One of the biggest decisions a retiree with a pension will face is whether to take the benefit as a lump sum or as an annuity, meaning a monthly payment for life. The benefit of the annuity is clear. It provides a predictable income stream for your life and potentially your spouse’s. The income is backed by the company paying the benefit, and at least some of it may be guaranteed by the Pension Benefit Guaranty Corporation (PBGC).
The downside of annuity income is that you give up control. You can’t take out more or less as your needs change. You may also lose purchasing power to inflation if the benefit doesn’t include a cost-of-living adjustment.
So what should you ask yourself before making this decision?
Do you need more guaranteed income?
What will your living expenses be in retirement, and how much will Social Security and other sources cover? Is the monthly pension needed to make up the difference? If it’s more than you need, see whether you could take income from part of the lump sum and invest the rest.
How is your health?
The longer you live, the better the annuity option looks. None of us has a crystal ball, but if you have serious health concerns and don’t expect to reach your life expectancy, the annuity may not be the best choice.
What is your risk tolerance?
If you don’t feel you have the discipline to stick with an investment plan and ride out market volatility, the annuity payments may be the better option.
What about your spouse?
Make sure the annuity would pay an adequate survivor benefit if your spouse outlives you. Choosing a larger single-life payment can leave a surviving spouse with nothing.
Do you want to leave a legacy?
Most pension annuities make payments only for your life and possibly your spouse’s, so nothing is left for heirs. With a lump sum, if it is invested well, there is the potential for money to be left over for your children or a charity.
How financially strong is your employer?
If your full benefit isn’t guaranteed by the PBGC, there is a risk that your employer may not be able to pay it if the company runs into financial trouble.
Shop around
Even if you decide the annuity is the way to go, compare the monthly benefit you are offered with current rates on an immediate annuity from an insurance company. You may be able to roll the lump sum into an IRA and buy an annuity with better terms. A direct rollover to an IRA also avoids paying tax on the lump sum right away.
How to receive a benefit you worked a lifetime for is a difficult choice that depends on your personal needs. Once you choose, you usually can’t change your mind, so weigh all of these considerations first. If you are also deciding when to start your pension, see Deciding When to Start Taking a Pension.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.
