Should I Take a $48,000 Lump Sum or $462 Monthly Payments for a Pension Annuity?

Buyout decisions have become increasingly common for those with a pension plan. If you get this offer, the most important questions to deal with include when you would you receive the payout, and how long you expect to live. The earlier you would receive a lump sum payout, the more it will be worth to you in retirement. On the other hand, the longer you live to collect monthly payments, they can add up to be higher over time. So as an example, if you’ve been offered $48,000 in exchange for waiving a $462 monthly payment, you may want to play the percentages and take a buyout if you’re above a certain age. Otherwise, monthly payments might be the preferable way to go

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Should You Take the Lump Sum or Monthly Payments?

A pension plan is a retirement benefit offered by some employers. Basically, it offers you a guaranteed amount of money every month starting in retirement and lasting for the rest of your life.

Increasingly, as a way of saving money, companies are offering their current and former employees an option known as a “buyout.” This means they’ll pay you a lump sum up front in exchange for any other payments. For example, you might have these two hypothetical choices:

Monthly Payments: $462 per month for life, starting when you retire
Lump Sum Buyout: $48,000 immediately, with no further payments

The question is, what should you do with an offer like this?

“There are a number of important points to evaluate before choosing either a lump sum or annuity payment,” Jeremy L. Suschak of DBR & Co. told SmartAsset. “First, the owner of the pension should consider their health. It is critical to think about this first since health-related factors could end up making the financial tradeoffs moot.”

Pension Value Is Based on Longevity

Suschak raises an issue known as longevity risk. Essentially, the value of a monthly pension is based on how long you will live. You don’t need to worry about bankruptcy risk, as the federal government’s Pension Benefit Guaranty Corporation insures monthly payments well above $462.

For instance, say that you start collecting your pension at the age of 67. Someone in good health can potentially expect to live another 25 years, making this pension worth $138,600, at $462 a month over that time. But that may only be true for someone in good health. If you expect to live, say, another 10 years, then this same pension is worth just $55,440. So the healthier you are, the more this pension is likely worth.

Longevity risk and your personal risk tolerance are important items to understand when making a crucial decision for your upcoming retirement. A financial advisor can help you understand these terms and build a plan for the future.

Lump Sum Value Is Based on Payout Date

Let’s assume you have no cost of living adjustments on the pension annuity or rate of return on the lump sum payment. Then, at $462 a month and $5,544 annually, you need to reach 8.65 years to have the pension payments break even with a $48,000 lump sum payment.

“In this simplified scenario, when the retiree’s life expectancy is less than 8.65 years, the lump sum would be preferred,” Bryan M. Kuderna, founder of Kuderna Financial Team, said.

This analysis represents the payout date issue, as the value of any buyout is based on when you would collect it. If you receive this buyout at or near retirement and withdraw $462 per month, even with a 10% rate of return, the money would only last about 14 years.

On the other hand, say you are offered the same buyout at age 37 and put the entire amount into an S&P 500 index fund with a historical average annual return of 10%. By age 67 when you might want to retire, it would be worth $837,571 if you didn’t contribute anything extra.

With these numbers, the sweet spot is around 14 years. If received at age 53, assuming the same standard S&P 500 return, a $48,000 lump sum can grow to about $182,000. That’s the breakeven point where your lump sum investment will exceed the amount you’d collect over a reasonable life expectancy.

Other Income and Longevity Concerns to Manage

Finally, suggests Suschak, “pension owners should think about the type and amount of other income streams available to them in retirement. All income sources, including the pension, should be considered in relation to the anticipated level of spending in retirement.”

What kind of Social Security payments will you receive? What do you have in other retirement accounts, and how secure are they? Overall, where does this pension fit into your retirement plans?

These questions help define how much you should prioritize the security of a monthly payment over the potential opportunity of a lump sum. If you have significant other sources of income, you might want to choose a lump sum and invest it. On the other hand, if this is a significant part of your retirement plan, it may be wise to prioritize the security of the annuity payments over the investment opportunities of the buyout.

Bottom Line

Whether you should take a pension buyout depends on when it’s offered to you and your life expectancy, among many other factors. For most pensions, the earlier your employer offers the buyout, the better a deal it can be. But the closer you are to retirement age, the more you may want to prioritize monthly payments.

Retirement Planning Tips

A financial advisor can help you build a retirement plan for the future. 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.

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