By Kurt Fillmore for Kiplinger Magazine
We’re getting closer, and some of us are already there.
Retirement – when to take it, how to do it – is a topic all of us seem to want to talk about. It makes sense; when we were in our 30s, we talked about babies and kids, in our 40s it was career changes and houses. And now… retirement.
If we’ve done good planning, we have options when retirement time comes. But before you take a lump sum or lock in monthly payments, carefully consider the consequences for you, your spouse and your heirs. Once you make a move, there’s no turning back.
First, many companies stopped offering them to new employees. Then they froze the plans they had in place for current workers so that no new benefits could accrue. And now, many companies are offering all plan participants the choice of taking a lump sum payment in place of the monthly checks they expected to get upon retiring.
It’s a more complicated decision than most people realize.
At first, it might feel as though you’ve won the lottery — suddenly having control over all that money — but there are several factors to consider, and if you have a financial adviser, your first move should be to give him or her a call. They can help you crunch the numbers and determine which option best suits your retirement needs.
Here are a few things you should look at:
- How confident are you that your employer will be around to make the payments throughout your retirement years? Pension liabilities are governed by federal regulations, so your employer can’t simply refuse to honor its obligations, even if the company is sold. But if the company goes bankrupt and defaults on the plan, the government’s Pension Benefit Guaranty Corporation (PBGC) will become the trustee responsible for paying your benefits — and it may pay less than 100%. The 2017 maximum annual guarantee for a 65-year-old retiree is about $64,400 per year.
- Do you have beneficiaries? Depending on your pension’s survivor benefit options, the payments could stop or be reduced when you die, and they will stop completely when your spouse dies. Your children get none of your pension survivor benefits. If you live a long life, that may not be a factor, but if you die prematurely, you’ll lose money that could have gone to your loved ones. Be sure to take your gift- and estate-planning goals into consideration.
- What does your portfolio look like? If the lump sum combined with your other savings is enough, it could allow you to delay claiming Social Security benefits until you turn 70, which would mean a substantial boost to your guaranteed income.
- How disciplined are you? If you’re looking at the lump sum and seeing a new car, a vacation or some other big-ticket item, remember: This is money you’re meant to live on in retirement. If you spend it, you may be damaging your future security. You’ll also pay taxes and possibly a penalty to the IRS that will significantly reduce the amount you receive. Even if you have the best intentions — perhaps you plan to roll it over into an IRA or pay off some debts — if you aren’t great with follow-through, you may wish to leave the money where it is until you retire. It may be the easiest choice.
- What is your expected rate of return? It is possible to calculate the rate of return that your employer is targeting to generate your lifetime pension payments. This calculation compares the lump sum amount to the monthly pension payments to determine the rate of return based on your average life expectancy. Some companies may only need to generate a 1% to 2% rate of return on their pension to pay you throughout your lifetime; others anticipate much higher rates of return. If the employer’s rate of return is high, it may be better to keep the pension. If it’s a lower rate of return, though, it’s probably a good bet to take the lump sum. A lump sum invested into a well-structured portfolio could generate higher income payments than the pension, or grow the lump sum as a legacy to leave to your heirs.
- Can you get the best of both options? Some companies will offer a partial lump sum, so you get part of the money upfront and a smaller monthly payment — a good compromise for many. I’ve also known couples who, based on the expected rate of return, take one spouse’s pension as a lump sum and leave the other spouse’s pension alone.
As with so many decisions, one must make regarding retirement income, there’s no one right or easy answer. Every individual, couple and family must consider what’s best for them.
Your financial professional can help by adding perspective on what your decision will mean to your overall retirement plan, including tax consequences, inflation, longevity and more.
Don’t delay in asking for help. Once you receive the offer letter from your employer, you likely won’t have much time to think about it. And the decision you make is final.