Would you rather have a monthly pension guaranteed for life or a lump sum of money now? Before I address that question, let me say that you’re lucky if you have the choice. Private pensions are on the way out, even among old-line companies. In older age, there’s nothing more comfortable than a check in the mail every month.
Normally, you’re not offered the choice of a pension or lump sum until you retire. Rising numbers of companies, however, are extending this offer to former employees who haven’t taken their vested pensions yet. They want to shift the burden of retirement investing over to you.
In fact, they’d like to get rid of you in the next 12 months.
That’s because the size of your pension or lump sum depends, in part, on how long the people in your age group are expected to live. Currently, pension plans are using outdated life expectancy tables. Starting in 2017, however, they’ll have to use newer tables, which show that people are living longer. That will require them to pay you more. Hence the rush.
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If you take a lump sum in place of a lifetime monthly pension, you’re making at least one of three risky bets.
Bet 1: You are betting that you can provide yourself (and your spouse) with a guaranteed monthly income for life that’s at least as high as you’d get from your pension. To check this, go to a website such as immediateannuities.com, which shows you what insurance company annuities pay. Enter the lump sum you’re being offered, your age and when you want the payments to start, then choose the type of annuity you want. Compare that payment with your vested monthly pension amount. Odds are, the pension will pay you substantially more, especially if you’re a woman, says Tony Webb, senior economist at the Center for Retirement Research at Boston College.
Bet 2: That your life span will be shorter than average. The lump sum is intended to last your expected lifetime, not your actual lifetime. If you live longer, you’ll need extra money in reserve.
Bet 3: That you can invest the lump sum in stocks and bonds and earn even more than the pension will pay. To check this, look at the “interest rate” in the fine print of your lump sum offer. (If it’s not there, ask the company for it.) Your investments have to grow by at least that percentage annually, after fees, to equal a pension that covers an average lifetime and much more, if you live longer than that.
Lump sums make sense if you’re terminally ill, if you have so much in other savings that you’ll never have to worry about running out of money or if the amount is small. To avoid taxes, roll the money into an individual retirement account.
But to assure yourself of an income for life, without taking stock market risk, pensions are hard to beat.
If the lump sum offer confuses you or leaves you anxious, don’t take it, says Ari Jacobs, senior retirement solutions leader at the benefits consultant Aon Hewitt. “You’ll be in the same spot you were before.”
For more information, go to pensionrights.org. In the search box, type in “Should you take your pension as a lump sum?”
Jane Bryant Quinn is a personal finance expert and author of Making the Most of Your Money NOW.
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