By: Josh Slocum, McClellan Wealth Management
If you’re nearing retirement, you may be facing some difficult decisions regarding your defined-benefit pension plan. You might be wondering whether you should opt for the traditional path and accept lifetime monthly payments or take a lump-sum distribution instead.
Well, for those of you who are unsure which to choose or aren’t entirely sure of the differences between the two, I’m here to explain the pros and cons to both types of pension plans. Hopefully, I’ll be able to provide some clarity on this crucial aspect of your retirement finances.
Regular vs. Lump-Sum Pension Plan: What’s the difference?
If you’re not sure what the difference between a regular pension plan and a lump-sum distribution pension plan is, then you’re not alone! So let’s start with the basic definitions of each.
A regular pension plan is a set monthly payment payable to a retiree for life, and, in some cases, for the life of a surviving spouse.
A regular pension payment, the traditional one of the two, offers a bit more security with set, monthly payments for life. Some pensions also include cost-of-living adjustments (COLA) which means payments go up over time, typically due to inflation.
On the other hand, a lump sum distribution is simply a one-time payment from your pension administrator.
If you choose a lump-sum payment, you will be given access to a large sum of money, which you can then save, invest or spend as you see fit.
The Benefits: Regular Pension vs Lump-Sum
A large benefit of a lump-sum payment is the financial flexibility it provides.
While it is a one-time payment, if invested properly, it can provide regular income for retirees.
Also, with a hopefully long retirement ahead, there will likely be some surprise expenses– and possibly large ones at that. A lump-sum payment may also be used, if it’s invested well, to prepare you to cover any surprises or bumps in the road ahead.
A big benefit of a regular pension plan is the lifetime guarantee of monthly income.
With a lump-sum distribution, there is no guarantee that the money will last a lifetime and it’s not uncommon for people to outlive their lump-sum payment.
Another thing to consider when choosing which pension plan is right for you is your children and/or other loved ones.
Do you want to leave something to them after your death? With a traditional pension payment, once you and your spouse die, the payments may stop. But with a lump-sum distribution, you can name a beneficiary to receive what money is left after your passing.
Additionally, while income from pensions is taxable, if you opt for a lump-sum distribution and roll it into your IRA, you will have more control over when you remove the funds and pay the income tax on them.
Regular Pension vs Lump-Sum Payment: The Drawbacks
Some argue that the main draw of a lump sum distribution, the flexibility, is the very reason one should avoid them.
While the money is there if needed, lump sums can invite overspending for some, where a traditional pension payment takes the temptation to carelessly spend on things you may later regret harder to indulge.
A lump sum also requires careful asset management because unless you are investing very conservatively, you are at the mercy of the market.
It’s easier for younger individuals to ride the highs and lows of the market, but those already in retirement, or headed there quickly, may not have the same luxury.
A possible downside of a regular pension payment, which is crucial to consider, is the possibility that an employer could go bankrupt and be unable to continue paying its retirees.
This should certainly factor into your decision, especially if your company is in a particularly volatile sector, or has pre-existing financial issues. But, to put your mind at ease, these worst-case scenarios are rare and shouldn’t be a major concern.
Financial Advising in Birmingham, Alabama
To sum it up, different plans are right for different people, so it may be a smart idea to consult with a financial advisor to determine which plan may be best for you and your loved ones.
If you have any questions, concerns or want to set up a consultation give us a call at (205) 208-9868 or shoot an email to firstname.lastname@example.org!
This material is provided as a courtesy and for educational purposes only and is not intended to be relied upon as specific investment advice and is not a recommendation, offer or solicitation to buy or sell any security. Investing involves risk including loss of principal. Before investing or using any strategy, individuals should consult with their tax, legal, or financial advisor. The opinions expressed here are those of the author and not Advisor Services Network, LLC.