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Your Pension Payout: Lump Sum or Annuity?

Roger Wohlner

This is an issue that I've helped a number of clients resolve over the years. This issue has been in the news a bit more of late with the decision by General Motors to offer some of its retired employees who are currently receiving monthly pension payments an opportunity to rethink their original decision.

The retirees can opt to continue with their monthly payments or take a lump sum. For at least some of these retirees, GM has added a couple of new monthly annuity payment options via Prudential. In all cases, the monthly payments and the future liability for those payments are being transferred to Prudential. This effort by GM is designed to remove the liability for the pensions of these retirees from its balance sheet. It has been widely speculated in the financial press that if GM's move is successful, other major employers might launch similar programs.

Whether you are a GM retiree or are simply looking at your pension options from another employer, here are a few things to consider in making your decision.

Lump-sum versus annuity payments. Your employer will calculate an amount that you can take as a one-time, lump-sum payment from your pension account, if this option is available. Typically, most retirees who take this option roll the balance into an IRA to preserve the tax-deferred nature of this money. If you do take some or all of the lump sum as a distribution, it would generally be taxable to you.

One way to determine which is the better alternative financially is to look at the stream of annuity payments and determine the present value of that stream of payments. There are many financial calculators on the web to help you do this. You will need to make assumptions about the rate of return that you would expect from investing the lump sum and the number of years during which you would be receiving the annuity payout (your life expectancy). If the present value of the annuity stream is higher than the lump sum, this is potentially a better deal. You will want to run multiple scenarios, varying the number of years and the expected rate of return. Complicating factors will include your income tax rate and the impact of any survivorship option on the annuity stream. You likely will not come to a single best answer, but rather you will need to look at the results of the various scenarios and apply some judgment.

What does your overall financial picture look like? Crunching the numbers is important, but another consideration is the make-up of your overall financial situation. Do you have a fair amount of assets accumulated in retirement accounts and taxable investment accounts? If that is the case, you might opt to take the annuity payout to vary your sources of income in retirement. I recently looked at this issue for a client. We determined that the combination of her pension as a monthly annuity plus the Social Security payments that she and her husband were receiving was enough to cover their regular monthly "nut." In addition, the two of them had in excess of $1 million in various retirement and taxable accounts to meet any additional needs.

Are you comfortable managing the lump sum? For many, a lump-sum payout might be the single largest chunk of money they ever receive. You will need to decide if you are comfortable managing this lump sum in terms of how to invest the money and in terms of withdrawals in retirement. If you are not comfortable, perhaps it is time to find a professional financial adviser with whom you are comfortable or perhaps opt for the annuity.

What is the longevity history in your family? This is inexact at best, but if your family history leans towards longevity, perhaps the annuity is the right choice. If it trends the other way, perhaps not. Again, this is extremely inexact and in my opinion should not be the main factor in this decision.

Is leaving an inheritance important to you? With an annuity, there might be a payment stream for a survivor (typically a spouse) depending upon the annuity choice you make. Once that is exhausted, that's it; there is nothing for your heirs. The lump-sum option rolled into an IRA could potentially allow you to leave something for your heirs, but this will depend upon your need to withdraw the funds to support your retirement lifestyle.

Who is behind the annuity payments? This is unique to the GM situation and perhaps others. As mentioned above, if the GM retiree opts for a monthly annuity payment, the responsibility for these payments will shift to Prudential. Under the current arrangement, if GM were to fall into a financial crunch and become unable to make the benefit payments, the retiree would be able to fall back on the PBGC, a government-backed organization that would take over the payments up to specified limits. Under the new arrangement, retirees opting for the monthly annuity payments will have to rely on the financial health of Prudential, or if it becomes unable to meet its obligations, the insurance department of the appropriate state.

In all cases, the decision on how to handle your pension at retirement is a critical one that should be given full and careful consideration.

Roger Wohlner, CFP®, is a fee-only financial adviser at Asset Strategy Consultants based in Arlington Heights, Ill., where he provides advice to individual clients, retirement plan sponsors, foundations, and endowments. Read more about Roger here.

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