You've been offered lump sum pension - should you take it?

As time goes by, fewer and fewer clients have pension plans through their employer, as most employers have moved to 401(k)-type plans. Doing so reduces the long term risk for the employer and puts that risk (and potential reward) in the hand of the employee. But they do still exist. And oftentimes when a client approaches retirement date, they are given the option to either take the monthly pension as planned or to take a lump sum benefit.

It can be really tempting to see that lump sum number and want to take it. After all, who wouldn’t want control of their money vs. waiting to collect that monthly amount for the rest of their lives. However, it may or may not be the right decision in your case, depending on many factors. In some ways, there are similarities with the social security discussion in a similar article.

Are you an aggressive or conservative investor? Just like how a 401(k) plan puts the risk on you as a client, taking the lump sum involves transferring investment risk from the pension provider to you. If you are aggressive, this favors the lumpsum because you could potentially invest for the long term and increase your future payout or inheritance amount (discussed more below). If you are more conservative, though, this favors taking the monthly pension. That monthly amount is guaranteed for life and depending on the choice you make also potentially guaranteed for the life of your spouse. If you will not be investing aggressively, itis less likely you would earn returns that would outweigh these guarantees.

Do you need the income? If you need the income, like being conservative above it favors the monthly pension. If you need the income, it forces you to be more conservative with your investing of the lump sum if you take it, which alleviates much of the advantage of taking lump sum. However, if you don’t need the income (if you have other sources) it may favor the lump sum since you can afford to invest for longer term and more aggressively if you choose to.

What are your thoughts on life expectancy? Few of us know when we are going to die but you may have preconceived notions about your probabilities. A long life expectancy expectation may favor the monthly pension, while a short one may favor the lump sum.

Do you want to pass on your wealth to kids? If so, that may favor the lump sum, as pensions cannot be passed to the next generation and the lump sum can. This is one of the strongest cases for lumpsum, but only if you are assured that your own income needs will be met in your lifetime.

What is the current interest rate environment? Generally speaking, if interest rates are low, the lump sum offered at any given monthly pension amount will be higher, strengthening the case for the lump sum. If rates are higher the lump sum amount will be lower relative to the monthly amount. In these cases, you have to weigh the benefits of the higher or lower lump sum amounts against your investment options to invest at lower or higher rates.

Do you trust yourself? For some clients. Having access to hundreds of thousands of dollars, even if they know they need the money, leads them to make short term spending decisions that they otherwise wouldn’t. For those clients, it’s hard to admit but they may be better off having the monthly pension.

Recognize that having the secured monthly pension has a value in other areas as well. For example, having your income secured may allow you to think about your other investments differently. Rather than worrying about providing current income, you can invest your other money over a 25-30 year period of time more aggressively in search of long term returns. This could have a value to you as well as the next generation.

There are of course other factors to consider as well. The point is that there is no one answer and it’s not a mathematical equation. Lump sum vs. pension options are actually meant to provide the same net present values in the aggregate. As such, your decision should once again be based on your situation and your priorities. You may find yourself with conflicts even on the above items, with some factors favoring lump sum and others favoring collecting monthly. It’s in this grey area where we can be valuable in helping you frame your choices against your priorities so that you can make the best decision for your situation.