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After years or even decades working, you’ve finally reached the age of retirement. Now, you get rewarded with a pension. However, that means you have to make a critical decision: Do you take the money as a lump sum, or do you have the money sent to you in monthly installments?
With everything going on right now, especially a pandemic that’s caused havoc on homes and businesses, a lot of people are retiring early. Most initially think they’d take the lump sum. Then again, some feel the installments would work best for their situation. Regardless, with both of these options, you’ll need to make some important decisions.
For example, if you think you’d want to receive your pension in installments, you need to determine who’ll manage the money. Is that something you would leave up to your employer, or would you be more comfortable managing it yourself? With the lump sum, depending on the amount, you might need some professional assistance to ensure it lasts throughout your retirement and perhaps beyond for your beneficiaries.
Unfortunately, most employers don’t give their retirees adequate time to make a well-informed decision. That can cause some individuals to make the wrong choice. When that happens, there is nothing they can do to change their decision.
You might think it should be easy to choose between monthly pension payments and a lump sum, but it’s not. For example, if you take all the money at once, you’re at higher risk of depleting your retirement funds prematurely. On the other hand, if you choose installments but pass away, there’s a chance nothing would go to your loved ones. That means, after all your hard work, you get less than you are owed.
Doing the Math
From a straight mathematical perspective, the calculation of which option is better is not that difficult. The WealthTrace Retirement Planner can be used to run scenarios for this type of question.
For example, consider a pension that pays out $50,000 per year at age 65 for life and does not grow at all. The option was to take a lump sum of $800,000 instead. It turns out that the lump sum is better in this case because that amount ends up growing with the investment rate of return and is a larger amount after 20 years. It also avoids the possibility of the company going bankrupt, which is discussed later in this article.
So, What’s the Correct Answer?
Well, it depends on the situation, including the individual, the amount of money, and the goals. Remember, if you take the lump sum, you can invest it, especially if you’re still relatively young. That way, your retirement money continues to grow. Then, you can set up a will that leaves it to your chosen beneficiaries.
If you’re unsure how much you’d get in a lump sum minus any state and federal taxes, you can always use an online calculator or speak with a financial advisor. The only downfall to using a simple calculator is that it can’t identify any potential risk, such as the fall of the stock market after retiring. You can get a pretty good estimate of your net payout using a service like this, but because there are so many variables involved, it makes more sense to work with a financial advisor.
Something else to consider when taking the lump-sum option is that you could end up getting shortchanged. Just look at the statistics on this: Multiple organizations found that within 5.5 years, one in five retirees had used all the money they took in a lump sum. These studies also showed that a whopping 35% of retirees said they had concerns that the money wouldn’t last long enough for them to enjoy their “golden years.”
When Does the Cash Option Make Sense?
If you’re worried that the company you work for could go out of business or face financial hardship, take the money and run. This also applies if you work for an employer in the public sector or a religious organization. There’s too much potential risk to go with the monthly installments.
Another viable reason to take the lump sum is if you feel comfortable investing. If you are good at managing money and building a strong portfolio, this option will give you a lot more flexibility to make choices. Even if you’re not an investment whiz, a professional financial advisor can help you so that your investment provides you with both stable cash flow and growth while retired.
There’s yet another reason to choose the lump sum. If you’re already financially stable or you’re included in your spouse’s retirement fund, having the money on hand would allow you to donate it to charitable organizations or pass it to your children or grandchildren. You could also roll the money into your 401(k) or an IRA.
When Do Pension Installments Make Sense?
Like with the lump sum, there are many circumstances when going with the monthly installments is a great option. Say you’re married. If you should pass away before your spouse, the monthly payments would provide them with a sense of financial security. However, the key is to make sure your pension has a “joint and survivor” option.
Another reason to take this route has to do with spending. Let’s be honest; not everyone is good with money. If you struggle to save or spend more than the budget allows, this is the better choice. Otherwise, you could easily go through the lump sum in no time.
Finally, if you’re someone who gets anxious about money, you might consider the monthly payment option. For some people, just having a set amount of funds come in each month eliminates a lot of stress and anxiety.
It’s an Important Decision
As you can see, both pension installments and lump-sum payouts have advantages and disadvantages. But it’s important to think deeply about this before making a decision.