There has been a wave of companies offering retirement packages recently – most notably Verizon. Employees from these companies are faced with a big decision about how to handle retirement packages.
The biggest question they need to answer is “Should I take the lump sum or the annuity option?”
This may seem like a simple issue to deal with, but it can actually be complex and deserves a fair amount of consideration. Many financial advisors will instruct you to take the lump sum without asking critical questions about the client’s situation. Many advisors (myself included) earn fees based on the value of the assets they manage. Sometimes this can be more of a driver in the decision process than the characteristics of the client.
In deciding on the lump sum option, you bear the responsibility for ensuring that the assets will fund your expenses for the remainder of your life. This can work out well if you have control over your expenses and can restrict your annual withdrawals from the portfolio to a pre-determined limit.
This method provides a lot of flexibility in that you can take additional distributions to pay for discretionary expenses such as taking a trip, helping your grandchildren with education costs, home improvements, etc.
Another benefit is that any remaining funds in the account can be distributed to your beneficiaries at the time of your death. This is a key feature not available with most traditional pension plans (unless you elect a spousal benefit or period certain option).
The key risk with this option is longevity – which is the risk that you will outlive your assets. A lump sum invested in a traditional investment account offers no guarantee that your money will last the rest of your life. There are annuities that offer these types of guarantees (at a cost), and in a future column we will review the pluses and minuses of them.
There are specific rules around how the guarantees work and if you violate one of the rules, you can cancel your guarantee. You also need to decide how to invest the assets. This can be challenging in light of the market volatility we experienced over the past couple of years. Taking money out of your portfolio in a down market significantly increases your longevity risk.
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Opting for the traditional pension commits you to receiving monthly checks from your company plan for the duration of your life. The biggest benefit of selecting the monthly payments is that you will most likely receive a payment that is higher than the payment you can afford to take from your lump sum distribution. You can also structure your payments such that they are guaranteed to continue for a minimum number of years even in the event of your death.
These periods can range from 10 to 20years. The longer the term, the more your payment is reduced. All pensions offer spousal benefit options that would provide survivor payments to your spouse in the event of your death. The options can range from 25 percent to 100 percent of your payment.
Here too, the larger the percentage the larger the impact on your monthly payment. Different than the lump sum option, the company takes on the investment risk involved in guaranteeing your monthly payment.
So what should you do? I have consulted with a number of prospective retirees from Mayfair, Holmesburg and many other sections of the Northeast. The suggested approach involves figuring out your financial situation and your approach to money.
What are your long-term objectives? Are you providing for your children, grandchildren or your parents? If you are married you need to consider what your spouse’s retirement picture looks like if they worked and accumulated assets or a pension as well.
Finally, once these variables are reviewed, you can decide on a course of action that is right for you. If you have a very predictable expense stream and do not have plans for a significant level of discretionary spending, you could consider the value of the annuity payments. If you plan to travel frequently, or desire to utilize money beyond what the annuity can provide, you may lean more heavily toward rolling the money to an IRA and setting up an investment account.
What About Both?
Thankfully, you also have the ability to do a combination of an annuity payment and an investment account. Here, you could annuitize (set up monthly payments) for a portion of the retirement assets and deposit the rest in an investment account. Normally, you would annuitize enough to cover your core living expenses and the rest would be covered by a distribution from your IRA in the investment account.
Most companies will only allow you to choose a rollover or lump sum. If you want to consider this option, you must rollover your entire account and then purchase an immediate annuity from a life insurance company to provide the monthly payment. This can be done without the aid of an advisor, but it may be better to consult with one. Most advisors have access to a number of insurance companies to help maximize your monthly payment.
As in all cases, every situation is unique and deserves a thorough review. Hopefully you have been convinced that this decision is not as black and white as it may first appear. If you engage an advisor who pushes you in one direction or another, without doing a detailed review your situation, it may best to seek an objective second opinion.
Jim Heisler is a Certified Financial Planner with Family Wealth Services in Holmesburg. You can read all his Financial Perspective columns here.
Registered Representative, Securities offered through Cambridge Investment Research, Inc., A Broker/Dealer, Member FINRA/SIPC and Investment Advisor Representative, Cambridge Investment Research Advisors, Inc. a Registered Investment Advisor. Family Wealth Services, LLC and Cambridge are not affiliated.
Jim Heisler, CFP®, CDFA™, CASL™
Family Wealth Services, LLC
8725 Frankford Avenue
Philadelphia, PA 19136