Frequently, people will ask for help answering the question if a lump sum or annuity payments should be chosen when a pension fund offers a buyout. While the topic has been examined in many blog posts, articles, and other financial media, here we want to review the subject while providing a history on how we got here. The resulting information produced two articles, one with considerations for the dilemma at hand while the second discusses the technical background of the companies offering payout options on a grand scale.
Evaluate your cash flow need
People who examine the payout options on their own frequently limit their analysis based on the moment. Many take the lump sum, spend the funds and end up owing a large tax bill. Before anyone gets to this point, list out all of your sources of income to be received later in life. You know in fact, that social security will be a source that will not pay out a lump sum, but rather a monthly cash flow. How much will you need to support your standard of living, and how much income will need to be generated from sources not producing regular and predictable cash flow from sources like Social Security and annuities? Some individuals will include dividends and interest from their portfolios as part of a regular income. Will these sources be enough to cover your essential expenses? If yes, the lump sum may be more attractive. If the answer is no, the edge may lean towards the recurring monthly payments.
Evaluate your likely lifespan
Does longevity run in your family? If so, you need to weigh the fact most pensions do not adjust for inflation, but a reciprocal benefit is knowing you will not outlive the income stream. Additionally, if your expected lifespan is short, a lump sum creates more flexibility in passing assets on to heirs besides a spouse. While this is not a promotion nor an endorsement of any site, the links below may help give you clarity on answering how you long you may live.
How important is flexibility for you?
People in general like options; however, too many options can also most paralyze one from making a decision. Most companies offer the typical payment choices, but if you take the lump sum, you can also look at buying an annuity later transferring the longevity risk back to another institution. One should note, however, at the time of this writing, more monthly payments from a pension are higher than an immediate annuity.
How disciplined are you?
Let’s face the fact some of us are more disciplined than others regarding money. For those of us who have a hard time keeping funds in a checking account, the monthly income will provide sustainability to our situation. If you are disciplined, still consider those who will end up with the income or asset after you are gone.
What is the state of the pension fund?
Part of evaluating options mean assessing the motive of the corporation offering the lump sum payout. Is the company in trouble financially, which could increase the probability the Pension Benefit Guarantee Corportation, PBGC, may take over the liabilities. Is the company looking to get the obligation off its books to reduce any future burden? You may not be able to clearly articulate the motive, but look for signs of financial distress.
So you have given adequate thought to the points above, maybe you have come to the point of comparing lifetime cash flows or break-even points. What rates of return were used, are the rates realistic, was inflation a consideration? As you can see, the math becomes complicated very quickly. Here is a site that may help you in evaluating the cash flow.
After evaluating the points above, you should have an indication of which option is best for your situation. If not, contacting an advisor to assisting should be the next step.