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If you’ve been in the workforce for some time, you may have accumulated a pension benefit at one of your past jobs.  And, when you are approaching retirement, you may be asked if you would like to take your pension as a monthly annuity or opt for a one-time lump sum payment. Both options have their advantages and drawbacks, and the right choice depends on various personal factors including your financial situation, life expectancy, investment risk tolerance, and long-term retirement goals. This article will explore how to evaluate these factors to help you make an informed decision.

Understanding the Two Options

Monthly Pension (Annuity): This option provides guaranteed, regular payments for the rest of your life (or the life of a spouse or beneficiary if you select a joint-and-survivor option). The amount you receive is typically based on factors like your years of service, salary, and the pension plan’s formula.

Lump Sum Payment: With this option, you receive a one-time payout that you can roll over into a retirement account, such as an IRA, or invest in other vehicles. You take control of how the money is managed, and there are no guaranteed payments. How you invest the lump sum will directly affect your retirement income.

Pension plans and their guarantees are subject to the financial stability of the plan sponsor and the specific terms of the plan. Outcomes may vary based on individual circumstances and market conditions. Investing involves risk, including the loss of principal.

Factors to Consider

Guaranteed Income vs. Flexibility

One of the key differences between a pension annuity and a lump sum is the trade-off between guaranteed income and flexibility. However, the right choice depends on your unique financial circumstances, including your goals, risk tolerance, and life expectancy.

Pension Annuity: Provides a predictable, lifelong income stream. This can be particularly attractive for those who prioritize the security of knowing exactly how much they’ll receive each month, regardless of how long they live or what happens in the financial markets. However, this option may not keep pace with inflation unless the annuity includes cost-of-living adjustments, and payments depend on the financial stability of the plan provider.

Lump Sum: Offers greater flexibility because you control the money. You can invest it, spend it, or manage it as you see fit. This option allows you to potentially grow your wealth through investments, but it comes with the risk of poor investment performance, market volatility, or outliving your savings. It is essential to consider your financial knowledge, risk tolerance, and long-term goals when evaluating this option.

Life Expectancy

Your health and life expectancy are critical factors to consider.

Pension Annuity: If you expect to live a long time, an annuity can provide value by continuing to pay out for as long as you live. This is especially true for those who are in good health or have longevity in their family.

Lump Sum: If your life expectancy is shorter due to health issues, the lump sum may be more beneficial, as it allows you to access and use a larger portion of your pension upfront. Additionally, you may leave any unspent money to your heirs, whereas a pension annuity typically stops upon death (unless you’ve chosen a survivor benefit, which reduces the monthly payout).

Note: Lump sum distributions may have tax implications, and improper management may lead to financial penalties or reduced savings.

Investment Risk Tolerance

Your willingness and ability to take on investment risk should influence your decision.

Pension Annuity: If you prefer low-risk options and don’t want to worry about managing investments in retirement, the stability of guaranteed payments from a pension annuity is appealing.

Lump Sum: If you’re comfortable managing your investments and can tolerate the ups and downs of the market, the lump sum could potentially provide more value over time. However, this strategy carries risk. Poor investment decisions or market downturns could deplete your savings faster than expected.

Inflation and Cost of Living Adjustments (COLA)

It’s essential to know whether your pension annuity includes cost-of-living adjustments (COLA) to keep up with inflation.

Pension Annuity with COLA: If your pension provides annual increases to keep pace with inflation, it can help maintain your purchasing power in retirement. This is an important factor because inflation can erode the value of fixed monthly payments over time.

Lump Sum: With a lump sum, you can potentially hedge against inflation by investing in assets that may grow at a rate higher than inflation. However, this also depends on your investment success.

Estate Planning

Your estate planning goals should also influence your decision.

Pension Annuity: Once you pass away, the annuity typically ends unless you’ve chosen a survivor benefit, which reduces the monthly payment to ensure your spouse receives a portion of the pension. This leaves little to pass on to heirs.

Lump Sum: If leaving money to your heirs is a priority, the lump sum option may provide that possibility depending on whether or not there is money left in the account after your passing.

Conclusion

Deciding between a pension annuity and a lump sum payout is a deeply personal decision that depends on several factors, including your need for guaranteed income, health, risk tolerance, and long-term financial goals. If you value stability and guaranteed lifetime income, the pension annuity might be the right choice. However, if you prioritize flexibility, control over your investments, and potentially leaving a financial legacy, the lump sum may be a better option.

Consulting with a financial advisor can help you evaluate your specific situation and guide you toward the best choice for your retirement. Our job at U.S. Asset Management is to help you make better decisions with your money. If you have questions about your situation, schedule an appointment by clicking this link or contact us at 678-894-0696.

1960 Satellite Blvd, Suite 2200 Duluth, GA 30097

Note: This material is provided as a courtesy and for educational purposes only.  Please consult your investment professional, legal or advisor for specific information pertaining to your situation.  Annuities are subject to the terms of the pension plan or insurer and may not adjust for inflation unless specified. Guaranteed payments are dependent on the financial stability of the provider. This information is for educational purposes only and does not constitute financial advice.

All views/opinions expressed in this article are solely those of the author and do not reflect the views/opinions held by Advisory Services Network LLC.  Advisory Services offered through U.S. Asset Management, a Member of Advisory Services Network, LLC.

U.S. Asset Management is a fiduciary advisor offering investment management and financial planning services. We aim to help our clients make better decisions with their money by assisting with investment management and financial modeling.  David Cross is a Certified Portfolio Manager, Certified Divorce Financial Analyst and Certified Retirement Planning Counselor.

All information contained herein is derived from sources deemed to be reliable but cannot be guaranteed.  This material is of a general nature and intended for educational purposes only.