Q. I am 59 and have been offered a lump sum payout for my retirement plan. I would normally be receiving $3,500 a month but have been offered $700,000 as the payout. I have a 401(k) plan that has done well along with max Social Security due to income levels. What is your opinion on lump sums vs. regular monthly retirement payments?
— Not retired yet
A. Over the last few years, many employers have been offering their employees an opportunity to elect a lump sum as a payment option for the employee’s pension.
The lump sum option gives the employer the opportunity to turn a long-term liability of their company into a short-term liability, said Bryan Smalley, a certified financial planner with RegentAtlantic in Morristown.
For the employee, the lump sum option could work in their favor but is a decision that deserves a thorough analysis before being made, Smalley said. The analysis involves weighing both the quantitative and qualitative factors that come into play.
On the quantitative side, Smalley said, you will want to evaluate the break even point between the lump sum and annuity payments.
“The key numbers driving this are your expected return on the lump sum as well as your life expectancy, and your spouse’s life expectancy if married and if your annuity has a survivor benefit tied to it,” he said. “The shorter the life expectancy and higher the expected return on the lump sum usually favors the lump sum payout.”
But, he said, in today’s lower interest rate environment — a key driver in determining annuity payment amounts — the expected return rate on the lump sum may not be as high as you think.
On the qualitative side, Smalley said, an important factor to consider is which option would help you sleep better at night.
“The lump sum provides upside potential but you would have to be comfortable with taking the market risk over a long period of time,” he said. “The annuity payment, which will lock you into a specific benefit amount, eliminates the market risk and provides you with a steady stream of income along with your Social Security benefit.”
Despite this lack of market risk, it is important to note that your annuity payment does rely on the ability of your employer to pay it over your life expectancy, Smalley said.
There is insurance available through the Pension Benefit Guaranty Corporation (PBGC) for most private-sector pension plans. This insurance should cover the full benefit owed to you but there are caps on its guaranteed coverage that you should be aware of.
And if your pension is a public pension, you should ask your human resource department what type of provisions are in place to insure your pension, Smalley said.
As you can see, there are many factors to be weighed in order to come to a decision on whether to elect a lump sum payout or take the annuity payments.
Given that this decision is irrevocable and the dollars are high, Smalley highly encourages you to reach out to a certified financial planner to help you evaluate the decision and give you the confidence you need to make the decision in light of your financial goals.
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