Lump Sum vs. Pension Payments: Which One is Best?
Ford Motor Company recently announced it will offer lump sum payments to 90,000 salaried retirees as well as salaried former employees who are due pensions, in hopes that they will give up rights to lifetime payments.
The plan, devised to help Ford avoid pension liabilities and improve its balance sheet, is unique because it applies not only to employees contemplating retirement but also to those who have already retired. Analysts say that if Ford's cost-cutting move is successful, it may lead more companies to offer pension buyout plans.
Deciding whether to take a lump sum payout or hold out for continued monthly payments "is a big deal, and once you make the decision, it's not reversible," says Doug Lockwood, CFP, wealth partner at Hefty Wealth Partners in Auburn, Ind. "Don't take it lightly."
If you're faced with this decision, first consider the pros and cons of taking a lump sum.
Why Take the Money and Run?
One advantage to accepting the lump sum is that you will receive "most of the money you were promised," says Peter D'Arruda, president of Capital Financial Advisory Group in Cary, N.C. "If Ford is admitting they need to mitigate their pension risk, then one would assume they are facing issues. If Ford employees choose to hold out for their pensions, they could end up like the employees of Delta and GM, who held out for their pensions and ended up facing severe cuts to their payouts."
Taking a lump sum allows retirees to control how the money will be invested, potentially creating an income plan that could be more profitable than the guaranteed monthly pension payments. "A pension is a fixed rate, and it never changes," Lockwood says. "If you manage your money well, you could use the lump sum to create other streams of income or an alternative pool of liquidity in case something changes in your life, such as a diagnosis of an illness. You don't know what your life will bring, and you could need more income than the monthly pension payment."
Keep in mind that your pension benefits will end with your death or your spouse's death, "but if you could take the lump sum and manage it prudently, you could have money left to go to beneficiaries," says Michael Mussio, CFP, of FBB Capital Partners in Bethesda, Md.
The amount of a lump sum payment is calculated based on average life expectancy, but "you may be different from the average person," Lockwood adds. Family history of certain diseases or a high-risk lifestyle could mean your life expectancy is shorter than average. In that case, a lump sum payout may be a better choice for you and your beneficiaries. Lockwood recommends using tools available from Living to 100 and the IRS to help determine your life expectancy.
[Related: Pensions: The Basics]
Why Hold Out for Lifetime Payments?
While taking a lump sum allows you an opportunity to create your own income stream and potentially leave an inheritance, managing the money well enough to do that can be difficult. If you choose to take a lump sum, "you are assuming the risk of generating an income stream from that money," Lockwood says. "If you don't manage it well, you may not have an income stream down the road."
Ford has not disclosed the terms of its offer to employees, but most of these types of payouts are determined based on corporate bond rates, Lockwood says. Currently, that rate is about 4.25 percent, a rate that is difficult to beat in the current investment market. If you expect to live an average life span and you want to take the lump sum, you'll have to be able to make more than 4.25 percent on the money in order to make your decision the right one.
If you take the lump sum, "the onus is on you to re-create that income stream," Mussio says. "Most people don't have the knowledge to do that in a risk-averse way, so you may need help from a professional advisor. Also, your month-to-month income may change, as investment income is not always static like pension income. For some people, that creates a different level of anxiety, to see a changing balance each month."
How to Make the Decision
Take your time and do your research before deciding whether to take a payout or keep the pension payments coming. "Don't be flippant, and don't be wooed by dollar signs," Mussio says. "Sit down with somebody who can help you determine what rate you'll be getting if you take the lump sum, and the likelihood of being able to re-create that income stream on your own."
Before making a choice, interview several retirement income planners. "These planners specialize in creating income streams from lump sums," D'Arruda says. "This is a different kind of strategy and area of expertise than other financial professionals, whose main objective is to grow your money. Have each planner come up with a plan based on what your lump sum would be versus the pension; then get a second or third opinion."
Read more: Are You Saving Enough for Retirement?