Pension Annuity versus Lump Sum

Some corporations offer employees the option to elect to receive their pension as an annuity (providing fixed monthly income payments for life) or as a lump sum balance that can be rolled over into an IRA. We encourage retirees to compare the various aspects of each option so that they can make an informed decision that best matches their financial needs, objectives, and comfort level.

Corporations typically offer several different pension annuity options to retirees. Two of the most common types of pension annuities are the single life (highest monthly payout) and Joint and Survivor (usually with your spouse, this option provides a lower monthly payment than the single life annuity option because benefits are provided for two lives instead of one). For non-spouse beneficiaries, there may also be period certain options available over a 5, 10, 15, or 20 year period. The monthly payouts on the period certain options vary between the single life and joint and survivor payout amounts. Pension annuitants have no control over the investment of the underlying assets used to provide for their monthly income payments.

Monthly pension annuity payments are guaranteed as long as the employer or insurance company that is managing the pension is financially solvent. A portion of the pension is backed, at a reduced benefit, by the PBGC (Pension Benefit Guaranty Corporation). Many companies do not factor in cost of living adjustment (COLA) increases into annuity payments as a result, fixed annuities do not provide inflation protection. You do not have access to the principal balance in your plan. Depending on the option you elect to receive after you and your spouse pass away, the monthly payments cease and there are no additional financial benefits to your family.

Once you commence your monthly annuity payments, you are no longer eligible to defer or delay these payments. The annuity pension option is inflexible. If your financial objectives change after retirement you cannot make changes to your pension annuity election.

The lump-sum pension allows retirees to receive a cash balance and either directly roll it over into an IRA (recommended) or have it paid directly to you (this is not recommended since taxes and a premature withdrawal penalty may apply). The lump sum is determined using the interest rate that is entered on the date the estimate was prepared. A higher lump sum interest rate will generally yield a higher lump-sum value. An actual lump sum may differ depending on the interest rate in effect at the Benefit Commencement Date. 

Some plans allow employees to receive a percentage of their pension benefit as a Lump Sum, with the remainder in the form of a monthly annuity. The Partial Lump Sum options allow you to choose to have 25%, 50%, or 75% of your benefit paid as a lump sum with an annuity optional form for the balance of your benefit. Your final benefit payment will depend upon the percentage you elect to receive as a Lump Sum and the form of annuity chosen. To receive this form of payment, you will need to make an election for both the Lump Sum percentage and the type of annuity. If you decide to defer commencement of your retirement benefit, this Lump Sum option may not be available at any future commencement date.

There are no guaranteed monthly payments under this option. The IRA rate of return is variable. We encourage retirees to distribute an IRA withdrawal rate of 4% or less of their total balance. We believe that doing so will enable investors to generate income while also having the potential to grow their assets to protect against inflation.

The lump-sum pension option provides more flexibility. Retirees have the flexibility to modify the amount and frequency of their distributions. There is a special tax method called IRS code (72t) that can be utilized for retirees who wish to withdraw assets from their IRA prior to age 59 ½ and avoid the 10% premature withdrawal penalty. When the IRA owner passes away, the balance in their account can be passed on to their beneficiaries. The ability to pass assets to their IRA owner’s heirs is one of the major advantages of receiving a pension lump-sum payment versus a fixed annuity. A financial advisor can assist retirees in determining an asset allocation mix that meets their investment needs and objectives. 

The views stated in this letter are not necessarily the opinion of First Allied Securities Inc. and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results. Investors should consider their financial ability to continue to purchase through periods of low price levels. All investing involves risk, including the possible loss of principal.

We are not tax consultants, nor do we provide tax advice. Please consult with your tax consultant regarding any tax reporting questions.

This information comes from sources deemed reliable but cannot be guaranteed. Please rely on confirms and statements for official reporting.