Lump-Sum vs. Monthly Pension: Making the Right Choice for Your Retirement

Companies are increasingly presenting their current and former employees with a crucial decision: accept a lump-sum payment now or hang onto their pension plan, in light of rising pension costs and increased volatility.

According to Aaron Korthas, head of Fidelity Investments’ retirement practice, “companies are offering these buyouts as a way to shrink the size of future pension obligations, which ultimately reduces the impact of that pension plan on the companys financials.” From the standpoint of the employee, the choice is essentially a trade-off between a source of income and a large sum of money that is made available to them right now. “.

A company may offer pension buyouts to its present or past workers. Long before you retire, your current employer might be offering you a pension lump-sum buyout, or you might have a vested benefit from a previous employer.

In any case, the general process for a pension lump-sum payment offer is as follows: Your employer notifies eligible employees that they have a deadline to choose whether to convert a future monthly benefit payment to a lump sum payment. If you choose the lump sum option, the company’s defined benefit (or pension) obligation to you will terminate, and you or a qualifying tax-qualified plan, like an IRA, will likely receive a check or IRA rollover for that amount from the company’s pension fund. On the other hand, nothing will change if you choose to maintain your monthly benefits, with the possible exception that the option to take a lump sum may no longer be available once the offer period ends.

Although the procedure is rather straightforward, choosing an option can be difficult. Here are some considerations for each option:

An annuity is a pension plan that pays a fixed amount each month for the remainder of your life starting on the date of retirement. Additionally, you have the option to accept lifetime benefits that follow you into death and go to your spouse. 1.

In addition, some employers are thinking about purchasing annuities for workers who decline the lump-sum offer. In this scenario, your benefits won’t alter other than the fact that your retirement checks will be made out to the insurance company, which may have a different risk profile, and that the insurance company will supply your guaranteed income. 3 (Companies that transfer the annuities to an insurance company can remove the pension liability from their books, just like when they offer lump sums. ).

A lump-sum payment may seem attractive. In exchange for a cash-out payment made now, which is usually the actuarial net present value of your age-65 benefit discounted to today’s value, you forfeit the right to receive future monthly benefit payments. Taking the money up front gives you flexibility. If you have any assets left over when you pass away, you can leave them to your heirs or invest them yourself.

Depending on your unique situation, you may want to keep your pension or take a lump sum. In addition to the previously listed factors, you will also need to evaluate the following:

You should consider a pension buyout in light of your overall retirement plan. If this option is made available to you, speak with a professional who can offer you objective guidance on your options. Lastly, keep in mind that more businesses are still debating whether to fulfill their pension obligations, so it’s a good idea to maintain contact with former employers. “It’s highly probable that you’ll be presented with a lump sum offer if you have a pension from a previous employer,” says Korthas. “Make sure your former employer’s administrator is aware of your current address; if they can’t find you, you could lose out on this opportunity.” “.

If you do receive an offer for a lump sum payment, discuss it with a reliable financial advisor. Everyones circumstances are different. You may not always agree with what is best for your friend, neighbor, coworker, or family member.

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Taking a lump sum or monthly payments depends on:

• Your retirement income and essential expenses
• Your life expectancy
• Wealth transfer plans

Companies are increasingly presenting their current and former employees with a crucial decision: accept a lump-sum payment now or hang onto their pension plan, in light of rising pension costs and increased volatility.

According to Aaron Korthas, head of Fidelity Investments’ retirement practice, “companies are offering these buyouts as a way to shrink the size of future pension obligations, which ultimately reduces the impact of that pension plan on the companys financials.” From the standpoint of the employee, the choice is essentially a trade-off between a source of income and a large sum of money that is made available to them right now. “.

A company may offer pension buyouts to its present or past workers. Long before you retire, your current employer might be offering you a pension lump-sum buyout, or you might have a vested benefit from a previous employer.

In any case, the general process for a pension lump-sum payment offer is as follows: Your employer notifies eligible employees that they have a deadline to choose whether to convert a future monthly benefit payment to a lump sum payment. If you choose the lump sum option, the company’s defined benefit (or pension) obligation to you will terminate, and you or a qualifying tax-qualified plan, like an IRA, will likely receive a check or IRA rollover for that amount from the company’s pension fund. On the other hand, nothing will change if you choose to maintain your monthly benefits, with the possible exception that the option to take a lump sum may no longer be available once the offer period ends.

Although the procedure is rather straightforward, choosing an option can be difficult. Here are some considerations for each option:

An annuity is a pension plan that pays a fixed amount each month for the remainder of your life starting on the date of retirement. Additionally, you have the option to accept lifetime benefits that follow you into death and go to your spouse. 1.

These monthly payments do have drawbacks, however:

• Generally, your benefit amount won’t increase between now and the date of your retirement if you’re no longer employed by the company making the offer. Furthermore, your payment amount usually does not include inflation protection once you start receiving life annuity payments. Your monthly benefits will therefore probably gradually lose purchasing power.
• If you choose to receive your pension as a life annuity, part of what determines when you will be able to collect your payments is the ability of your employer to make them. A federal organization known as the Pension Benefit Guaranty Corporation (PBGC) will pay a portion of the benefits up to a legally specified limit if your company keeps the pension and is unable to make the payments. For most people who retire at age 65, the maximum benefit guaranteed by the PBGC in 2023 is $6,750 per month (straight-life annuity). The monthly guarantee increases for retirees who retire after age 65 and decreases for those who retire before that age. State Guaranty Funds provide additional protection for annuities, but only to a limited extent that varies by state. Generally speaking, the larger the percentage that will be protected, the smaller your pension is. In the event that an insurance company takes over payment for you, your guarantees will come from the insurance company rather than the pension plan. 2.

In addition, some employers are thinking about purchasing annuities for workers who decline the lump-sum offer. In this scenario, your benefits won’t alter other than the fact that your retirement checks will be made out to the insurance company, which may have a different risk profile, and that the insurance company will supply your guaranteed income. 3 (Companies that transfer the annuities to an insurance company can remove the pension liability from their books, just like when they offer lump sums. ).

A lump-sum payment may seem attractive. In exchange for a cash-out payment made now, which is usually the actuarial net present value of your age-65 benefit discounted to today’s value, you forfeit the right to receive future monthly benefit payments. Taking the money up front gives you flexibility. If you have any assets left over when you pass away, you can leave them to your heirs or invest them yourself.

However, keep in mind the following cautionary factors:

• Making the money last throughout your retirement is your responsibility.
• Market fluctuations may affect your investments, which could raise or lower the value of your assets and the income you can get from them.
• Interest rates and lump sum payment amounts are inversely correlated; generally speaking, lump sum values decrease as interest rates rise.
• Should you choose not to immediately roll over the proceeds into an employer-qualified plan such as a 403(b) or 401(k), the distribution will be subject to ordinary income tax, which could potentially place you in a higher tax bracket. If you take the distribution before the age of twenty-five percent (C2%BD), you might also be required to pay an early withdrawal tax penalty of 10% of the total amount.
• You may use all or part of the lump sum to buy an annuity, usually an immediate annuity. This kind of annuity could offer features like inflation protection or other built-in optional features, along with a monthly income stream. The annuity may or may not replicate the monthly pension payment you would have received from your employer, but as an individual buyer, you might not be able to negotiate as good a deal with the insurance provider as the benefit you would have received by taking the pension plan annuity. In addition, you should carefully consider the credit ratings of potential providers of annuities and ensure that you have read and comprehended the annuity’s terms and conditions.

Depending on your unique situation, you may want to keep your pension or take a lump sum. In addition to the previously listed factors, you will also need to evaluate the following:

• Your retirement income and essential expenses. Guaranteed income simply refers to something you can rely on each month or year that isn’t affected by market and investment returns, like Social Security, a pension, and fixed annuities. The best option might be to keep the monthly payments if your guaranteed retirement income (including your income from the pension plan) and your essential costs (like food, housing, and health insurance) are about equal. This is because the monthly payments are essential to meeting your needs for essential retirement income. Should your assured income surpass your necessary expenditures, you may want to think about accepting the lump sum. You can invest the remaining amount for growth and utilize a portion of it to pay your monthly expenses. If you’ve already retired, these comparisons might be fairly simple, but if you’re still working, it might be challenging to accurately estimate your retirement income and expenses. Avoid the temptation to use the lump sum to cover other current expenses, such as paying off credit card debt, and not just because you’ll probably have to pay a sizable tax bill. According to Korthas, “Lump-sum distributions originate from a pool of money that is specifically intended for retirement.” It jeopardizes the standard of your retirement if you use those funds for another purpose. ” .
• Longevity. Actuarial calculations were used to determine the lump-sum amount and your monthly benefit payment. These calculations took into consideration your current age, mortality tables, and IRS-set interest rates. However, neither your individual health history nor the longevity of your parents, grandparents, or siblings are factored into these estimates. Should you anticipate living a longer life than average, you might prefer the stability of consistent payments. It can be reassuring to have a guaranteed income stream for the duration of your life. However, the lump sum might be more advantageous if you anticipate living a shorter life than average due to personal factors like your family’s medical history.
• Wealth transfer plans. It’s appropriate to think about wealth transfer plans after you’ve thought about retirement income and expenses and have budgeted appropriately for longevity, inflation, and investment risk. You frequently cannot transfer the benefit of a pension plan to your children or grandchildren. Please consult an estate planning attorney.

You should consider a pension buyout in light of your overall retirement plan. If this option is made available to you, speak with a professional who can offer you objective guidance on your options. Lastly, keep in mind that more businesses are still debating whether to fulfill their pension obligations, so it’s a good idea to maintain contact with former employers. “It’s highly probable that you’ll be presented with a lump sum offer if you have a pension from a previous employer,” says Korthas. “Make sure your former employer’s administrator is aware of your current address; if they can’t find you, you could lose out on this opportunity.” “.

• First and foremost, confirm with your current or previous employers if you are eligible for a pension benefit and maintain current contact details with them. If you are unaware of an offer, you are unable to even consider it.
• With our Planning tool, you can see your retirement plan in its entirety.
• If you choose to convert your lump sum pension payment into an IRA rather than receive monthly benefits, you might want to think about doing so. It might be best to roll over your employer’s plan funds directly to your IRA provider (trustee to trustee) in order to maintain their tax-deferred status because there won’t be any immediate taxes associated with this transaction. You should consult your tax adviser.

If you do receive an offer for a lump sum payment, discuss it with a reliable financial advisor. Everyones circumstances are different. You may not always agree with what is best for your friend, neighbor, coworker, or family member.

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