Better to Take a Lump Sum or Monthly Pension?

by | Sep 29, 2023 | Asset Management, Podcasts

When presented with the option is it better to take a lump sum or monthly pension? If you’ve changed jobs before or are on the cusp of retirement, this question of lump sum or monthly payment will likely require an answer.

This topics applies to every corner of personal finance. From tracking your expenses, to investment returns, to the future value of an income stream.

In this week’s podcast, Tom, Casey and Brendan dive into the pro’s and con’s of each choice and discuss how we help folks make this exact decision.

If you don’t know whether to choose a lump sum or monthly pension, check it on out!

Show Notes

Should I Take a $44,000 Lump Sum or Keep a $423 Monthly Pension – The Wall Street Journal

Moving From Saver to Spender – Mullooly Asset Podcast

Better to Take a Lump Sum or Monthly Pension? – Full Transcript

**Click here for a full downloadable PDF version of this transcript**

Casey Mullooly: Hello and welcome back to the Mullooly Asset Podcast. I’m your Casey Mullooly, back with you for episode 455. We’ve got Tom and Brendan joining me this week. Guys, thanks for hopping on. And we’re going to talk about whether or not someone who is retiring should take a lump sum payout or a monthly check, and this discussion is inspired by an article in the Wall Street Journal by Ann Tergesen.

She is going through this herself and wrote about her decision and how she arrived at her decision. Guys, I think this is something that applies to the real world and applies to discussions that we have around this very conference table pretty regularly. So, at a high level, how should people be thinking about taking a lump sum versus getting a monthly check?

Tom Mullooly: I’ll begin by saying if you work or worked for an employer that offered a pension plan or offers one, you’re probably going to be having this discussion soon, or at least in the next few years. More and more employers. Well, there’s very few pension plans that are offered , in 2023. Most of them are public sector.

So, if you’re a private sector and you still have, a pension plan, then, yeah, this is probably coming, because most of those plans are either already shut down or they’re putting the wheels in motion to do so. Yeah, they’ve turned these plans and many of them into frozen plans, where they will just they’re starting to shut these things down and no further contributions they shut down, gave you 401k instead and maybe a match.

That was generous for those who were still participating in the old plan. We see this stuff a lot with people here. In practice, I think, from the employer’s side of the table, they look at this and say, hey, the market hasn’t been that bad over the last few years, not like month to month or quarter to quarter, but over the last several years the market’s been okay, and so their funding levels are getting closer to that 100% funding level, or maybe over it, so they don’t have to do a lot of catching up in terms of putting money into the plan.

On the other side of the coin, though, interest rates on annuities are now at pretty good rates the highest that they’ve been in years, and so they’re looking at an opportunity to say, hey, this plan was projected to compound at 6% or 6.5%. If we can get something close to that in annuity, we’ll just shut the plan down and we’ll flip all of this into annuities, offer some people lump sum payments, but most of the people may wind up taking something like this that’s just compounding on an annual rate.

They don’t need to run a plan anymore. So more and more employers private sector are starting to look at the option of shutting these things down for good.

Brendan Mullooly: The decision’s definitely more case by case though in terms of the old answer of it depends. But it’s finances, so it’s personal here, because there are a lot of emotions and factors that go into this. I mean, being offered a lump sum from a pension plan is kind of just eye-popping for some of us To be overwhelming. It’s a lot of money and it’s a lump sum, and I think I saw a stat maybe not in this article, but a comparable one that said between 50% and 80% of plan participants that are offered a lump sum take it, and that’s across different industries and employer types.

It’s pretty enticing to see such a large number offered to you, but I think you do have to do the work to consider whether the monthly income would be a fit for your situation too, because I think you can make a case for both of those things being advantageous, depending on the person’s finances we’re talking about. We’ve coached people to do both of those things.

There’s not one answer like always take the lump sum or always take the income. In fact, something we usually talk about with people when we’re having that discussion is how a lot of financial advisors, if they’re not being 100% fiduciaries, have every incentive to tell you always take the lump sum, because most advisors are paid based on the assets that they manage for you and they would like more assets instead of you getting an income, when I think you really do have to be fiduciary and coach people to get to the decision that is correct for their particular situation.

Yeah, that’s a good point. Let’s just walk through some of the benefits of both choices. Some of the benefits of taking the lump sum are it’s usually the biggest check someone will ever receive in their entire life. You can take that check and then hopefully invest it in the stock market. The author of the article said that was her choice was to take the lump sum and then invest it in an IRA.

She said it Average annual returns of 7.4%. I know that that’s not a smooth 7.4. So you take the lump sum, invest it hopefully, watch it grow until you need it down the road in retirement. Believe it or not? there. There is a significant percentage of people I wish I had the numbers, but there’s a significant percentage of people who will have 20% of the lump sum withheld for taxes and get a check. Not roll it over, they’ll just put it in the bank and that’s a car crash waiting to happen, in my opinion.

I think you got to look at that too and think about in the future if you were to roll a lump sum out and not cash it out but to roll it into an IRA, continue the tax deferral and invest wisely based on what makes sense for you. I mean, you reach a point where you’re probably relying on the money in some capacity, and so what would be responsible at the date where you envision relying on that money? What would it look like to begin withdrawing from that lump sum and what it’s grown to and comparing that to what kind of income the plan is offering you as a guaranteed monthly income and how those stack up against one another in the future?

Right, so that’s the biggest benefit of taking the monthly check is your. It’s a known amount, it’s a known thing and for a lot of people making the choice to retire, that guaranteed income each month can feel pretty good. It lowers the amount if they still need to take portfolio distributions. It lowers the amount they need to take from there and, you know, provides kind of a floor in place.

The unfortunate side of that is many of these annuity programs that are set up through the pensions don’t have any kind of cost of living adjustment, and so in this example that was used in the Wall Street Journal article $423 a month stays $423 a month, and that without even knowing what the rate of inflation will be in the future. We just know that your $423 a month won’t go as far as it does today.

So I think with that you have to take into account how much of your liquid net worth the pension lump sum represents, because if it’s 100% of it or a large portion of it, then I think you do need to worry about that, because certainly rising cost in retirement one of the biggest things that you know we have an eye on, it’s one of the biggest reasons people are investing their money.

But you know again, I think if it’s not such a big piece of the pie, then then I think you know you look at income in terms of guarantees in retirement serving a different role than inflation protection, like you’re never going to get something that does both of those things well.

The market’s not good at providing guarantees to people, and monthly income is good at providing guarantees, but not good at keeping up with inflation and the market is, so it’s trade-offs and you got to take into account the bigger picture of how much this money represents to you and your situation. One of the ways that Ann Tergesen, the author of the article, decided to take the lump sum, one of the exercises she did was to go to an insurance company and ask how much would it cost for her to buy an income stream starting at age 65?

How much would it cost to get that? $423 a month, and it would cost her more than the lump sum payment. So was that something Great exercise to do. Yeah. So the number that New York Life came back with was she was being offered a lump sum today of $44,000.

She would need $55,000 to replicate the same thing, and you want to do that exercise to make sure that there’s not something you’re missing. In most cases, the way it should work with a pension is that you should be getting a better rate than somebody like an individual shopping for, you know, single life or joint life annuity, because you’re pooling the risk in a pension payout and so your individual circumstances aren’t as important as the broad pool of people who are being offered the pension.

But if you do that exercise, you get the opposite answer. That’s right and that’s a great signal that it’s not such a great deal. I think and this is something that I think gets overlooked because we’ve seen examples where people have said hey, I took my lump sum and then I bought an annuity with the money.

You’re being offered an annuity in your plan. Do it? Yeah, it’s not. I guess you know, if your circumstances, if you take a lump sum and you invest the money and let’s say this was well prior to retirement, maybe it’s one of these plans that gets shut down and then it turns out at retirement that you would like a little more guaranteed income and so you use some of your retirement savings between old pension funds and 401ks and stuff to buy an annuity.

It’s, you know, at that point it’s maybe your circumstances had changed and it was tough to have the foresight so far away but to but to basically take the lump sum and then turn or turn around and buy an annuity immediately with some of the money. Hopefully the math was done prior to that to make sure you didn’t pass up on a better opportunity, having the chance to just just get some pension income you know from from the source right away.

So would you say that if someone, the further away someone is from retirement, the more likely it is that they should take the lump sum. Well, one of the biggest benefits is the flexibility of taking the lump sum Right, and so, since we can’t predict anything about the future with with any degree of certainty, the idea of having more control and and the flexibility to to change your plans over time could be valuable. So, yeah, I mean I think the further, the further way you are, the less idea you have of what you’re going to need or what life’s even going to look like in retirement.

So I couldn’t blame you for for weighting that heavily in your decision. Yeah, there’s something that I don’t think gets discussed enough when we’re broaching this topic with folks is the thought that people are looking at numbers on a sheet of paper usually and it’s I can take this gigantic amount lump sum, roll it over into an IRA, or I can take this on my life, for the rest of my life. If you know that you’re going to live to 95 or 100, the math may work out.

But what if you don’t? What if you get hit by a bus tomorrow? Those payments end or they’re severely curtailed. If you did it over, say, a joint life, you just don’t know. That’s a wild card in all of this. In in practice, I do feel that people weight that way too heavily, Just just like the irreversible, irreversible nature of that decision. I think that, from what we’ve seen, the pension lump sum kind of just like makes people go nuts. And then the whole idea of I don’t know how long I’m going to live.

So, like I and for whatever reason, it just seems like most people are like I’m not going to live that long, when in reality we know that life expectancies have been going up, you know, and and based on the sort of clientele we have here, and then the means that people have at their disposal. In most cases who we’re speaking with, I think the odds are they’re they’re probably going to be closer to average life expectancy or longer when we’re talking about those things, but everybody thinks the opposite, for, for whatever reason,

Maybe we’re trying to like reverse the drinks ourselves out of an early demise. Yeah, I couldn’t blame anyone for trying that, but it’s kind of the same when we talk about social security. Thank you, I was gonna, that’s where I was going. Next, people want to claim as early as they can because it’s their money and they want to get it while they’re still able to, instead of maybe deferring until they’re 70 and maximizing the amount that they can get. Again, it kind of boils down to to personal preference.

But I think we’re here to to be the balance to those maybe Unwarranted feelings, to provide, you know, the the numbers to those feelings and help them make the decision. Everyone has an anecdote, you know, and it’s a sad anecdote, that everybody has somebody who they know, who was gone too soon, and people like latch on to that very emotional, I think, attachment that they can, they can see in those situations it’s a shame and so it’s, I think, very vivid in our minds and can and can shift the decision.

And you know, again, can’t blame anybody for feeling you know a certain way, but I do think you got it. You got to try to lay things out there as rationally as you can and think it through and at least, if you’re making a decision where that’s a factor, just being aware of it and the fact that it may not be 100% based on logic, that’s alright, but you got it.

You got to be open to that possibility, I think, is the important part. I think what has surprised me over recent years is the fact that what we have these discussions with people some people aren’t even aware that they do have the option and they think, okay, I Need to take this lump sum payout and do something with it. When Brendan, in particular, has sat down with people and shown them the math, like, hey, you’re going to get X dollars per month for the rest of your life, guaranteed that kind of changes the conversation that

People are having, whether here or at home. It’s especially tough if there’s a deadline attached to the decision to, because then people feel rushed into making a decision and might feel might be subject to, you know, not making as well-informed decision as they would otherwise.

And one of the things for people who are closer to retirement again, because you have a little more certainty about what the world looks like when they’re relying on things like pension income or investments is Seeing what their overhead looks like in comparison to other sources of income, like social security, that they’re going to be banking on, like how much of their expenses hard costs at least are going to be covered by social security or, yeah, other guaranteed income, if they’ve made choices like like owning annuities, or if there’s other pensions that are even in the discussion here too and that can that can be a big deciding factor too, like if they’re set and they project to have all of their like very defined expenses, you know, fixed costs, covered by social security, then then perhaps the pension.

You could make a choice to take a lump sum and invest and and deal with the greater uncertainty for the chance of maybe more upside If it’s invested well, versus the alternative, if social security doesn’t project to cover very much of the fixed costs, maybe some extra monthly income on top of that that’s guaranteed, as opposed to, you know, subject to market market volatility and fluctuation and needing to be invested and invested well, that can factor into the, the trade-off too. Yeah, that seems like a good way to go about making a decision.

I wanted to talk about RMDs and how, how they factor into this decision. So if you do take the lump sum payment and you roll it into a tax-deferred account and you know let’s say you’re in your early 60s You’re gonna be required to take that money out down the road.

The RMD age is it’s changed the last couple years and is scheduled to change again in the future. So sometime in your early 70s you’re gonna be required to take this money out. I think that that’s just something that people need to be aware of when, when, making that decision, especially if they don’t want to take RMDs or have feelings about you know being required to take that money back out. I think a lot of people overlook the fact that that’s a required minimum Distribution.

You also don’t have to spend that money. I mean you’re you’re gonna have to pay tax on it either way. So you know you you can take the money out, pay tax on it and then you know, reinvest it back in the market. If you don’t want to have it in your bank account, that’s an option for it. Before we turn the mic on. We were talking about how a lot of folks are unhappy that they have to take a required minimum distribution and it’s going to be taxable income for them.

But what I think a lot of folks overlook is that they may have had 20, 25, 30 years of Contributions going in that they did not pay tax on and what would that have done if they were saying a higher bracket going back in time? It’s a trade-off. We all make. I don’t know if we all make it with eyes eyes open, because you kind of just get like auto Enrolled into a 401k plan and a lot of cases for people. But yeah, the dollars you send in there are not included in your taxable income for the year and so you receive the benefit in all of those years leading up to it and so at some point in the future.

The other side of that trade is that you have to start taking money out. So less tax now versus potentially more tax down the road. It’s one way of looking at it. You know the money’s going to compound over time and so you’re gonna be taking at least minimum distributions larger amount in the future. But the original concept behind 401K plans and IRAs is that when you’re retired you will most likely be in a lower tax bracket.

Doesn’t always work out Right. So any other thoughts on this lump sum versus monthly payment debate that we have going on here? I know, bren, like you said, it’s personal preference. A lot of the time there’s no blanket answer and the author of the article decided to take the lump sum here that she was offered. But she also mentioned that she went through this exact same scenario, I think back in 2015, and she decided to take the monthly payment.

So even the same person has done both options here and it’s all depended on their circumstances at the time of making that decision. Well, in regards to that, once you make the decision to take the monthly check, you can’t really go back and say, well, now I want the lump sum, you’re not getting it. So that lump sum opportunity is there and you really need to sit down with someone you trust and do the math and see if it makes sense for you.

So taking the lump sum does give you more flexibility because, like we said, you can always go back and purchase an annuity for maybe more money, but you can always go and purchase some sort of guaranteed income stream. It might just cost you more. That’s one option. I think both of the options are pretty irreversible, so you just have to choose which one makes sense for you. I don’t know that you’re going to be able to get the same deal on an annuity in the future.

You can do it, but it’s not going to be the same deal you were offered from the pension plan itself. I don’t know. I would say you got to look at your situation, actually take all the pros and cons into account and, like I said at the onset, I think you got to avoid some advisors out there that are hammers looking at nails and telling you to roll over a lump sum every single time because it makes them get more money, it makes them get more assets to manage.

Yeah. I’m happy to turn down the opportunity for someone to do a lump sum roll over if it makes sense for their situation to take the income, because it’s the right thing to do, and that’s being fiduciary. That’s what it’s all about. We want everyone to be making this decision with Eyes Wide Open, and I think that’s going to wrap it up here for episode 455 of the Mullooly Asset Podcast. Thanks, as always, for tuning in. We’ll be back with you next week.

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