We believe there are at least three reasons why you should take the lump sum and just one for taking the pension.
1. Investment Return
If you have a choice between $250K for life with annual payments of $12,500 per year or $200K lump sum, then you should calculate your break even on the lifetime of payments. $200K lump sum divided by $12,500 = 16 years. In other words, it will take 16 years for the company to pay you back the lump sum option that you could have received day one. 16 years! If you receive the $200K lump sum at 65 years old and invest it with just a 2% return, you have to live to be about 94 years old for the pension to do better. If you can get a 4% return, you can’t rationally live long enough to have the pension provide a better return. The lump sum option provides more funds if you can get a return on those funds.
2. Estate Risk
Imagine that you and your spouse retire, choose the pension option of $250K for life, and ride out into the sunset. However, tragedy strikes, and both you and your spouse die. What happens to that pension? It’s gone! Had you chosen the $200K lump sum and both you and your spouse die, the money stays in your estate and is passed to your beneficiary. Those who choose the lifetime pension retain “estate risk.” The lump sum option has no estate risk.
3. Company Risk
Pan Am Airlines is the poster child for company risk. What happens to your pension if the company goes bankrupt? The Pension Benefit Guarantee Corporation can step in but usually negotiates a smaller pension. The lump sum option does not have any corporate risk.
Reasons for Taking the Pension
1. Security
There is just one reason, in our opinion, to draw the lifetime pension: security. More important than investment return, estate risk, and company risk is simply security, and that is okay.
Things to Consider in Drawing a Pension
You can choose your survivability options. If you choose to take the highest pension option, then your spouse gets nothing when you pass away. If you choose to have 100% of your pension pass to your spouse when you die, then you will get paid less per month. There is a middle option to have 50% of your pension income pass to your spouse when you die, which is a higher monthly payment than the 100% survivability payment option. We recommend the 100% survivability option to most of our clients to make sure the surviving spouse has recurring income even when the other spouse pre-deceases them. Some planners suggest the higher income option, with no survivability, and a plan to invest the surplus in insurance to make up for the income loss at the passing of that spouse. What we have seen is far too many “good intentions” to carry out this plan but no actual follow through.
