Second only to the decision about when to retire is the
decision to either take either a lump sum or a pension annuity for your
retirement benefit—that is, if you are one of the fortunate ones to still have
a defined-benefit retirement plan. The decision is especially difficult because
the two options are very different in nature. There are, however, a number of
qualitative differences that you should carefully consider even if they cannot
be exactly quantified.
1. Pass to heirs: The pension annuity will end with the
death of the retiree or their spouse, if the spouse outlives them. The lump sum
can survive the death of both, thus providing a legacy to leave to heirs.
2. Ability to invest: The lump sum, once it is rolled over
to an IRA, can be invested in accordance with the overall portfolio allocation
of the participant based on their time horizon and risk tolerance.
3. Keep up with inflation: The pension annuity payment may
not be adjusted for inflation. The ability to invest the lump sum, on the other
hand, allows the participant to counter an inflationary environment by
allocating some of the lump sum to stocks or inflation-protected fixed-income
4. Control: With the lump sum the retiree has the ability to
control distributions. If, for example, the retiree plans to do some consulting
after retirement, and doesn’t need the income from the pension annuity for some
years, taking the lump sum may result in tax savings during those years.
1. Longevity insurance: As long as the company stays
solvent, the retiree will not outlive the income stream provided by the pension
annuity. This is a powerful argument in favor of taking the pension annuity,
especially if the retiree has longevity in their family and has had trouble
controlling expenses prior to retirement. While there is credit risk if the
company goes bankrupt, the Pension Benefit Guaranty Corporation generally
insures against this risk up to a level that will cover many annuity recipients.
2. Stock-market risk: The income stream is not dependent on
the ups and downs of the stock market. This can be an important benefit for
conservative retirees who are particularly risk averse.
3. Spousal benefits: According to the Retirement Equity
Act of 1984, with some exceptions, the pension annuity must include a spousal
benefit in the event that the retiree predeceases their spouse. This benefit
can only be changed by written approval of the spouse. A retiree can be assured
that even with their death, their spouse will be provided a benefit that they
cannot outlive or outspend.
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