If you're the lucky recipient of a company pension, then as you approach retirement age, you'll have an important decision to make: Should you take the pension in the form of lifetime payments (i.e., an annuity) or as a single lump-sum distribution? The answer depends on several factors. Read on to figure out which option looks best for you.
The argument for annuities
Getting your pension in the form of an annuity has some significant potential advantages, including the following:
An annuity provides a fixed, guaranteed monthly payment for the rest of your life. That can be an extremely important source of income for a retiree, especially if their portfolio takes a beating at some point during retirement.
Annuity payments are calculated based on your life expectancy, so the longer you live, the more money you'll end up getting. So if you're in good health and expect to live longer than average, then an annuity makes a lot of sense.
The calculations that determine annuity payments don't account for gender. Because women live slightly longer than men, female retirees can often get a marginally better deal than men if they choose the annuity option.
Company pensions are insured by the Pension Benefit Guarantee Corp. (PBGC), making them less risky than the annuities sold by insurance companies. Should your company pension fail, the PBGC will step in and provide you with your benefits (although in some cases, the PBGC will not pay you the full original benefit amount).
The argument for lump-sum distributions
If you're the DIY type, a lump-sum distribution probably sounds pretty appealing. After all, getting your money up front means you get to manage it yourself instead of leaving it in the hands of some faceless fund-manager. Here are some of the other advantages of a lump-sum distribution:
Annuity payments are not indexed for inflation. What's more, the payments are calculated based on interest rates at the time you make the election. In a very low-interest rate environment such as today's, that could make annuity payments a bad deal compared to a lump-sum distribution.
If you take annuity payments, that fixed payment amount means you'll be paying a fixed amount in taxes on those benefits each year. On the other hand, if you take a lump-sum distribution, you can roll that money into an IRA and only pay taxes on the amount you choose to distribute in a given year (but don't forget to take your RMDs).
If you take a lump-sum distribution, any money you don't spend during your lifetime can go to your heirs. With annuities, you have the option of having payments go to your spouse after you die (at the price of receiving smaller benefit checks now), but you can't have payments sent to any other dependents.
Taking a lump-sum distribution gives you the chance to invest the money yourself and possibly get a high return, meaning you could end up with far more money than you'd get from annuity payments over your lifetime. Even an inexperienced investor would likely enjoy superior returns by simply investing in a fund that tracks a major index like the S&P 500, which has averaged 7% per year over the past several decades.
Lump-sum distributions can be dangerous for uninformed investors and those who can't resist the urge to spend the money they have on hand. A 2016 Harris Poll survey found that 21% of workers who had taken a lump-sum distribution spent that money within 5-1/2 years. Given that the average life expectancy for someone turning 65 this year is about 20 years, spending the money that's supposed to finance your retirement in less than six years is a pretty serious problem. If you choose a lump-sum distribution, it's vitally important to set up a plan for how you're going to use that money -- and stick to it. Getting advice and guidance from a financial planner with experience in such matters can be extremely helpful, too. With care and discipline, the lump-sum distribution can be a great choice, but if you'd rather take risk off the table and leave the investment decisions to the experts, go for the annuity.
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