Question: I’ve worked for the same company for most of my career. Now they are offering me a retirement pension check or a lump sum of money instead. Which is usually better?
Sometimes individuals approach me and ask my opinion about a retirement option being offered to them by their employer.
Having worked for the same folks for many, many years and expecting a retirement pension check once they reach retirement, now they are being offered a choice between taking the monthly pension check guaranteed for life, or a lump sum of money.
And they always ask me the same question - “Which option is better for me?”
The first thing to figure out is how much money you’re going to need (want!) after you retire. I find that most people would be happy with a “take home” number that is close to what they take home now.
So sit down with your paycheck stub. That usually backs out all the taxes, employee benefits, insurance and retirement savings. Just for jollies, suppose you get paid $4,000 per month. But after payroll taxes, income taxes, health insurance, 401K contributions and United Way contributions are deducted, you come up with $2,800.
If you’ve got money left over at the end of every pay period, you likely spend $2,800 or less each month on your lifestyle. Do you have debts (car notes, house notes) that will be paid off by the time you retire? Great. Suppose you spend $800 on a house note and another $500 on a car note (or two).
Then I’m going to leave the $500 in your budget (you probably have not bought your last car), but I’ll pull out the $800 that is now going to the mortgage, assuming the mortgage will be paid off by the time you retire.
We’re down to $2,000 per month (seriously?). You might find your Social Security retirement check will cover most of that obligation. Taxes are pretty low at this income level.
If that is the case, perhaps taking the pension offer in a lump sum makes sense. You don’t need the income and you have a chance to grow the wealth. Of course, you could also take the monthly pension and save it each month to build wealth. But if you die
prematurely (before age 80, for example), your heirs will likely get less than if you’d taken the lump sum.
For many reading this column, the thought of living on $2,000 per month in retirement sound ridiculously low.
So let’s assume your number is much higher. You need $8,000 a month to maintain your lifestyle.
For you, the next question is, “What other assets do I have that can produce an income for me?” If Social Security pays you $2,000 per month (to keep things consistent with our first example), you’ll need income from other sources of about $6,000. And then you’ll have to pay taxes on top of all that.
Maybe you’ve got rental income from houses or buildings you own. But for most, the income will come from investments. If you want to be able to safely withdraw enough from your accounts to have $6,000 per month after tax, you’re going to need about $2.5 to $3 million.
What I usually find with pension lump sum offers is that, with the lump sum offered, the only way to create a reliable income stream is to buy a guaranteed income annuity with the lump sum. In other words, instead of taking the company’s monthly pension offer, you’re taking one offered by a private insurance company.
If you need the income, the pension is often the best route to take. But it never hurts to get an advisor to check to see if you can get a better deal in the private market place.
If you don’t need the income now and want to pass the wealth on to your heirs, the lump sum may be worth considering.
Either way, make sure you examine all your options carefully and make your decision in light of your overall plan.
