Frozen Pension Benefit – Do You Take the Lump Sum?

It’s a difficult question without an easy answer. For many, income security in retirement depends upon getting the answer right.

Employers have been fazing out pension programs for many years now, replacing them with 401(k) and similar employee-contribution type plans. Many of these fazed out pensions were frozen, leaving participant employees eligible to receive at least some benefit from the pension plan. For those who are entitled to a benefit from a frozen pension plan, many have the option to receive an up-front lump sum payment of their accrued pension benefit in lieu of a lifetime monthly annuity payment.

Faced with that option, do you take the money, or settle for the lifetime annuity? The knee-jerk reaction of many is to take the lump sum. I’ve seen lump sum offerings in the six-figures, a pretty significant chunk of change. But even then it’s not an easy question to answer, especially for those who have limited savings or other income resources beyond Social Security. Will that lump sum be enough to see you through for the rest of your life?

When you retire, a primary goal is to have sufficient income to cover living expenses for the rest of your life, regardless of how long you live, factoring in economic conditions such as inflation, and fluctuations in the financial markets. For married couples, that income must last for two lifetimes. To complicate things further, if you are like most people that I’ve work with, you will underestimate how long you will live in retirement. (Everyone faced with the lump sum payment question thinks they’re going to die in a car accident tomorrow so they want the money today.) But for a married couple in their middle sixties, it is reasonable to expect at least one spouse will live into their 90s. Living 3 decades in retirement is becoming commonplace.

If you elect the annuity, you (and even your spouse with certain elections) will get a check every month for the rest of your life, no matter how long you live. You bear no risk.

Suppose you decide to take the lump sum. You’ll receive a single payment from the pension plan regardless of how long you end up living. Now you have to invest that money to generate an income stream that will last the rest of your lifetime. How long will that be; and how confident are you the money will last that long? It depends upon many factors, but that risk is on you. And you don’t want to run out of money during retirement.

So what’s the answer – do you take the lump sum or settle for the annuity? Let’s look at some of the factors that can play into that decision:

If you (and your spouse if married) are in good health, and the security of a lifetime income stream is important to you, the annuity makes sense. If you are not comfortable handling your own investments, the annuity lets you leave investment decisions to the pension plan. If you are pessimistic about the economy, inflation, or other risk factors in the future, you can leave that risk with the pension plan choosing the annuity option.

The lump sum option may make sense if you (and your spouse if married) are older and in poor health. If you have sufficient savings and investments that the annuity would not be a needed source of lifetime income to make ends meet, then the lump sum may be the better choice. Also, if you are confident in your abilities to manage your investments to generate a good rate of return, and can prudently manage withdrawals from savings and investment over your retirement years, the lump sum may be appropriate.

In any event, if you are offered a lump sum payment as an option from a frozen pension plan, it is crucial to work with a competent advisor who can help you make a proper decision that meets your goals and objectives in light of your financial situation. Avoid an advisor who has a vested interest in your opting for the lump sum – like they want to manage and invest the money (for a fee).

If you are struggling with the lump sum vs. annuity question, give me a call, I can help.