A: First, it’s important that you understand the provisions of your pension. According to Joe Tomlinson, a certified financial planner in Greenville, Maine, it is indeed typical for lump sums being offered to decrease when interest rates increase, but not for the monthly income offered to change with interest rates. “So step one would be to understand what monthly income the pension offers and whether such payments are fixed for life or adjust for inflation,” he says.
Of note, the Consumer Financial Protection Bureau (CFPB) just released a guide for consumers thinking about a taking their pension as a lump-sum payout vs. a monthly payment. According to the CFPB, the guide is for consumers with a private-sector defined-benefit pension plan. It’s designed to help workers like you think though the trade-offs and implications of taking a lump-sum payout.
Here are some links to what they published:
Now, before you decide to take the lump sum or the pension, and long before you consider which product — a fixed annuity or a fixed index annuity — is best for you, consider creating a retirement income plan. Such a plan will help guide your decision. In the main, try to pay for your essential expenses with guaranteed sources of income, such as Social Security, a pension, annuities and the like. Next, consider paying for your discretionary expenses with the investments from your taxable, tax-deferred (IRAs, for instance), and tax-free accounts (Roth IRAs, for instance).
So, here’s the pinch point in this process. You might learn after going through this exercise that, in addition to Social Security, you’ll need additional sources of guaranteed income to pay for your essential expenses. In your case, you may have to decide between taking the pension (either as a single-life annuity or as a joint-and-survivor annuity if appropriate), or taking the lump sum and investing it in the fixed index annuity (FIA), some form of fixed annuity, or something entirely different.
How to decide? Well, the pension is straightforward. You get income for life. Plus, a consumer’s pension is typically insured by the Pension Benefit Guaranty Corporation (PBGC), according to the CFPB. So, if your company declares bankruptcy or cannot make its pension payments, the PBGC guarantees those payments up to a certain amount. Pension payments are also protected against certain creditor claims or debt collectors. With a lump-sum payout, you typically lose these protections, the CFPB reports.
By contrast, you’ve got at least two products (or product categories) to consider if you take the lump sum:
- A FIA is an annuity on which credited interest is based upon the performance of an equity market index, such as the S&P 500. The principal investment is protected from losses in the equity market, while gains add to the annuity’s returns.
- The term fixed annuity refers to a number of different products that either specify a rate of interest to be earned or guaranteed payment amounts, either for a set period or for life. The issuing company assumes the investment risk.
According to Tomlinson, when you get to retirement, you could consider shifting this bond fund money to a couple of different options (noting, of course, that other options may also become available in the future). The most straightforward option would be a single-premium immediate annuity (SPIA). Of all the products you could buy, SPIAs are the most straightforward and easy to understand. You pay X dollars up front and receive Y dollars per month for life — it’s as simple as that.
By contrast, Tomlinson says FIAs are not straightforward at all. “There are a variety of methods for crediting interest to the accounts, and insurance companies have the flexibility to adjust charges after issuing contracts,” he says. “A lot of careful reading and analysis is required to understand what is being purchased.”
SPIAs are also fairly easy to purchase; you can buy one directly through a firm such as Vanguard, says Tomlinson. By contrast, FIA purchases (and a fixed annuity for that matter) require the involvement of an insurance agent.
Tomlinson gave this example comparing payouts for a SPIA vs. a FIA:
For a 65-year-old female and a $100,000 purchase, highly rated insurers offer SPIAs paying about $533 per month for life. A popular FIA offers a level $442 per month for this same case. If one wants annual inflation increases, the starting monthly income for an inflation-adjusted SPIA would be $393 per month. That would be for payments that actually increase with the consumer price index (CPI) similar to the way Social Security increases. A SPIA with fixed 2% annual increases would pay $439 per month. There are FIAs that offer the potential for increases, but such increases are uncertain and depend on product performance.
By the way, if you decide to take the lump sum, the CFPB suggests checking for lump-sum calculation errors: “Many factors determine a lump-sum payment amount, including age, years of work, earnings history, taxes withheld, and the terms of the plan, the CFPB reports. “Consumers can detect errors by taking a look at their most recent pension statement or a consumer can contact a pension counselor for assistance or to resolve errors.”
Also, if you take the lump sum, you’ll likely pay taxes on a lump-sum payout, unless you roll over that money into a qualified retirement account.
Culled from USA Today
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