If retirement is on the horizon, and if you are a beneficiary of a workplace pension plan, you’ve got an important decision to make. Will you take your pension as monthly payments, also known as a pension annuity or lifetime income, or is it better to withdraw your retirement funds a lump sum? Read on for a rundown of factors to consider when it comes to pension planning—from taxes, to investing, to spousal benefits and beyond.
Receiving a lump sum payment up front gives you more control over your retirement funds. This can be an advantage or a disadvantage, depending on how you manage your money. Some people prefer the opportunity to invest their own money and, potentially, grow this sum via stocks, bonds, mutual funds and so on. This is especially true considering that monthly payments don’t get larger over time—so, due to inflation, monthly payments will in effect be decreasing as time goes on.
Considering that the average stock market return is 10 percent per year, taking your pension as a lump sum and investing it wisely should result in steady growth for your retirement savings in order to counteract the effects of inflation. This option may be appealing to retirees who are in good health and expect to be living on their pension payments for the next ten, twenty or even thirty years. Of course, as always when it comes to investing—there are no guarantees.
In terms of taxes, keep in mind that taking a lump sum from your pension means you are immediately responsible for paying taxes on the entire withdrawal, at a rate of 20 percent. The exception is if you immediately (within sixty days) roll over the money into an Individual Retirement Account (IRA), which won’t be taxed until you begin taking distributions. This can be a good option to invest your money and potentially grow its worth, before you begin taking withdrawals and paying taxes on the funds.
One major advantage of forgoing a lump sum and choosing monthly pension payments is that, in most cases, payments are guaranteed for the rest of your life. Depending on the annuity option you choose, they may even continue after your death, so that your spouse will be financially supported; whereas with a lump sum payment, there is no avenue to guarantee an ongoing monthly income for spouses.
When you receive your pension as monthly income, it’s subject to ordinary income tax. In many cases, this tax will be less than the 20 percent tax you’d pay if you took your pension as a lump sum. You can also defer tax payments until after retirement, which can be beneficial to people who want to take out their pension prior to leaving the workplace.
Another benefit to receiving monthly payments is that it erases the need for serious financial management. You don’t need to decide how to invest the lump sum payment, or worry about looking after its growth. You can simply enjoy the guaranteed security of a monthly income.
Keep in mind that once you decide how to receive your pension benefits, it’s rarely possible to change your mind down the road. Therefore, it’s always a good idea to consult a trusted financial advisor before making this important decision. The best pension withdrawal strategy for you will depend on your plan for retirement, your health, your family’s needs, and your overall financial situation—including debts which need to be paid post-retirement, and other sources of post-retirement income.