Is there a downside to taking your pension on a monthly basis vs. taking a lump sum? The monthly payments would be higher than the return I would get on the lump sum.
– Claudette
There are certainly some downsides of taking monthly pension payments instead of a lump sum. But that doesn't necessarily mean it's the wrong choice. There is also plenty of upside, and for many people, choosing the monthly payment can be a great move.
If you need help making a major financial decision, talk it over with a fiduciary financial advisor first. Connect with your advisor matches today.
Of course, the same can be said about taking a lump sum payout. As with all financial decisions, it’s about the tradeoffs. There are both benefits and drawbacks, and neither is the best choice in all circumstances. You need to weigh the pros and cons of each to see which is better for you. I'll walk you through this comparison.
Monthly Payments vs. Lump Sum
Most pension plans provide several payout options for participants to choose from when they retire. The choices normally consist of a few different types of monthly payments and a single lump sum offering. Evaluating this choice starts with understanding the differences between the two.
Monthly Payments
With this option you'll receive a regular monthly payment in the form of an annuity. In terms of your cash flow, this functions similarly to the way you receive a recurring paycheck. Every month another deposit lands in your bank account. The common annuity options are:
- Single life annuity: You'll receive a monthly payment for as long as you live. However, when you die the payments stop. Your spouse or other beneficiaries will not receive anything.
- Joint and survivor annuity: With this option, your spouse will continue to receive a benefit when you die. Your spouse's survivor benefit is a percentage of the payment you receive, such as 100%, 75% or 50%. In order to gain a survivor benefit, you'll typically receive a lower initial payment than you would under the single life option.
- Period certain annuity: These payments aren't based on lifespan, but a predetermined period of time, such as 10 years. Period certain payments stop after that period of time. If you die before then, the payments continue for your beneficiaries for the remainder of the period.
Lump Sum
When you take your benefit as a lump sum, you won't receive regular payments. Instead, you'll receive a single large payment. It's then up to you to decide how you want to manage the money and plan your withdrawals.
You can take this money in cash, but it will be a taxable distribution. Since this is likely to be a substantial sum of money, it’s often very inefficient to take the tax hit in one big chunk. If you plan to use this money to fund future spending, it's usually best to roll it into an IRA (assuming certain conditions are met) and pull it out gradually. This will delay taxes until you start making those withdrawals.
(Remember, a financial advisor can help you evaluate your pension payout options and navigate other areas of retirement planning.)
Pros and Cons of Monthly Payments
When you receive monthly pension payments, you’ll have the peace of mind knowing that your monthly benefit won’t vary based on the performance of your portfolio. The payment is guaranteed regardless of markets or interest rates. This can be a major draw for retirees.
Additionally, the lifetime option offers some protection from longevity risk, or the chance that you run out of money in retirement. Payments are also often insured by the Pension Benefit Guaranty Corporation or the state/government entity that administers the pension, providing another layer of security.
However, the downsides of the monthly payment options are clear. For example, if you choose to receive your pension as a single life annuity, the payments will stop when you die and your beneficiaries will not continue to collect from the plan.
Also, depending on our pension plan, your benefit may not adjust for inflation each year. This could mean that the real value of your monthly benefit falls over time, which could prove especially challenging if you live a long time and see prices increase substantially over those years. (If you need help creating a retirement income plan that accounts for inflation and other risks, consider working with a financial advisor.)
Pros and Cons of a Lump Sum
On the plus side, the lump sum option provides maximum flexibility, since you can decide how much to withdraw and when. Depending on how you invest, you money could grow at a rate that allows you to withdraw more than you would receive via monthly payments. This may help you better keep pace with inflation and maintain your standard of living.
Additionally, your heirs will receive any funds that remain in your account when you die.
However, you'll need to decide how you want to invest your money, which can expose you to market volatility. You'll also need to craft a withdrawal strategy to ensure you don't run out of money. This will require some careful consideration and planning, and potentially the expertise of a financial advisor. (And if you need help finding a financial advisor, consider matching with up to three for free.)
Making Your Decision
The advantages and disadvantages of both options above should give you some context for thinking about which might be better for you.
A monthly payout might be better if you:
- Prefer or need a stable, fixed income
- Aren't as concerned about leaving an inheritance for your heirs
- Have a low investment risk tolerance
- Need greater longevity protection
The lump sum might be better if you:
- Have enough secure income from Social Security or other savings
- Are comfortable with volatility
- Prefer the potential upside of investing the lump sum
- Like greater flexibility
- Want to leave money for your heirs
Depending on how you value each of those considerations, it may be an obvious choice. If you like or need some aspects of both, then it may be more difficult to decide. (But remember, a financial advisor can help you assess your options and make a decision based on your unique situation.)
Bottom Line
A monthly payment from a pension plan can provide a stable foundation of retirement income. It's an excellent choice for many retirees. However, it does come with tradeoffs. To decide if it's the best choice for you, think about how the benefits and drawbacks align with your personal needs and preferences.
Retirement Income Planning Tips
- Relying solely on Social Security or a single income stream can be risky. Combine income sources like pensions, retirement accounts (401(k) or IRA) and passive income from investments to create a balanced portfolio. Also, consider dividing your assets into “buckets” based on when you'll need the funds. For example, keep cash and short-term investments for immediate needs, medium-term bonds for the next five to 10 years, and equities for long-term growth to outpace inflation.
- A financial advisor who specializes in retirement planning can help you build a retirement income plan based on your assets and spending needs. Finding a financial advisor doesn't have to be hard. SmartAsset's free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you're ready to find an advisor who can help you achieve your financial goals, get started now.
- Are you a financial advisor looking to improve your marketing? SmartAsset AMP (Advisor Marketing Platform) is a holistic marketing service financial advisors can use for client lead generation and automated marketing. Sign up for a free demo to explore how SmartAsset AMP can help you expand your practice's marketing operation. Get started today.
Brandon Renfro, CFP®, is a SmartAsset financial planning columnist and answers reader questions on personal finance and tax topics. Got a question you'd like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.
Please note that Brandon is not an employee of SmartAsset and is not a participant in SmartAsset AMP. He has been compensated for this article. Some reader-submitted questions are edited for clarity or brevity.
Photo credit: ©iStock.com/Leonsbox, ©iStock.com/Luke Chan
The post Ask an Advisor: Is There a Downside to Taking a Monthly Pension vs. Lump Sum? appeared first on SmartReads by SmartAsset.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
