If you are able to ask this question, consider yourself fortunate. Many, if not most retirees today do not have a company pension, and for them, the only guaranteed lifetime income stream they have is Social Security. Usually, retirees are offered pension payments in various different forms and amounts ranging from a) a lump sum distribution of the full value of the pension that can be rolled over tax free to an IRA, to b) a series of equal monthly payments for the lifetime of the retiree and their spouse.
Taking a pension payment for only the life of the retiree usually provides the highest monthly income. However, most pension plans offer retirees options to take lower initial monthly payments in return for either guaranteeing that the monthly payments will last a certain number of years regardless of how long the retiree lives, or if the retiree predeceases their spouse, guaranteeing that monthly payments at a predetermined percentage of the initial monthly payment will continue for the life of the spouse.
Deciding what to do about your pension is a very important and long lasting decision. In my experience, the decision usually comes down to either taking a lump sum distribution and rolling it to your IRA, or taking a monthly pension payout. If you are considering taking a lump sum taxable distribution at retirement and paying taxes, the tax hit usually makes that option look very unattractive. Before making your decision, you should consider the following questions and more:
- What rate of return would a lump sum rollover to an IRA need to earn in order to generate the monthly income being offered by the pension plan options? Is it a reasonable rate of return based on current and projected interest rates and investment returns?
- Based on that rate of return, in what year is the principal of the lump sum rollover expected to run out and the monthly income cease?
- f the rate of return determined in a. above is not reasonable, what monthly income level could a lump sum rollover reasonably be expected to sustain over your (and your spouse’s) life expectancy?
- If you take the lump sum rollover and buy an annuity from a high quality insurance company to provide you an income, how does that compare to the income options being offered by the pension plan?
- How long do you (and your spouse) expect to live? Consider your current state of health and your family history. If you take the lump sum and use it to give you a monthly income, what is your longevity risk, the risk of outliving your money?
- Do you think you will ever need a lump sum of money for things like home repairs, gifts to children, etc.? If so, do you have other investment assets to meet those needs?
- Many monthly pension payments do not increase with inflation. Do you have other assets or income sources that you can use to supplement your pension to offset the effects of inflation on your long-term purchasing power?
- How strong is the company offering the pension? Does the Pension Benefit Guaranty Corporation (PGBC) back the pension? What would happen to the pension payments if the PGBC did have to back the pension?
There are many factors that figure into the decision regarding what to do with your pension. I believe your best opportunity for making good decisions regarding your pension plan will come by evaluating the above and other important questions, really considering how the different options fit into your plan, and consulting with a financial professional about how they see your pension plan fitting into your retirement plan and what other factors they would consider.