Should You Take Your Pension In A Lump Sum?

Some companies may offer to cash out the pensions of certain retirees and instead give them one lump-sum payment.  Here is some information on lump sum payments and how they could negatively affect your retirement finances.

While having a large sum of money is tempting, this is a decision that you will have to live with for the rest of your life. If you take the lump sum, you will not have a lifetime income.  You will have to take care of your own investments and make sure the money lasts throughout your retirement.

Usually, a guaranteed stream of income for life is a better option than a lump sum.

The only situations in which a lump sum should be considered are:

• If you are in poor health -
• You don’t expect to live long,
• You do not have a surviving spouse who will need lifetime income; or
• If you already have money -
• You have a substantial nest egg,
• You have another source of income, such as a spouse’s pension.

Here are some questions you should think about before accepting a lump sum:

• Could I or my spouse live longer than expected?
  • A lump sum is decided on average life expectancies.  If you or your spouse lives longer than expected, your lump sum won’t be enough.
• Can I afford to lose some or all of the money?
  • If you take a lump sum, no one is responsible for taking care of you except you.  
  • If you are wealthy enough that you don’t need your monthly pension or if your spouse has a large pension, you have greater flexibility to consider taking the lump sum. 
• How good are my investing skills? How good are my spouse’s investing skills?
  • If you already own stocks and bonds, look at your past investing history.  You will have to earn enough through investments to make the lump sum grow and last throughout your retirement years.
  • Most retirees invest much more conservatively than younger workers, so they usually have lower investment returns.  
  • If you take a lump sum and then die, it will be up to your spouse to make the money last through his or her lifetime.

What are the tax implications of the lump sum?

• If you take the lump sum and don’t roll it over directly into an IRA, the lump sum will be counted as income for the year.  Depending on how much money it is, that might push you into a higher tax bracket, making you pay more in taxes. 

How large is my current pension benefit?How do I know it is secure?

• If your pension is paid by your former employer and that employer goes bankrupt, the Pension Benefit Guaranty Corporation (PBGC), the federal pension insurance agency, might take over your pension.  
• The PBGC has limits on the benefits that it can pay, so your monthly benefit might be reduced.  However, the vast majority of retirees who get their benefits from the PBGC receive the same amount that they were getting before the PBGC took over their plan.
• If your annuity comes from a private insurance company, in the unlikely event that the insurance company goes under, your benefits will be guaranteed up to certain limits by insurance industry state guaranty associations.

What if I change my mind?

• If you take a lump sum and decide later that you want to use the money to purchase an annuity from an insurance company, individual annuities typically are very expensive. 
• Keep in mind that annuities are expensive, particularly for women, because they are charged even more for annuities on the assumption that, as a group, women have a longer life expectancy.  
• Women do not have this issue when getting a traditional pension or an annuity that was purchased by the pension plan.
• You will likely get a lower monthly payment than if you had stayed with the annuity purchased by the plan.  
• To see how much of an annuity you might be able to purchase with your lump sum, check out an annuity calculator, such as www.ImmediateAnnuities.com.

Workers should know that the value of their lump sums will depend on what the interest rates are when they retire.  Be aware that if you have earned the right to receive special early retirement benefits or subsidized survivor benefits, you could lose those if you take a lump sum.

Other Important points:

• Make sure that your employer has your correct information including your age, salary, dates of employment, and any spousal or other benefits you have chosen.
• Unless you have other sources of income, don’t take a lump sum for non-retirement purposes, like paying off debt, paying for everyday expenses, or helping out family or friends.
• Check into bias of anyone advising the lump-sum option.  For example, a financial adviser might encourage you to take a lump sum because the adviser will get fees or commissions for handling your money.  These fees and commissions could lower your return.

If you have questions about lump sum or other pension issues, you should call Iowa Legal Aid's Pension and Retirement Rights Project at 1-800-992-8161.  The Pension and Retirement Rights Project provides free legal counseling for Iowa residents as well as former Iowa residents with Iowa related pensions or retirement plans.

Iowa Legal Aid provides help to low-income Iowans. 

To apply for help from Iowa Legal Aid:

• Call 800-532-1275. 
• Iowans age 60 and over, call 800-992-8161.
• Apply online at iowalegalaid.org

If Iowa Legal Aid cannot help, look for an attorney on “Find A Lawyer.”   A private attorney there can talk with you for a fee of $25 for 30 minutes of legal advice.

*As you read this information, remember this article is not a substitute for legal advice.