Should I take a lump sum of $48,000 or $462 monthly payments for a retirement annuity?

By | December 18, 2023

Buyout decisions have become increasingly common for people with pension plans. If you get this offer, the key questions you’ll need to answer include when you would receive the payout and how long you expect to live. The sooner you receive a lump sum, the more it will be worth to you when you retire. On the other hand, the longer you live to collect monthly payments, they can add up over time. For example, if you’ve been offered $48,000 in exchange for forgiving a $462 monthly payment, you may want to play with the percentages and do a buyout when you’re over a certain age. Otherwise, monthly payments may be preferable

Do you have questions about your pension plans? Talk to a financial advisor today.

Should you take the lump sum or monthly payments?

A pension plan is a retirement benefit offered by some employers. Basically, it offers you a guaranteed amount of money every month, starting at retirement and lasting for the rest of your life.

As a way to save money, companies are increasingly offering their current and former employees an option known as a “buyout.” This means that they pay you a fixed amount up front in exchange for any other payments. For example, you might have these two hypothetical choices:

  • Monthly payments: $462 per month, for life, from retirement

  • Lump sum redemption: $48,000 immediately, with no further payments

The question is: what should you do with such an offer?

“There are several important points to evaluate before choosing a lump sum or annuity payment,” says Jeremy L. Suschak of DBR & Co. against SmartAsset. “Firstly, the pension owner must consider their health. It is crucial to consider this first as health-related factors can ultimately challenge the financial considerations.”

Pension value is based on longevity

Suschak raises an issue known as longevity risk. Essentially, the value of a monthly pension is based on how long you will live. You don’t have to worry about bankruptcy risk, as the federal government’s Pension Benefit Guaranty Corporation insures monthly payments well above $462.

For example, suppose you start collecting your pension at age 67. Someone in good health can potentially expect to live another 25 years, making this pension worth €138,600, compared to €462 per month during that time. But that may only apply to someone who is in good health. If you expect to live another ten years, this same pension is only worth $55,440. So the healthier you are, the more this pension is probably worth.

Longevity risk and your personal risk tolerance are important things to understand when making a critical decision for your upcoming retirement. A financial advisor can help you understand these terms and create a plan for the future.

The lump sum value is based on the payout date

Suppose you have no cost-of-living adjustments on the retirement annuity or the return on the lump sum payment. Then, at $462 per month and $5,544 per year, you need to reach age 8.65 to break even on retirement benefits with a lump sum payment of $48,000.

“In this simplified scenario, when the retiree’s life expectancy is less than 8.65 years, the lump sum would be preferable,” said Bryan M. Kuderna, founder of the Kuderna Financial Team.

This analysis represents the issue of payout date, as the value of each payout is based on when you would collect it. If you receive this buyout at or near retirement and withdraw $462 per month, even with a 10% return, the money would only last about 14 years.

On the other hand, suppose you are offered the same buyout at age 37 and put the entire amount into an S&P 500 index fund with a historical average annual return of 10%. At age 67, when you might want to retire, it would be worth $837,571 if you didn’t contribute anything extra.

With these figures, the sweet spot is around 14 years. If taken at age 53, a lump sum of $48,000, assuming the same standard S&P 500 return, could add up to about $182,000. That’s the breakeven point at which your lump sum investment will be greater than the amount you would accumulate over a reasonable life expectancy.

Other income and longevity concerns to manage

Finally, Suschak says, “pension owners should consider the type and amount of other income streams available to them in retirement. All sources of income, including the pension, should be considered relative to the expected level of expenditures in retirement.”

What social security benefits do you receive? What do you have in other retirement accounts and how safe are they? How does this pension fit into your retirement plans in general?

These questions will help determine how much you should prioritize the safety of a monthly payment over the potential option of a lump sum. If you have significant other sources of income, you may be able to choose a lump sum and invest it. On the other hand, if this is a significant part of your retirement plan, it may be wise to prioritize the security of the annuity payments over the investment opportunities of the buyout.

In short

Whether you need to take a pension buyout depends on when it is offered to you and your life expectancy, among many other factors. For most pensions, the sooner your employer offers the buyout, the better the deal can be. But the closer you get to retirement age, the more you’ll want to prioritize monthly payments.

Retirement planning tips

  • A financial advisor can help you draw up a retirement plan for the future. Finding a financial advisor does not have to be difficult. SmartAsset’s free tool matches you with up to three vetted financial advisors serving your area, and you can have a free introductory meeting with your advisors to decide which one you think is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

Photo credits: ©iStock.com/g-stockstudio, ©iStock.com/megaflopp

The post Should I take a $48,000 lump sum or $462 monthly payments for a retirement annuity? first appeared on SmartReads by SmartAsset.

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