Millington Financial Advisors
Lump Sum or Monthly Pension?
Frequently Asked Questions...
When you are faced with the decision to receive a lump sum or monthly pension from your employer, you may have a number of unanswered questions. We at Millington Financial Advisors are ready to answer these questions and provide you and your family a sense of comfort and control. Below you will find a handful of frequently asked questions on this topic:
1. Is there a calculation you can prepare to determine whether or not you should take the lump sum?
Yes, the calculation depends on how long you think you'll be able to live and how much you'll think you'd be able to make investing the lump sum.
The longer you'll think you are going to be able to collect the pension stream, the less likely you are to want to take the lump sum. The more you think you'll be able to make investing the lump sum the less likely you want to take the income stream.
Every plan is different, but calculations for a single life annuity tend to be around the following, for a 4% expected return the calculation says take the pension if you think you'll be able to collect for more than 20 years. For a 6% expected return the calculation says take the pension if you think you will be able to collect for more than 25 years. If you have an expected return greater than 8% the calculation says take the lump sum.
Of course this is a pure academic approach, in reality no one knows for sure how long they are going to live or how much they'll be able to earn investing. The value placed on controlling the asset has typically drives most of our client's decisions.
2. What are some softer reasons why you should or shouldn't take a lump sum?
You have to ask yourself would you value having control over a pool of money to make distributions and invest as you see fit, or are you more concerned about out living your money.
On the flip side of outliving your money, are you concerned with collecting your pension for only a short period of time and then passing up an opportunity to provide a potentially sizable inheritance for your loved ones?
3. What else goes into determining whether or not I should take a lump sum or monthly pension?
An understanding of your personal financial picture is a key component to answering this question. What do your personal financials look like? What are your liquid & non-liquid assets and liabilities? Do you have a good estimate of your current and future living expenses? Do you have any unique future goals, vacations or major home improvement projects in mind? Do you have any other sources of retirement income such as social security or any other pensions?
With a clear understand of the above you can then build out what your future cash flows and resources may look under different scenarios, like a higher inflationary environment or low return environment.
4. ​What's the great advantage to taking a lump sum?
The greatest advantage is control over your money. You can invest the funds however you choose, and utilize your resources how you see fit.
5. What are some advantages to taking a monthly pension?
Choosing to receive monthly payments enables retirees to have a steady income for their lifetime. You are not left to deal with the stress of how to invest a large amount of money all at once and feels very similar to collecting a paycheck.
6. What are your investment options with a lump sum?
If you roll your lump sum proceeds into an Individual Retirement Account (IRA), you have the flexibility to invest in a number of different ways including, stocks and bonds, alternative investments, and various management styles.
7. If I select the lump sum option, what is the tax impact?
Provided you go through what is referred to as a direct roll over to an IRA there is no initial tax impact. Distributions taken from your IRA are treated as ordinary income. You can elect to have an amount withheld to pay taxes, similar to when you were receiving a paycheck. It's important to understand your overall tax situation, and how timing your distributions can impact the tax rate you are subjected to on an annual basis.
Once the proceeds are in an IRA it's also important to adhere to the required minimum distribution requirements. At age 70 ½ you'll need to begin taking an annual distribution based on the value of all your IRAs at the previous year end.
There are a number of IRS rules governing how and when you can contribute and distribute from an IRA, it's important to work with professionals that can help you navigate your options before taking any action.