Companies that have been severely impacted by the pandemic have turned to early retirement offers as a way to reduce their workforce. If your employer has a defined benefit pension plan, your offer may include the option of selecting a monthly pension paid throughout your lifetime or a single lump sum distribution of approximately the same value. Employers typically prefer that workers take lump sum payouts to lower the company’s future pension obligations. But the choice for employees is not so clear-cut.
I advise clients in this situation not to base their decision solely on financial considerations. There are also significant emotional and behavioral factors to think about. Getting to the heart of the matter requires asking yourself questions like those below and coming up with honest answers.
1. Will I need the money right away for income?
If you know you will need monthly retirement income above and beyond your Social Security benefit and earnings from personal savings, then a monthly pension may fit the bill. With this option, your employer promises to pay you the same amount of money per month for the rest of your life. Usually, that monthly income is fixed and will not change, which is a plus because it eliminates surprises. But there’s a downside too: some pensions provide no cost of living increases that will help preserve your purchasing power in the face of inflation.
If the combination of Social Security and individual savings will provide all the income you need, then you may benefit more by rolling over a lump sum directly into an IRA. A direct rollover lets you continue investing the money on a tax-deferred basis, with the option to tap it when and if you need it. By owning growth-oriented investments within the IRA account your nest egg has the potential to keep up with rising costs during several decades of retirement.
2. Am I responsible with money?
Are you dreaming of using that lump sum to pay off a mountain of credit card debt? Of for writing checks to your children and grandchildren? If the answer is yes, then consider whether you really have the self-discipline necessary to take a lump sum distribution.
If you’ve a proven saver (and not a spendthrift), you may be able to preserve the money. But many people who start out with good intentions don’t succeed. A 2017 research study commissioned by MetLife MET study showed that 1 in 5 people (21%) who took a lump sum from their workplace retirement plan depleted the money within 5.5 years.
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3. Can I invest a lump sum wisely or do I know someone trustworthy who can help me?
Managing a lump sum distribution successfully requires a knowledgeable investor. If you’re a novice, the do-it-yourself approach can be daunting, and poor choices can jeopardize your retirement security.
If you don’t have the know-how yourself, you will want help from a trustworthy person. It’s rarely wise to base important financial decisions on the advice of friends or family members. Consider working with a professional financial advisor who is trained in retirement planning and experienced in working with pre-retirees like you.
Keep in mind that knowledge and skill aren’t all the necessary qualifications for do-it-yourselfers. Creating and managing an investment portfolio requires a significant commitment of time. While you may be up to the challenge right now, the demands can become a burden as you age.
4. How will the decision impact the people I love?
Most pension payments stop after the death of the employee or the death of a surviving spouse, and there’s no opportunity to designate beneficiaries. If leaving a legacy is a priority for you, consider the benefits of a lump sum distribution with a direct IRA rollover. With an IRA, you can designate beneficiaries, including individuals or institutions, so you dictate the distribute of your assets.
In making your decision, be aware that the promised duration and amount of future payments is contingent upon the solvency of the pension plan. If you have concerns about the financial stability of your employer’s plan, you’ll want to investigate the details thoroughly.
Here is another important point to remember: There’s no changing your mind after you submit the required paperwork. The election is irrevocable, which means you have only one chance to get it right. Seeking professional financial advice early in the decision-making process can result in a confident choice.