As you approach retirement, one important decision you may be
faced with is whether to take your company sponsored retirement
plan in a single lump sum distribution or as a traditional
monthly pension. The lump sum may provide you with more money
than you have ever had all at once. You may find that exciting,
or quite possibly, frightening. On the other hand, you may be
attracted to the security of a monthly pension. Before you make a
decision, you should consider the pros and cons of both options.
Benefits of Lump Sum
- Investment Independence
- By taking a lump sum distribution, you have the
independence to make your own investment decisions or hire a
financial planner to guide you. If the funds are managed
well, the ability to earn a higher return could afford you a
higher standard of living throughout retirement or the
ability to provide a larger inheritance to your loved
ones.
- Leaving an inheritance
- While most pensions have options available to provide a
continued income to your spouse upon your death, there is
generally nothing left for your kids or other beneficiaries.
In the event of an early death for you and your spouse, the
remainder of the lump sum will go to your desired
beneficiaries.
- Tax Flexibility
- If you opt for a monthly pension, your income will be
taxed like ordinary income. Likewise any distributions from
your lump sum [assuming you rolled it over into an Individual
Retirement Account (IRA)] is also taxable. However, by making
smart decisions around your IRA distributions, you can
maximize your after tax withdrawals. For example, you may
consider doing a partial Roth conversion to fill the bottom
tax brackets in years which you have large tax
deductions.
- Distribution Flexibility
- You may decide to take a larger or smaller distribution
in certain years depending on your situation. A larger
distribution may be due to a large one-time expense (a major
vacation, medical expense, home remodel). A smaller
distribution may be due to reduced expenses, or cash flow
from other sources (deferred compensation, receipt of
inheritance).
Benefits of Monthly Pension
- No Investment Risk
- Poor or inappropriate investment decisions with the lump
sum (for example, poorly timing the market or being overly
conservative or aggressive), may result in low returns
hampering your standard of living through retirement. The
monthly pension eliminates that risk.
- Higher Guarantees
- Depending on the monthly payout options available, you
may be able to secure a higher guaranteed income than you
would from a lump sum. Keep in mind that we're talking about
the guaranteed amount, not total lifetime cash flow.
Generally, the highest guaranteed income is one that pays you
through your lifetime with nothing remaining for your spouse
or other beneficiaries. Carefully consider your goals and
family situation before selecting a pension option.
- Psychological Peace of Mind
- Not being able to see your lump sum amount rise and fall
with the market may give you added peace of mind. It will
also prevent emotional mistakes that are often made by
investors, such as selling near the market bottom in a moment
of panic.
Few decisions will have a greater impact on your quality of life
through retirement. Be sure to evaluate the pros and cons of your
options and consider hiring a financial planner to help you
through the process.
FPA member Eric S. Toya, CFP®, is Vice President of
Wealth Management for Trovena, LLC in Redondo Beach, Calif. Eric
graduated from the University of Southern California with a BS in
Finance and Accounting. Eric has been quoted in national
publications, including The Wall Street Journal, Money Magazine
and the Los Angeles Times.