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Pension vs. Lump Sum Distribution

“A Tough Decision”

Pension Considerations:

  • A pension is a fixed benefit payment, payable for the life of the retiree. Its payments are promised by the issuing company to last as long as the retiree lives.
  • The normal pension stops at the death of the retiree, but is normally offered with a “joint and survivor” option with a reduced benefit. Should the retiree die, then the survivor receives a percentage of the pension payment. However, there is a mortality cost to this benefit which results in a lower monthly lifetime benefit to the retiree.
  • The pension usually pays its benefits for a fixed amount yet sometimes, but not often, is made available with an inflation adjustment which could increase the payment in future years. However, this is an expensive benefit and not often included in the pension options for the employee.
  • The promise to pay by the pension is subject to the “claims paying ability” of the insuring company to pay the benefit; however, the government agency, PBGC (Pension Benefit Guarantee Corporation), exits to guarantee the pension in case of default and is subject to amount restriction rules.
  • There is no access to principal; the only amounts available are received in the monthly income stream of payments. 

Lump Sum Considerations:

  • The offer of a lump sum distribution in lieu of a fixed benefit pension can be enticing to the participant. The amount of the lump sum is based on the issuer’s calculation of a present value for a future stream of income payments. The amount depends on the age of the participant and the Single Life annuity amount of the pension with an assumed rate of interest.
  • The lump sum, if invested properly, should be designed to grow at a conservative rate in order to equal the pension amount while increasing enough to provide an adjustment for inflation. The distribution amount can be changed on an annual basis to adjust to changes in the economic cycle.
  • The participant is in control of the management of the account and has access to principal if needed. Conversely, he or she has no control over a fixed benefit pension.
  • Should the participant predecease the beneficiary, the lump sum proceeds are available as a benefit to the beneficiary. In addition, the participant can assign various percentages to different beneficiaries if desired.

In Contrast, the beneficiary of the pension is determined at the time of distribution and cannot be changed- it is an irrevocable decision.

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