Money Matters

Before you take your pension in a lump sum go through these 5 steps

May 5, 2013 

Q. I just received a letter from my former employer offering to provide a lump sum payment in lieu of a monthly pension payment. We could use some money right now to help our son pay off his student loans. I’m 64, so there would not be a 10 percent penalty. We are not totally prepared for retirement so we are not sure what to do. How do we determine if the lump sum is even a fair offer? We figure getting us to take the lump sum must be in the company’s best interest, why else would they make this offer?

A. A lot of companies are offering former (and even current) employees the option of taking a lump-sum payment in lieu of a pension income benefit. It does save the company money and improves the appearance of their balance sheet by reducing the pension liability and any underfunding requirements.

I would not take the lump-sum to pay off your son’s student loans if you are not financially prepared for retirement. Your son has a long time to pay off his student loans; you don’t have much time to save for retirement. Since you are over 59 1/2, there would not be an early withdrawal penalty but if you take the lump sum directly versus rolling it into an IRA, you will owe income taxes on the entire amount. Depending on the amount distributed to you this could push into a much higher tax bracket. The choice should be between the pension options and the lump sum rolled directly to an IRA.

There are a lot of factors to consider. For some, the lump-sum may be best and for others the pension may be best. You’ll need to do some research and perform the analysis yourself or pay a professional that specializes in retirement planning to help you make this irrevocable decision.

The following steps may assist you in making a decision or preparing to meet with a professional:

1. Review the pension amounts and determine which pension option is best in your situation. Some of the most common options are:

• Single life option: This will provide the highest monthly income but stops at your death;

• 50 percent joint survivor option. The monthly income will be less than the single life but your beneficiary will receive 50 percent of this amount at your death;

• 100 percent joint life option. Provides the least benefit amount, but this amount is constant as long as either you or your beneficiary are alive.

2. Verify the lump sum payment you would receive.

3. Estimate the mortality age for yourself and your beneficiary. Pension plan administrators and insurance companies rely on research data that tells them when you and your beneficiary are most likely to die. If you live beyond a certain age and continue to receive benefits you may “win,” but the majority of people will stop receiving benefits or have benefits reduced long before that age. A mortality age of 90 for a healthy person in their mid-60s would be reasonable for this analysis. Subtract your retirement age from your mortality age; this provides the number of years you want your money to last.

4. Determine a conservative rate of return based on your (and your beneficiary’s) investment philosophy and risk tolerance. What average rate of return do you think you could count on for the number of years determined in step 3.

5. Calculate the lump sum needed to produce this income stream (a financial calculator may be needed) for X number of years. You will be using principal and interest. Compare this to the lump sum you will receive at retirement.

Example: Former employee, age 64, wife age 59.

Step 1. Selecting a 100 percent joint and survivor pension would provide $1,800/month beginning at husband’s age 64.

Step 2. Lump-sum available to roll directly to an IRA is $350,000.

Step 3. Estimate wife’s mortality age to be 95, which means the $1,800/month, is expected for 36 years.

Step 4. The couple determine a 5 percent rate of return to be easily attainable.

Step 5. Using a financial calculator, they determine that a lump sum of $360,323 invested at 5 percent would generate $1,800/month for 36 years. Since this is close to the lump-sum of $350,000, they decide to take the lump-sum roll it directly into an IRA. The IRA provides them with more control as to the flexibility of the amount and timing of distributions, beneficiary designations and the possibility of obtaining a higher rate of return. If they decide they are more risk adverse as they age, they may be able to buy a commercial annuity that replicates the pension option.

Holly Nicholson is a certified financial planner in Raleigh. She cannot answer every question. Reach her at or P.O. Box 97128, Raleigh, NC 27624

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