EP 64 – When A Pension Lump Sum Is Better Than an Annuity Payment

Common Sense Financial Podcast

Episode 64 When A Pension Lump Sum Is Better Than an Annuity Payment

Episode Intro

How do you pick between a lump sum payment from your pension and an annuity? A lot of that decision depends, but if you want to have control over your financial assets, a lump sum is often the better option. Find out when you should take a lump sum option instead of an annuity, why insurance is one of the most important pieces of the puzzle, and how to ensure your family doesn’t lose out either way.

Show Notes

  • The choice between a pension annuity and a lump sum often comes down to which provides the greatest income, but that’s not the only factor you need to consider.
  • We’re seeing fewer and fewer pensions than we did 20 years ago because of the systemic issues with defined benefit programs. They are often replaced with defined contribution programs like 401(k)s.
  • People used to retire at the age of 65 and could expect to live another 10 to 15 years on average. Today, people are retiring sooner and living longer than ever, and that is making the traditional approach to retirement unsustainable.
  • Historically, pensions aimed for between 4.5% and 7.5% to calculate their projection of benefits. With interest rates being below that range for decades and with life expectancy being lower in the past, the math worked out, but that’s no longer the case.
  • According to an article in the Daily News, nearly 1 million working and retired Americans are currently covered by pension plans that are in imminent danger of insolvency.
  • Pensions are insured similarly to bank accounts by the Pension Benefit Guaranty Corporation (PBGC), but according to Heritage.org, they found that for promised benefits of $24,000 a year, they’re insured up to $12,870.
  • The PBGC has the same problem as the FDIC. The FDIC has billions and reserves, but has exposure to trillions of dollars in bank accounts. The promise of insurance for both pensions and bank accounts is not mathematically supported.
  • If the PBGC becomes insolvent, the promise goes from $12,870 down to about $1,500.
  • If you are relying on an annuity payment from a pension, you’re placing a lot of trust in the pension calculations. And if the calculations are off, there’s not enough insurance to cover the loss.
  • The alternative to the pension annuity, the lump sum payment, gives you much more control over the future of your finances.
  • Not all pensions are destined to go broke, but the risk should be taken into consideration when constructing the income streams that will support you for the rest of your life.
  • A lump sum payment gives you control over your financial assets. Your income needs can fluctuate in retirement and the control of the assets backing your income gives you flexibility to meet your income needs. In the event that you predecease your spouse, they gain control of the asset.
  • Your heirs can also inherit the asset, which is not the case with a pension annuity.
  • Not all pensions offer a lump sum offer. In that case, the goal is to move as much of it into your control as possible. A single life annuity option is often your highest monthly benefit and is the quickest way to get the most from the pension in the shortest period of time.
  • The downside to electing this option is that it can leave your spouse with an income shortage, which is why your spouse will have to sign off on it. In that case, you should buy insurance either within the pension or outside of it.
  • With insurance outside the pension, you would accept the single life benefit taking the highest annuity payment then pay a premium to an insurance contract to pay a lump sum to the surviving spouse or the children if you die. Inside the pension, you take the lower annuity amount to ensure your spouse continues to receive the benefit after your death.
  • Buying insurance within a pension that has a cost of living adjustment also comes with additional costs which compound over time. For most people, this means you’re paying an ever increasing monthly premium for a decreasing benefit.
  • It’s critical that the type of policy you purchase and the amount of the insurance obtained are in alignment with what you need to protect your family. One misstep in this process can leave your policy at risk of lapsing or expiring, leaving your spouse vulnerable to a significant income gap.

Mentioned in this episode:

The podcasts here are historical in nature. They aired before July 1, 2022 and were previously approved by Kalos Capital. The views and statistics discussed in these shows are relevant to that time period and may not be relevant to current events. This is intended for informational and entertainment purposes only. It is not intended to be used as the sole basis for financial decisions, nor should it be construed as advice designed to meet the particular needs of an individual’s situation. Investing involves risk, including the potential loss of principal. Any references to protection, safety or lifetime income, generally refer to fixed insurance products, never securities or investments. Insurance guarantees are backed by the financial strength and claims paying abilities of the issuing carrier. Our firm is not permitted to offer and no statement made during this show shall constitute tax or legal advice. Our firm is not affiliated with or endorsed by the US Government or any governmental agency. The information and opinions contained herein provided by the third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed by our firm.

Newer Posts