One Lump or a Monthly Bump?

Perhaps you have heard your grandfather or an uncle talk about the pension they receive from their former employer. Every month they gleefully open their mailbox and find a check from their former employer, a reward for their years of service.


Pension plans were the go-to retirement plan of large employers for most of the 1900s. Once 401(k) plans came into existence in the early 1980s, however, that changed. Since 401(k) plans hit the scene, the number of pension plans have been steadily dwindling in the United States.


But they still exist. Teachers often have them. Government workers too. Even private sector employers.


In fact, I have met with a good number of employees who either currently or recently worked at SKF USA Inc. Many of them have a pension plan.


As SKF’s Seneca operations wind down, these employees are faced with an enormously important question related to their pension plan. Should they take a lump sum from the plan or rely on a monthly benefit? That same question can be asked when contemplating whether to buy an annuity.


It is a simple question, but it is not always easy to answer.


Here’s the thing. When you end employment with a company that provides a pension plan, you typically have two choices. You can either receive one, big lump sum from the pension plan, or you can choose to keep your money in the plan and instead take a monthly check for the rest of your life – and perhaps that of your spouse’s.


Number-crunchers for the pension plan try to make the two options roughly equivalent from a mathematical standpoint. But other factors creep into the equation, often muddying the waters.


The monthly benefit for life is attractive. Like Social Security, it offers steady income over a long period of time. You do not have to worry about investment performance or managing a portfolio. The pension plan does that for you. That can be comforting.


Then again, most pension benefits do not increase with inflation. So the dollar amount you receive when you are 65 years old is the same dollar amount you will receive when you are 85 years old. Meanwhile, the price of almost everything you purchase may be 60% to 75% higher by the time you are 85, thanks to inflation. Your monthly benefit check won’t buy you nearly as much the older you get.


Also, those checks stop once you die, unless you choose a benefit that is based on the joint life of you and your spouse. But those joint options decrease the monthly amount you receive as the pension plan compensates for the likelihood of paying benefits over a longer period.


In addition, you want to understand if the pension plan is well funded prior to electing a monthly benefit. Keep in mind, a pension is simply a promise. Individuals participating in underfunded pension plans have discovered in the past that promises can sometimes be broken.


On the other hand, most pension plans allow former employees to take a lump sum and roll the assets into an IRA. This option offers the most control. You get to decide how to investment the money. If your investments earn a high enough rate of return, you can end up with more money than a monthly benefit provides – hopefully at least keeping up with inflation.


The opposite could also happen, however. You could earn poor returns – because of bad investments or just a bad investment environment – and end up with less money than a monthly pension check would provide.


So how do you decide? Here is a simple way to think about it.


If you are confident you will live a long life and you have no desire to pass on assets to heirs or charity, a monthly benefit is probably the way to go. On the other hand, if you have concerns about dying at a relatively young age or being able to provide a legacy to heirs or charity, the lump sum might be the best option.


In the end, there is no right or wrong answer. The best decision is the one that allows you to eat well during the day and sleep well at night.

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