Should I take the annuity or lump sum? A question retirees and older workers likely will be asking as U.S. companies move to de-risk their defined benefit plans by removing expensive pension obligations. Employers may purchase annuities for their pensioners, while others offer cash or a single lump sum payment to “buy them out” upon plan termination. The rising premiums that employers pay to the Pension Benefit Guaranty Corporation (“PBGC”) along with the most recent mortality tables (which identify an increased age in life expectancy), will further encourage employers to reduce their pension exposure.
The lump sum and annuity withdrawal options are commonly offered under a “hybrid” plan such as cash balance plans. The annuity option is now frequently offered under defined contribution plan (such as 401(k) plans) whose normal form of payment is a lump sum.
The decision on whether to take the annuity or lump sum at retirement is a very important financial decision and typically, not an easy one to make. It’s to your benefit and well-worth the time to carefully consider the advantages and disadvantages of each option. In most situations, your election is irrevocable. This means that if you choose the lump sum, you permanently forfeit the right to receive a lifetime income that the annuity provides. Similarly, if you elect the annuity, you can’t change your mind and elect a lump sum at a later date.
The Society of Actuaries (SOA) published a paper, in May 2016, referencing the senior workers who are approaching retirement and the junior ones that are being offered the choice to cash out their deferred pension for a lump sum. The SOA provides a good summary of benefits and drawbacks of each decision.
Making your decision
Some financial advisors have suggested this plan: Come up with enough guaranteed lifetime income to cover your basic living expenses in retirement – mortgage, food, utility bills, insurance, transportation, etc. This way if you live a long time or the stock market crashes, you won’t run out of money. If your Social Security payment covers these expenses, you may not need the monthly pension. In this case, you could elect the lump sum and invest it to cover your discretionary living expenses, such as travel, hobbies and gifts.
No single retirement benefit choice is right for everyone. Retirees differ greatly in household situations and family, tax matters, retirement income needs, and many other factors, so one should focus on what fits their own situation. Pension option decisions are so important that you may want to obtain guidance from a financial professional or advisor who specializes in retirement planning.