Should I Take My Pension as a Lump Sum? 5 Key Things to Consider

This is a question I get a lot from clients who are approaching retirement. As with many other financial decisions, the answer is neither simple nor straightforward. And that’s because one pension option isn’t necessarily better than the other, and each comes with its own risks.

Choosing the right option for you will depend on your personal financial situation. You need to factor in things like your life expectancy, money management style and how much you’ll need in retirement.

It can be a complicated decision, so holistic planning is key. That’s why it’s a good idea to work with a financial advisor who can help lay out the pros and cons of your options after conducting a thorough financial analysis for you.

I believe that having a clear understanding of your financial picture can help give you the highest probability for success when it comes to securing your retirement future.

Ahead, I’ll highlight some key things you’ll want to keep in mind as you work through this important retirement decision.

#1. The lump-sum option could offer flexibility and control

When deciding between a lump sum and lifetime monthly income, here’s an important question to ask yourself: Who do you want making the decisions over your money – you or your employer’s pension administrator?

Instinctively, many of us may point to ourselves, but this actually requires some careful thought.

Keep in mind that if you choose to take a lump sum, you become responsible for managing that money. You have to decide how to spend, save or invest it to help make your money last.

While you may prefer to control your own funds, you have to do a little self-evaluation. Do you consider yourself a disciplined money manager? Are you comfortable with being in the driver seat when it comes to making investment decisions?

Here’s why these questions are important. When taking a lump sum, there’s always a risk of you outliving your retirement – in other words, running out of money before the end of your retirement. This could happen for a number of reasons such as sequencing risk, miscalculation of your life expectancy, overspending or poor investment decisions. And if you don’t have the skills to manage these potential risks on your own (or have a trusted financial advisor to help you), you may want to consider the monthly income option instead.

However, if you’re comfortable with managing your own money, taking the lump sum can offer more flexibility than the monthly income option. You can spend and invest the lump sum however you see fit. (Of course, the potential downside of having this kind of flexibility is that you could end up overspending if you’re not careful!)

Bottom line: While walking away with a lump sum of cash might be tempting for many, it may not be right for everyone. Generally speaking, taking the lump sum could be a good option if…

• You’re comfortable and have the skills to manage the lump sum responsibly.
• You want to have a greater degree of control and flexibility over your pension funds.
• You’re concerned about the financial health of your employer’s pension plan (i.e., how it’s managed or funded).

#2. The monthly payment option could provide a steady stream of lifetime income

With the monthly income option (also referred to as “lifetime income”), you would receive a set amount from your pension plan each month over your lifetime. This means that you won’t have as much control over your money since your pension administrator is essentially managing those funds for you.

Going with the lifetime income option may be a smart choice for those who have a habit of overspending. The regularly scheduled payments could help impose some financial discipline. Think about it this way: With the monthly income, you’re basically being put on an “allowance,” which could help you stick to your retirement budget.

Retirees who are in good health (or have a long life expectancy based on their family history) may also want to seriously consider the monthly pension option, as it could help provide a steady stream of income through retirement. And being able to count on this regular source of money can bring some real peace of mind.

Still, there are some potential risks to consider.

Some retirees may be hesitant about taking the monthly payment option for fear of dying prematurely and not being able to make full use of their pension. However, this is why it’s important to make sure you understand the details of your plan. Many traditional pension plans have a joint-and-survivor option, which allows your spouse (or another beneficiary) to receive your payments – sometimes at a reduced amount – over their lifetime after your death.

Another potential risk lies in your employer’s handling of your pension. An inadequately-funded or poorly managed pension plan can mean trouble for your money. That being said, if your company does go bankrupt, your pension may be federally insured up to a certain amount by the Pension Benefit Guaranty Corporation.

Bottom line: While you may not have as much control or flexibility over your pension, taking the lifetime monthly income may make sense for you if…

• You’re worried about overspending and running out of money before the end of your retirement.
• You’re not comfortable with the idea of taking a lump sum and investing it on your own.
• You’re married and would like your spouse to continue receiving your pension payments after your death.

#3. Inflation can erode your buying power over time

Many pension plans do not adjust their monthly payments for inflation. If you’re unsure about the details of your particular plan, check in with your pension administrator to see if it comes with an inflation or cost-of-living adjustment.

What about taking the lump sum? You could hedge for inflation if you manage or invest the money properly. Again, this is where you might want to work with a financial advisor who could suggest an appropriate mix of investments to help your money keep up with inflation.

#4. Think about your other assets, too

If you have a well-funded 401(k), IRA or another source of reliable income, you may want to consider taking the lump sum option. Why? Because if you don’t need the monthly payments from your pension to cover your essential expenses in retirement, you could use that money for something else. For instance, paying off debt, reinvesting it, building a legacy for your family, etc.

On the other hand, if you don’t have other retirement assets you can count on (or they’re not in the best shape), then going with the lifetime income option may make more sense.

#5. Understand the potential tax implications of your options

Whether you’re taking the lump sum or monthly payments, there are important tax considerations to keep in mind. For instance, generally speaking, both monthly income and lump-sum payments are taxable at the ordinary income rate. And if you choose a lump-sum payout, your money may be subject to a 20% withholding tax, as well as a 10% early withdrawal penalty (if you take a lump-sum payout before age 59 ½). See IRS Topic No. 412: Lump-Sum Distributions.

Bottom line: When deciding between your pension options, consult your financial advisor or tax professional to make sure you understand the tax implications of your decision.

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