Pension Lump Sum vs. Monthly Payments: How to Choose the Best Retirement Option

Navigating Pension Choices: Lump Sum vs Monthly Payment

In this episode of the 'Retire Early Retire Now' podcast, host Hunter Kelly, a Certified Financial Planner (TM)  from Palm Valley Wealth Management, discusses the crucial decision for those with pensions on whether to take a lump sum or monthly payment. With pensions becoming rare, Hunter examines factors like life expectancy, risk tolerance, investment potential, and tax implications in making this decision. He also shares a real client case study to illustrate the considerations involved. This episode equips high-income professionals with the knowledge to make informed retirement choices.

00:00 Introduction to the Podcast

00:16 The Decline of Pensions

00:55 Pension Payment Options

03:04 Calculating Your Pension

05:17 Client Case Study: John and Jane

06:38 Key Factors to Consider

08:22 Breakeven Point Analysis

12:35 Final Thoughts and Advice

14:17 Conclusion and Disclaimers

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Transcript

Shure MV7 & FaceTime HD Camera-3: 0:00

And welcome back to the Retire Early Retire Out podcast. I'm your host, hunter Kelly, certified financial planner and owner of Palm Valley Wealth Management. I do this podcast every Tuesday to help high income earning professionals make smarter decisions about their financial situation and maximize their wealth. And today we're tackling a big question that most people don't face anymore because pensions are becoming a thing of the past. But for those that still have one, this is a major decision that can impact your entire retirement. I'm actually currently working with a few clients, to help make this exact choice. running through my review phase this spring with my clients and a couple of'em are retiring. Work for some corporations that still have pensions. and I thought it'd be a great segue from our previous, last two podcast episodes going from what benchmarks we should hit by age 40, age 50, and now transition into some decisions that we have to make about retirement. And so one of those decisions that people make, is should I take a pension, lump sum payment, or should I take a monthly pension payment? So if you're still one of those few that. Have a pension through your company, you'll eventually have to make this critical choice. So which one is it? The pension monthly payment. What type of structure should be within that payment? Should it be a single lifetime payment? Should it be a joint option to, with your, with spousal benefits? so we'll break down all of these considerations that you should be making to help you make this decision. And then throughout this podcast, I'll interweave a real client case study that I'm. helping a client with right now, making this decision, should I take a lump sum or should I take that pension payment? And which pension payment option should I take? Right? So if you're watching this on YouTube, go ahead and subscribe and like this video. Leave a comment below. Should companies start offering pensions again? Should we make pensions great again? Right. this, again, they're becoming a thing of the past. They are what's called a defined benefit plan. and most companies are going to what's called a defined contribution plan. Things like 4 0 1 Ks, where there's some sort of defined contribution into these plans where you have to invest it yourself, and you really don't know the benefit. But with these pension plans, you know exactly what you're getting. and what that payment is going to look like. So, should we have pensions, let me know in the comments below. If you're listening on your favorite podcasting app, leave a five star review, but let's jump right into it. Pensions, whether it's a lump sum or a pun, monthly payment, is a big decision. It's rare to have them, like I just mentioned. but when it's time to choose, you need to choose the correct one for you because it can have a major impact on your retirement. So the lump sum gives you an immediate control over your money. While a monthly pension provides guaranteed lifetime income. So which li which choice is right for you is a very personal situation, that you need to consider. One, your financial situation, your life expectancy, and your risk tolerance. what we should talk about first before we get into some of those considerations is, well, how is this darn thing calculated? it isn't just a magic number. Generally these pension plans use three factors to calculate your pension payment, and that would be one your years of service. So how long have you worked at this employer? The longer you work, the higher your pension will be. the second, factor would be your final average salary. So usually it is a three to five year, highest. Earnings average. So if you made, you could average a hundred thousand in your last five years, that would be your average, right? and the last thing they consider is a multiplier, and that would be a percentage. So 1.5 multiplier or a 2% multiplier. and so if you. take these as an example. maybe you worked at a company for 30 years, you had an average final salary of a hundred thousand, and then your multiplier is 1.5. So if you multiply all of those together, you would get$45,000 per year. Or just over$3,700 per month as your monthly payment for life. So that's how they'll calculate it. Now, there could be, nuances and differences from plan to plan, but generally speaking that's exactly how it's, calculated. And then along with that calculation, there would be some sort of lump sum payout, number as well. And so you can either take that monthly pension, or you can take the lump sum. And so now let's transition into. What key factors should we be considering? The first one, and I think the most important because you're gonna have to call, you're gonna have to figure out what, your breakeven point is your life expectancy, right? So how healthy are you? What is your family history? if you had to guess, when do you think. you would pass away. I know it's kind of morbid to think about, but the longer you live, the better, the pension is gonna be for you. but if you think you have a short time left, the lump sum would make more sense for you. So obviously this is a guessing game, but you can generally take some key factors from your health and family history and things of that nature and take an educated guess. Right. And so let's start to weave in, my client situation that we'll talk about throughout this podcast. they work for a very large logistic company that, everyone has heard of. he is, retiring in May and he has an option. Do I take,$1,400 a month or just under$1,400 a month, or do I take about$215,000 lump sum? He's 65. and then he has a spouse that is about six years younger than him. those are some key things that he will have to be considering now for his life expectancy. He is very healthy, very active. has a family history of his family living well into their eighties. His life expectancy is going to be fairly high, right? that leads to us considering, maybe the pension would make the most sense, but there's some other things that we should consider. Now, for him, his pension payment does not have what we call a COLA or a cost of living adjustment. But that is one thing that you would have to consider, with these payments. So a lot of times pension payments will have a cost of living adjustment where they'll increase that. payment either by 1%, 2%, or maybe, with inflation. And so each year you would have some sort of increase in that payment. The next thing is the investment potential. So if you take the lump sum payment, what do you think you could get as far as an investment return to generate potentially more income than this pension, would you not be able to, right? Would you have to take on too much risk, to get the amount of return that you would need to make that lump sum worth it, right? And so that's where your risk tolerance and your risk capacity comes into play. What other investments do you have? are you gonna be waking up every day? worried about the market, fluctuating up and down, especially like we, the market we've had the last couple weeks where there's been a lot of volatility. Is that going to keep you up at night? And so. If, if those types of things will keep you up at night, then the pension would make more sense. But if you think with what the lump sum that they're gonna give you and the return that you would need to make it worth your while, one is not gonna keep you up at night and is two is fairly reasonable, then the lump sum may make more sense. the other thing that you would want to consider, what are your legacy goals? what about your spouse? How did they play into it? for my client's situation, we'll call her Jane. Jane is six years younger than John. having that pension may make more sense, for her because again, they have a long life expectancy that we'll talk about here in a second. the last thing would be taxes. Once everything's taken care of as far as, these other factors, then we'll want to start thinking about taxes. If you're taking that monthly pension, it's gonna be detached as ordinary income. So would it make more sense for you to roll over a lump sum so that you could put it into an IRA and make it tax deferred, and maybe do some raw conversions and things of that nature. so you would want to consider taxes as well. And so for me, the next thing that I would consider as a financial advisor or if you're making this decision is what is. Breakeven point. So again, John is receiving, is retiring and is receiving this pension, whether that be the$215,000 lump sum or just over$1,300 a month. Right? what is the breakeven point? So I'm going to pull up a chart. And what you'll see is on the Y axis, you'll have a dollar amount where it starts out at 50 or$0, working up in$50,000 increments, all the way up to$400,000. And on your X axis, you have age. So for this instance, John is 65, he's going to start his pension at 65. And we're gonna go all the way to what I think is a fair, life expectancy for. John, and that is age 90. And so what we're looking at here is a dotted orange line versus a solid yellow line. The solid yellow line is the lump sum pension. So if we take that$215,000, we invest that with a 8% return, In this case, I want to be a little bit more aggressive'cause I, I want to try to exaggerate that break even point to see is it even worth potentially looking at the lump sum.'cause a lot of times these pension payments make more sense, especially if there's a long life expectancy. so I want it to be a little bit more aggressive to see if it even makes a difference. And then the orange dotted line is looking at the accumulated pension payments that John would receive. So obviously starting out he's gonna receive$1,300 that first month, and then so on and so forth. And I'll accumulate over time. So what does that break even point? When does the amount that he has received from the pension. Exceed the amount that he would have in some sort of IRA or investment portfolio, um, over time, if he took that lump sum. And so here, uh, the breakeven point is when John turns 80, or let's say 15 years. So when I consider this situation, I consider his health, what his life expectancy is, what his spouse's situation is like. other factors, what other type of assets he has. He has some IRAs and 4 0 1 ks and things of that nature. for me, I think taking the pension for him makes more sense. And so why do I think that? I think this for a couple reasons, but the main reason is that one, his wife is about six years younger than him. So the likelihood of her living past 15 years is fairly likely. Um, and again, I don't know that I mentioned it, but this is a joint payout, so he'll receive, 13, over$1,300 per month for, on both of their lives. So if he passes away before her, she'll continue to see, receive that payment. And so because she's six years younger. Both of them are very healthy, very active. the likelihood of at least one of them living past age 80 is fairly likely, right? And so now mathematically, this is starting to become, in the favor of taking that monthly pension, as a joint payout. Now, he was not as healthy, or. his wife was not as healthy, then maybe we would want to consider either a single payout where he gets a little bit more each month because it's not on both lives. Or we would want to consider that lump sum. because if he passes away, the risk here is that if he passes away or they both pass away before age 80, then the lump sum would make more sense'cause they would end up with more money. and. Be able to pass that on to their heirs, things of that nature. Right. Um, and so in this case, I think taking the pension would make more sense just based off the breakeven point. Now there are a couple other things I would want to consider, some tax things that we just won't get into in this podcast today. But, for that particular scenario, the breakeven point. is age 80, I think either of them could easily live past age 80. So we'll take, that pension in this case. some other things to, consider if you need guaranteed income and prefer simplicity. So if you're, if you just don't wanna worry about investments, the pension plan might be better for you, might be the best, option for you. If you're comfortable with investing, you want more flexibility, obviously that lump sum will make, a better fit for you. there's some other flexibility you could do, and I think I mentioned it a little bit before, is maybe you roll that over into an IRA and because you have other assets or maybe you don't need as much income. Based off what that pension would give you, you could start to maybe convert this to, a Roth IRA at a lower tax rate. And this could potentially be, an inheritance play or just a more long-term investing play. So other factors, obviously spousal needs, taxes and estate planning goals you would want to consider. Should I take the pension plan versus the monthly payment? So if you're facing this decision, don't guess. Run the numbers. Understand your situation. Where is your breakeven point? What does your tax situation look like? Do you have other assets that you could pull from if you did take the lump sum and still generate enough income to meet your retirement needs? If this is something that you're considering and you need help, you can always reach out to us at Palm Valley Wealth We can help you create a strategy, run these numbers. and determine which one is the best one for you. so go ahead and check out my website, palm valley wm.com, and we'll see you in the next one.

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As a reminder, making decisions about pensions, whether that be the lump sum or pension payment, is a very serious and, uh, important decision. So, uh, just as a reminder, this podcast is for educational purposes only. Do not make any pension decisions based off this podcast alone. Please seek professional help from a financial advisor or tax advisor, and please keep Palm Valley wealth management in mind when making those considerations.