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.

Approaching retirement and want another opinion on where you stand? Not sure if your investments are right for your situation? Need help getting on track? Check out my Financial Review/Second Opinion for Individuals service for detailed guidance and advice about your situation.

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Retirement Planning: 8 Conservative Assumptions to Consider


Social Security Poster: old man

According to the folks at PBS Frontline, retirement is a gamble at best.  One way to increase your odds of success is to use conservative assumptions.  As a financial advisor I generally use conservative assumptions in all aspects of client financial planning.

If you’re concerned about running out of money during retirement, you need to be realistic and conservative with your assumptions. Here are 8 conservative assumptions for you to consider:

Assume you will need 100 percent of your current income in retirement  

Many rules of thumb suggest you’ll need between 70 and 100 percent of your pre-retirement income in retirement, but plan on at least 100 percent to be safe. Today’s retirees are active, they want to travel, pursue hobbies, and live a generally active lifestyle.  This costs money.  Even though you will likely slow down a bit as you age, medical costs later in retirement will likely rise and may replace what you were spending on activities and travel earlier in retirement.

Add extra years to your life expectancy  

We are all living longer with advances in medicine and the like.  Many factors come into play here including the history of longevity in your family.

Reduce your estimates of Social Security benefits  

The youngest of the Baby Boomers can likely count on Social Security as we know it but I’m guessing that those younger than 50 may see reduced benefits.  In the interest of being conservative, I suggest that you take your current estimate from Social Security and reduce it by say 25%.  If things work out better that’s great, if not then you’ve planned and saved accordingly.

Cut back on your living expenses now  

This not only frees up money to set aside for your retirement, but it helps you adjust to a potentially lower standard of living in retirement.

Be conservative with your investment expectations

We are four plus years into a stock rally and the stock market is at record levels.  For investors nearing retirement it is a good idea to adjust your portfolio and expectations regarding investment returns accordingly. 

Rethink early retirement  

Saving enough to last from age 65 to age 85 or 90 is a difficult task. Trying to retire at age 55 or 60 is just not practical for most individuals, unless you’re willing to significantly change your lifestyle. Working a few more years can go a long way in helping fund your retirement. Those years are typically your highest earning years, so hopefully you’ll be able to save significant sums during that period. Also, every year you work is one year you don’t have to support yourself with your retirement savings.

Consider working during retirement 

Especially during the early years of retirement, you should consider having at least a part-time job. Even modest earnings can help significantly with current retirement expenses help delay the need to withdraw money from your retirement accounts at least to some extent.  Additionally this can be a great way to transition to “full retirement” especially for those retiring early.

Take conservative withdrawals from your retirement accounts  

Don’t plan on taking out more than 3 to 4 percent of your balance annually.  The “four percent rule” is a handy rule of thumb, but it is just that.  Everyone’s situation is different.  It is best to start with a detailed retirement expense budget and then determine what your investments and other sources of income can support.

The best retirement planning strategy is to have a financial plan in place. Monitor your retirement accumulation progress against the plan’s benchmark and make adjustments as needed in areas such as the amount you are saving, your investment allocation, and the lifestyle that your resources will support.  Always be conservative in your planning, it’s much better to have more than you planned on than to hit age 80 and realize that you are out of money.

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.  

Photo credit:  Wikipedia

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Don’t Underestimate Inflation



Given the current economic environment inflation may seem like a non-existent threat. In fact we are hearing about the possibility of deflation on some of the financial newscasts. While nobody can predict the future, its unlikely that inflation is dead. Some say that within a few years the various economic stimulus measures currently being put into place will trigger the next round of inflation. When planning for retirement ignoring the impact of inflation can prove to be disastrous.

An inflation rate of 2% or 3% per year, over a period of many years, can seriously erode the purchasing power of your funds. At 2.5% inflation, $1 today will be worth 78 cents in 10 years, 61 cents in 20 years, and 48 cents in 30 years. That can have a major impact on those entering retirement for several reasons:

New retirees are less likely to have defined-benefit pensions. Thus, they must rely more on Social Security benefits and personal savings, including defined-contribution plans such as 401(k) plans.

Cost of living adjustments for Social Security benefits are less generous. While Social Security benefits are still adjusted for inflation based on the consumer price index (CPI), the methodology for calculating the CPI changed dramatically in 1999, reducing increases in the CPI.

Retirees are living longer. As life expectancies increase, retirees are spending more years in retirement, so their retirement savings are subject to the impact of inflation over a longer time period.

Health-care costs are becoming more of a burden to retirees. More and more companies are reducing benefits or eliminating health care insurance for retirees, and health-care costs tend to increase faster than overall inflation. For instance, in 2006, the overall CPI increased 3.2%, while medical care costs increased 4.0% and hospital and related services increased 6.4% (Source: Bureau of Labor Statistics, 2007).

To combat the effects of inflation on your retirement income, consider these tips:

Use a conservative inflation rate for planning purposes. Since your retirement is likely to span decades, consider inflation over long time periods. For instance, while inflation has averaged 2.54% over the past 10 years, it has averaged 4.31% over the past 30 years (Source: Bureau of Labor Statistics, 2007).

Consider investment alternatives likely to stay ahead of inflation. Thus, a significant portion of your portfolio will probably be invested in stocks, which have typically earned returns in excess of inflation. While it may be tempting to move away from equities after the market losses of the past year, doing so may impact your ability to stay ahead of inflation. Your investments should be diversified among various vehicles based upon your risk tolerance, your income needs, your age, etc.

Invest in tax-advantaged investment vehicles. Look into 401(k) plans, individual retirement accounts, and other retirement vehicles. While each has different rules for taxing contributions and earnings, all provide some tax-free or tax-deferred benefits. Since you aren’t paying income taxes on earnings throughout the years, that typically means you’ll have a larger balance at retirement than if you were paying taxes throughout the years. Thus, you’ll start out with a larger retirement base to help combat inflation’s effects.

Keep fixed expenses as low as possible. Try to enter retirement with as few debts as possible. If you aren’t using a significant portion of your income to pay a mortgage, car payment, or credit card debts, you’ll have more flexibility to deal with higher prices.

Decide how you will deal with health-care costs. While Medicare will help once you turn age 65, it still does not cover many health-care costs. Look into Medigap policies and prescription coverage to help with those noncovered expenditures, especially if your employer does not provide health insurance after retirement.

Minimize withdrawals from your retirement assets, especially during the early years of retirement. To counter inflation, you need to withdraw larger and larger sums just to maintain the same purchasing power. To make sure you don’t run out of funds late in life, keep withdrawals during the early years to a minimum. Conventional wisdom in the financial planning world says that 3%-4% can generally be withdrawn each year. The reality is that you will need to manage and potentially adjust your annual withdrawals based upon factors such as inflation and investment return.

Be prepared for change. After retirement, keep a close eye on your investments. If inflation increases and you are concerned that increasing withdrawals may deplete your investments, you may want to look for ways to reduce your living expenses or go back to work at least part-time.

Please feel free to contact me with your retirement and financial planning questions.

Photo credit:  Wikipedia

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