Should You Take the Pension Income or a Lump Sum Rollover?
If you have a pension, deciding between monthly payments and a lump sum is an important part of your retirement plan. Both options have their merits and potential drawbacks, so you’ll want to take the time to understand the implications. Let’s explore some factors to consider when making this decision.
The Pension Income Option
A pension typically provides guaranteed monthly payments for life. This steady income stream can be attractive for those seeking financial predictability. Here are some advantages and disadvantages of taking pension income:
Pros:
Guaranteed Income: A pension offers a predictable and stable source of income, which can be comforting.
Longevity Protection: Payments continue for as long as you live, reducing the risk of outliving your savings.
Simplicity: You don’t need to manage investments or worry about market fluctuations; the employer handles the payouts.
Spousal Benefits: Many pensions offer survivor benefit options that continue payments to your spouse if you pass away, providing additional security for your household.
Cons:
Lack of Flexibility: Once you choose pension income, you’re locked into the payment schedule, with limited options for accessing additional funds in emergencies.
Limited Legacy Options: Pensions may not transfer to heirs beyond a spouse.
Inflation Risk: Many pensions don’t adjust for inflation, meaning your purchasing power may erode over time.
The Lump Sum Rollover Option
A lump sum allows you to transfer the value of your pension into an individual retirement account (IRA), where you or a trusted financial advisor controls how the funds are invested. While this approach offers flexibility, it also comes with added responsibilities.
Pros:
Flexibility: You decide how and when to withdraw funds, tailoring your income to your needs.
Growth Potential: Properly managed investments can grow over time, potentially outpacing inflation.
Legacy Planning: Any remaining funds in the account can be passed on to your spouse and heirs.
Cons:
Market Risk: Investments are subject to market volatility, which could impact your balance and income.
Self-Management: Managing your investments requires time and knowledge. You can also seek professional advice.
No Longevity Guarantee: Without careful planning, there’s a risk of depleting the funds prematurely.
Factors to Consider When Choosing
Your choice depends on several personal factors, including financial goals, health, and risk tolerance. Here are some considerations to guide your decision:
1. Your Current and Future Income Needs:
How much income do you need to cover your retirement expenses?
Will your pension alone provide sufficient income, or do you have other sources of retirement savings, such as Social Security income, rental income, or investment portfolio withdrawals?
2. Your Health and Life Expectancy:
If you expect a longer-than-average lifespan, the guaranteed income of a pension might be more beneficial.
Conversely, if you’re in poor health, a lump sum might allow you to enjoy more of your savings or leave a legacy.
3. Inflation Considerations:
A lump sum provides opportunities for investments that could grow and help you keep pace with inflation.
If your pension doesn’t adjust for inflation, its purchasing power will decrease over time.
4. Your Risk Tolerance:
Are you comfortable managing investments and accepting the ups and downs of the market?
If not, the steady income of a pension might feel more secure.
5. Legacy Goals:
If leaving an inheritance is important to you, a lump sum may provide greater flexibility.
6. Spousal Considerations:
If you have a spouse, you’ll want to evaluate the survivor benefit options offered by your pension. Will the payments continue at the same rate or a reduced amount? Will the amount, along with your partner’s other income sources, be sufficient?
A lump sum may offer more tailored options for safeguarding your spouse’s financial security if something happens to you.
The Role of Taxes
Both options have tax implications:
Pension Income: Generally taxed as ordinary income.
Lump Sum Rollover: Rolling the funds into an IRA is tax-deferred, but withdrawals are subject to income tax. Planning withdrawals strategically can help minimize taxes.
Tips for Making the Right Decision
Making the choice between pension income and a lump sum rollover is not one-size-fits-all. Here are some steps to help you evaluate your options:
Run the Numbers: Compare the lifetime value of the pension versus potential growth from a lump sum. Consider different scenarios, such as varying life expectancies and investment returns.
Understand Your Pension Details: Review your plan’s rules, including survivor benefits, inflation adjustments, and payout options.
Seek Professional Guidance: A fiduciary financial advisor can help you weigh your options, taking into account your overall financial picture and goals. Fiduciary advisors are legally obligated to act in your best interest, helping you feel confident that their recommendations prioritize your financial well-being.
In Conclusion
Choosing between pension income and a lump sum rollover is a financial decision with long-term implications. By understanding the pros and cons of each option and carefully considering your personal circumstances, you can make a choice that helps support your retirement goals.
Schedule a complimentary 30-minute discovery call with a fiduciary wealth advisor.