furnace.
These large expenses do not have to be emergency scenarios. Maybe there is a big vacation you have always wanted to take in retirement. Perhaps you have a child getting married, and you would like to help significantly with wedding expenses. While your monthly pension payout is great, having a large account of liquid assets that could be drawn from in any of these scenarios would be even better.
What would happen if the Lord called you home within a year or two of retirement? What would happen to your pension? If you are married and chose the joint annuity option, your spouse would likely continue to get a portion or the entirety of your pension until his/her death. Many pensions provide a death benefit if you die before meeting certain criteria regarding how much money has been paid out to you over time. It is important to know exactly how your pension operates in these scenarios, especially if your spouse relies on your retirement pension.
Taking the lump sum option on your pension can help mitigate the risks of dying before you have your full benefit. With the lump sum option, it is easy to designate beneficiaries. This beneficiary could mean your spouse, your children, your church, or anyone you so choose. It doesn’t matter what the death benefits might be; you will have a large account to leave to whomever you wish. It won’t matter if you die five years, fifteen years, or thirty-five years into retirement—your rollover IRA will not vanish at your death the way your pension may.
Determining what pension options to take can be a very daunting task. At Faithward Advisors, we look at your entire financial picture to help you decide which pension options are right for your unique situation. We can help you determine if a lump sum option may be right for you and what type of annuity option best fits your financial goals. For any questions about your pension, contact our team, so we can walk through these decisions with you.
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