Evaluating Pension Options

Each year we are seeing fewer workers covered by a company pension plan.  Overwhelmingly companies are trending away from the traditional pension- a defined benefit, to a defined contribution plan like a 401k.  By and large employers have decided that guaranteeing a retirement income is too expensive.  If you are lucky enough to be in the minority covered by a pension, it’s a valuable benefit and can present the most vital decision for your financial future.  Determining when and how you access your pension benefit requires a blend of hard math and a softer evaluation of your family’s attitude and goals.

Pension plans usually have several options for a retiring employee.  You can choose to take a lump sum upon retirement or a series of monthly payments.  There are often several different options for payments.  Payments can be guaranteed for the worker’s life or for a worker and spouse.  They can also be guaranteed for some number of years to a beneficiary if the worker passes early in retirement.  Each added guarantee reduces the monthly benefit.  We can analyze the differences to determine the actuarial assumptions made by your plan and see if one option is “mispriced” in relation to current assumptions.

With the projected payments in hand, the first big decision uses hard math to do a somewhat morbid break-even analysis.  When choosing between a lump sum and payments, how long must the payments last to outdo the lump sum?  If it takes until age 100 to break even, most would prefer to take their chances investing a lump sum.  If the break-even age is closer to life expectancy, the math is less compelling and leads to a personal value judgement.

The value judgement is much more art than science; there is never a perfect answer.  The pension must be examined alongside the entire family’s picture.  If other retirement income like Social Security and real estate income is strong, you might rely less on monthly payments and choose a lump sum.  A lump sum is also available for heirs, if that is an unmet priority.  However, monthly payments can be right for someone who is risk averse or could benefit from the forced budgeting inherent to fixed payments.

When and how to access a pension is a very personal decision, yet we have some advice that is perfect for all workers with pensions- learn your options early.  Planning a decade out while other opportunities are still available maximizes success.  Some pensions escalate in value immediately before retirement, while others see very little change in benefit after peak earning years.  Learning the facts early may make you want to change companies or hold on for dear life!  As with any other piece of the financial puzzle, it’s best to know what you own and plan early and often.

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