Two weeks ago, I initiated the first of a three-part series on pension election decisions. Today, I will discuss pension math and factors to consider.
If you are on the verge of retirement and fortunate enough to have a pension, you may be faced with an important choice. Should you take the regular, lifetime payments that your company plan offers or should you select a lump-sum distribution option and invest the funds on your own, perhaps rolling the proceeds into an Individual Retirement Account (IRA) or investing in an annuity form not offered under your company plan that is more tailored to your needs?
Before you make an irrevocable decision about your future, you should take time to understand what options are available to you and what each choice might mean for you and your family. Doing groundwork now can help you understand your options and allow you to plan for the retirement income program that you feel is most appropriate for your situation before a decision has to be made.
PENSION MATH AND FACTORS TO CONSIDER
It's important to understand that all of the payment options are designed to be "actuarially equivalent" by law, meaning that any one of the choices would net out the same if you and your spouse live for an average length of time. Currently, American women live an average of 81 years and American men live an average 76 years. However, longevity tends to run in families. With this in mind, your decision should be based not just on averages but also on other factors specific to your situation. Considerations that favor monthly payments:
• You are likely to live past the actuarial average.
• You would like another source of guaranteed income to meet current and/or anticipated future monthly expenses.
• You want the convenience and security of a monthly check.
• You are not certain of your desire or ability to effectively manage a potentially large single sum payout.
• Your plan has a "cost of living" adjustment that increases your monthly pension payments to take inflation into account.
• Your spouse may not be as capable as you of managing a lump sum.
• You (and your spouse) have sufficient additional assets saved to address unforeseen economic needs.
Considerations that favor a lump-sum payment:
• You want financial control over the money and have the self-discipline and investment knowledge needed to manage it well.
• You believe that you can earn a higher rate of return on your lump sum than what is assumed as part of the pension calculation.
• The solvency of your employer or your plan is in question, and the PBGC does not fully guarantee all of your company pension plan benefit.
• You don't need additional monthly income to meet expenses.
• You don't think your pension plan's cost-of-living increases (if available) will be sufficient to keep up with the growth of your expenses down the road.
• You want to have more control over how your retirement funds are invested.
• You want to leave all or part of this asset to loved ones.
This may not be an "all or nothing" decision, depending on the circumstances. Some other options include the following:
• If you choose a lump-sum benefit and then use all or a portion of it to buy an annuity, it would also generate regular monthly income. Therefore, the choice of a lump-sum payment does not necessarily mean giving up the advantages of regular monthly payments, and individual annuities may offer other valuable features that are not available under your company plan options.
• Another alternative is to just leave the money in your former company's pension plan to grow at a predetermined rate until you are ready to take it. This option often provides for lower or company-subsidized management fees versus some other choices. However, if your balance is less than $1,000, the company may require you to roll the funds out of their plan.
You shouldn't make a decision in isolation about how to receive your pension benefits. Preparing for retirement requires a comprehensive planning process. Your financial advisor can estimate the cost of your retirement, analyze your income sources and choose an appropriate investment strategy to meet your goals and family situation.
• William Creekbaum, MBA, CFP, a Washoe Valley resident, is senior investment management consultant of Morgan Stanley Smith Barney LLC. He can be reached at William.a.creekbaum@mssb.com or 689-8704.