What should you do: take the traditional, lifetime monthly payments or a lump sum distribution? You might be tempted to go with the lump sum. However, before you make this big decision about your future, be certain that you understand what the options might mean to you and your family, says Investopedia in the article “Lump Sum vs. Regular Pension Payments: What's the Difference?”
A lump sum distribution is a one-time payment from your pension administrator. Taking a lump sum payment gives you access to a large sum of money that you can spend or invest as you want. You have flexibility.
Once you and your spouse die, the pension payments might stop. However, with a lump sum, you could name a beneficiary to receive money after you and your spouse are gone, if any money is remaining.
The income from pensions is taxable, but if you roll over that lump sum into your IRA, you’ll have much more control over when you take out the funds and pay the income tax on them. You’ll have to take required minimum distributions from your IRA at age 70½.
A regular pension payment is a set monthly payment retirees get until death. Some pensions continue with the surviving spouse at that point, but some don’t.
A lump sum requires careful asset management, and with a lump sum, there’s no guarantee that your money will last a lifetime. You also need to think about health insurance because in some situations, company-sponsored coverage ends if an employee takes the lump sum payout. Therefore, you may need to include the extra cost of health insurance in your calculations.
A downside of pensions is that an employer could go bankrupt and find itself unable to pay retirees. Benefits are safeguarded by the Pension Benefit Guaranty Corporation (PBGC). This is a government entity that collects insurance premiums from employers sponsoring insured pension plans. The PBGC only covers defined-benefit plans (stated payments) and doesn’t cover defined-contribution plans (like 401(k) plans). It earns money from investments and receives funds from the pension plans it takes over. The maximum pension benefit guaranteed by PBGC is set by law and adjusted yearly.
Think about why your company would even want you to cash you out of your pension plan. Employers may use it as an incentive for older, higher-cost workers to retire early. They may make the offer because eliminating pension payments gives them accounting gains that increases corporate income.
If you take the lump sum, your company won’t have to pay the administrative expenses and insurance premiums on your plan.
Take a look at how the company determines the amount of lump sum payouts. From an actuarial standpoint, the typical recipient would receive approximately the same amount of money whether he chose a pension or a lump sum. The pension administrator calculates the average lifespan of retirees and adjusts the payment schedule accordingly. Therefore, if you have a longer-than-average life, you will end up ahead, if you take the lifetime payments. However, if not, the opposite is true.
Reference: Investopedia (April 14, 2019) “Lump Sum vs. Regular Pension Payments: What's the Difference?”