Objective information about retirement, financial planning and investments

Pension Payments – Annuity or Lump-Sum?


I’m often asked by folks approaching retirement whether to take their pension as a lump-sum payment or as an annuity (a stream of monthly payments).  Investment News recently published this excellent piece on this topic which is worth reading.

As with much in the realm of financial planning the answer is that “it depends.”  Everybody’s situation is different.  Here are some factors to consider in deciding whether to take your pension payments as an annuity or as a lump-sum.

Factors to consider 

Among the factors to consider in determining whether to take your pension payments as an annuity or as a lump-sum are: 

  • What other retirement assets do you have?  These might include:
    • IRA accounts
    • 401(k) or 403(b) accounts
    • Taxable investments such as stocks, bonds, mutual funds, or others
    • Cash and CDs
  • Will you be eligible for Social Security?
  • Will the monthly pension payments be fixed or will they include cost of living increases?
  • Are you comfortable managing a lump-sum yourself and/or do you have a trusted financial advisor to help you?
  • What are your expectations for future inflation? 
  • What is your current tax situation and what are your expectations for the future?

Factors that favor taking payments as an annuity 

An annuity might be the right option for you if:

  • You have sufficient other retirement resources and are seeking to diversify your sources of income during retirement.
  • You are uncomfortable with managing a large lump sum distribution.
  • You are not eligible for Social Security.
  • Your pension payments have potential cost of living increases built-in (typical for public sector plans but not for private pensions).

Factors that favor taking payments as a lump-sum 

A lump-sum distribution might be the right option for you if:

  • You are comfortable managing your own investments and/or work with a financial advisor with whom you are comfortable.
  • You have doubts about the future solvency of the organization offering the pension.  This pertains to both a public entity (can you say Detroit?) and to a for-profit company.  In the latter case pension payments are guaranteed up to certain monthly limits set by the PBGC.  If you were a high-earner and your monthly payment exceeds this limit you could see your monthly payment reduced.
  • You are eligible for Social Security payments. 

The factors listed above favoring either the annuity or lump-sum options are not meant to be complete lists, but rather are intended to stimulate your thinking if you are fortunate enough to have a pension plan and the plan offers both payment options.  A full listing for each option would be much longer and might vary based upon your unique situation.

Moreover the decision as to how to take your pension payments should be made in the overall context of your retirement and financial planning efforts.  How does each payment method fit?

Lastly those evaluating these options should be aware of predatory financial advisors seeking to convince retirees from major corporations and other large organizations to roll their retirement plan distributions over to IRA accounts with their firm.  While this issue has seen a lot of recent press in terms of 401(k) plans it is also an issue for those eligible for a lump-sum pension distribution. If you are working with a trusted financial advisor an IRA rollover can be a viable option, but in some cases rollovers have been directed to questionable investment options putting many retirement investors at risk.

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Is My Pension Safe?


Logo of the United States Pension Benefit Guar...

The city of Detroit recently filed the largest municipal bankruptcy in history.  One of the potential casualties of this situation will likely be retired city workers receiving pensions.  While pension payments are promises made by the employer, should the bankruptcy go through the city will be free to cut pension benefits as part of the restructuring of the city’s finances.  In light of this situation, how safe is your pension?

What is behind your pension? 

Your employer starts an investment fund that is designed to grow via investment returns and contributions from the employer to a level that will support the pension benefits you’ve earned based upon the plan’s benefits formula.  Pension benefits are typically earned by workers based on a formula that usually takes into account factors such as career earnings, years of service and perhaps other factors.  Each year an actuary calculates the amount that the employer must contribute to the pension plan in order to maintain an acceptable level of funding.

Sadly in far too many cases, especially in the public sector, we’ve seen employers under contribute to their pension plan causing severe underfunding.  In my home state of Illinois this is rampant and is a major part of our state’s ongoing pension crisis.  Certainly this was also a factor in Detroit’s case as well.

Let’s take a look at some of the issues with private employer pensions and those in the public sector.

Private employer pensions 

Pension plans offered by private employers (which I define as those employers who are not municipalities, state or federal government entities, etc.) are a liability of the company in much the same fashion are their accounts payable or a bank loan.  Failure to make good on these obligations can result in the bankruptcy of the firm.

Should a private employer be unable to make good on its pension obligation, in most cases the Pension Benefit Guarantee Corporation (PBGC), an independent governmental agency, will step and cover the pension obligations of the company up to its limits.  The maximum benefit they will guarantee depends upon the year in which the plan was terminated and your age among other factors.

For many workers the PBGC maximums will cover the pension payments promised via their employer’s plan.  Some highly paid retirees receiving large monthly pension payments might see their payments reduced once PBGC coverage kicks in.  A case in point occurred here in Chicago in 2005 when locally based United Airlines defaulted on its pension obligations and many retired pilots and other highly paid retirees saw their monthly benefits reduced by the PBGC.

Municipal and governmental pensions 

The issue for the retired Detroit workers is that municipal and governmental pensions have no backstop such as the PBGC.  Detroit will be the biggest test of the Chapter 9 municipal bankruptcy process but there is much speculation that current and future retirees will see cut on the order of 30%-40% or more in their monthly payments.

At the state level it is less clear to what extent that states such as Illinois would be able to reduce pension payments due the rules in place.

Steps to consider

If you are retired and drawing a pension there probably isn’t much that you can do.  One step to consider is taking your Social Security now if you are eligible and have been waiting to draw upon it until a later age to maximize your benefit.   You might also look at getting a part-time job or hanging out your shingle as a self-employed consultant if you have skills that are applicable to this route.

If you are approaching retirement and your pension plan offers the option to take a lump-sum benefit as an alternative to annuitizing this option might be even more attractive now.  As always you should look at all of the factors involved such as the financial stability of your employer, your other resources available in retirement, etc.  This might be a good time to engage the services of a fee-only financial planner who can help you evaluate your options.  While a lump-sum still needs to be managed in terms of the investments chosen and the timing of withdrawals, you do eliminate any issues surrounding future benefit reductions due to your employer encountering financial difficulties.  If you are offered an early retirement package you should give it serious consideration as well.

Younger workers should take this as a wake-up call and make sure they are saving for retirement especially if they are counting on a pension plan from their employer.  Many companies freeze their pension benefit which means that you will receive the benefit that you’ve earned but you won’t be accruing a larger benefit via increased earnings and years of service.  Take full advantage of defined contribution retirement plans such as a 401(k) or a 403(b).  Fund an IRA account.  Save and invest in taxable accounts.  Strive for financial independence as soon as possible.

Employees with a pension plan generally have a leg up in retirement.  The Detroit situation simply highlights the fact that nothing is set in stone.  At the end of the day we are all responsible for our own retirement, plan accordingly to the extent that you can.

For more background on this situation check out these two excellent pieces on the Market Watch site:

Detroit not alone; public pensions vulnerable

Will your pension disappear, post-Detroit?

Approaching retirement and want another opinion on where you stand? Not sure if you are invested properly for your situation? Check out my Financial Review/Second Opinion for Individuals service.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Please check out the Hire Me tab to learn more about my freelance financial writing and financial consulting services.  

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