Pension Decision

Pension Decision: Just One Critical Piece of Information Is Needed to Decide

In Income Planning, Tax Planning by Adam Cufr

Have you or will you be asked to choose between a pension lump sum or income payments when you retire? Lucky you.

For while pensions in America are going the way of the Rolodex, those who still have them get a lot of mileage from them. But how does one decide whether it’s best to take the pension as a lump sum or as a stream of lifetime income payments? It turns out that there’s one piece of information that will clear this matter up very quickly. 

How old will you be when you die? 

See, if we know this piece of information, then we can accurately do the math that’s required. What, you don’t know this? Okay, so we’ll have to introduce some nuance in order to get to the ‘best’ decision for you. Before we do that, let’s look at a simple calculation that would help us determine the best mathematical answer if we did in fact know the date of your death. 

If your pension lump sum offer is $100,000 and your pension annuity income offer is $500 per month, then we can determine that $500 per month times 12 months per year is $6,000 annually. Divide $6,000 into $100,000 and we get 16.67 years. Thus, if you had taken the pension lump sum and simply put the money under your mattress and used $500 per month to live on, then the money would run out after 16.67 years. Are you still alive? Because if you are, you’d have been better off taking the pension income offer instead of the pension lump sum. 

But what about the rest of the story? For example, what if you had taken the $100,000 lump sum and invested it instead of placing it under a mattress? How would that change the ‘breakeven’ math? And what if life happened and you needed a lump sum of money from the pension lump sum? As with anything, life can be quite complicated. 

The pension lump sum versus pension income decision, like so many decisions in life, has a lot of variables to consider. So, while it’s tempting to do a quick napkin calculation, this can become perplexing very quickly. And we haven’t even mentioned the tax implications, risk, inflation, interest rates, and family dynamics involved in financial decision-making. These factors make the old days sound nice; the company you worked for simply told you how much pension income you’re getting, and you just learned to live on that amount. No big decisions required. 

When deciding among various pension options (one person we work with had 22 pension options!), it really does pay to factor in as many planning variables as one can. By first building a holistic retirement plan, a decision like pension lump sum versus income can be made within proper context. In other words, one decision like this can play off another known reality like social security income amounts, current tax rates, inflation factors, and more. By integrating all of your financial information into a unified whole, the pension decision begins to become less daunting on its own.

Before you make an irrevocable one-and-done decision about your pension, consider how you might improve your chances of success by first seeing the bigger picture of your financial life. While it’s not possible to know the timing of our passing, we can use the information we do have to make some reasonable choices about pensions, investments, taxes, and estate plans, which can make the pension decision itself a bit less daunting.