Pension Plan Lump Sum Payments: Arguments for Taking Them

Last Updated Sep 23, 2010 6:14 PM EDT

Last week, I wrote a post titled Pension Plan Lump Sum Payments: Why You Should Avoid Them. In that post, I responded to a CBS MoneyWatch video interview of John Carl, President of the Retirement Learning Center, during which John stated that you should consider taking a lump sum payment from a pension plan. Here John responds to my prior post with the reasons why you should consider taking a lump sum payment. I've included John's comments in their entirety, for which John has given his permission to publish here.

"Differing opinions make the world go 'round. Therefore, I am pleased to respond to Steve Vernon's commentary on my CBS MoneyWatch.com interview on retirement distribution options. With respect to lump sum distributions from defined benefit pension plans, I'd like to clarify what I said during my interview with Rebecca Jarvis, and expand on a few points.


First, during the interview, I was careful to point out that if a lump sum distribution is available it should be considered -- not necessitated. I stand by that comment 100 percent. If you have a lump sum option, you should fully evaluate it along with the annuitization option.

While a lump sum may not be right for everyone (e.g., my brother's wife in upstate New York felt annuitization was right for her), it may be appropriate for some. There are pros and cons for both annuitization and lump sum distributions, and here is a quick outline of some of those considerations.

Lump sum distributions can be attractive because you have control of the assets vs. the plan. Proceeds can be invested and utilized at your discretion (or with guidance from your financial advisor) in differing amounts and in various investment vehicles -- including fixed or variable annuities. This flexibility to have cash flow as needed in retirement can be especially appealing for semi-retirees who -- by choice or necessity -- continue working during a phased retirement period.

Lump sums offer broader, more flexible legacy planning options. You can roll over lump sums to IRAs, and freely name beneficiaries so any remaining proceeds can pass to future generations or to charitable causes. While it is true that most defined benefit plans offer some type of survivor annuity option, often it is only available for a spouse (i.e., no kids, grandkids, or life partners). Also, once selected, the option is irrevocable. A decision that seemed prudent at 62 may not be optimal at 72 or 82.

Additionally, a lump sum distribution is simply the net present value calculation of what the pension income stream would have been. Interest rates are big part of the calculation: the lower the rate -- the higher the lump sum payment. With interest rates at historic lows, these lump sum values are more favorable than in a higher rate environment.

The major downside to a lump sum distribution, as Steve aptly pointed out, is investment risk. So a lump sum distribution requires careful consideration, and investment in a conservative portfolio that perhaps includes some guaranteed income options.

Annuitization also has pros and cons. On the positive side, you receive a guaranteed stream of income. Many individuals find this attractive and comforting. The plan's trustees invest the monies with guidance from professional consultants, in most cases, so you don't have to worry about the investment aspects and risks.

On the downside, annuitization gives you a fixed monthly payment, so if you need extra cash, say for an unforeseen expenditure, annuitization cannot provide it.

There is also historical precedent for allowing bankrupt employers to shirk their pension responsibilities. While this is not an everyday occurrence, we have seen a growing number of businesses struggling financially in this economy. A recent case in point is the bankruptcy of St. Vincent Catholic Medical Centers based in New York City, which affected 9,500 workers and retirees.

Both Steve and I mentioned the government agency that insures private pension plans -- the Pension Benefit Guaranty Corporation or PBGC. According to the PBGC, the breadth of business failures during its 2009 fiscal year was unprecedented in its 35­-year experience. These bankruptcies and plan defaults have affected tens of thousands of employees (70,000 Delphi employees alone), so one must consider this as a possible risk.

And while the PBGC will act as a safety net for defaulted pension plans, it is functioning under a $21.9 billion deficit. Moreover, the maximum PBGC benefit is capped -- at $54,000 this year if you worked to age 65. But your actual maximum benefit is based, in part, on your age on the plan's termination date -- and the PBGC does not guarantee certain pre-termination benefit increases, supplemental benefits. or cost-of-living increases. Ask a Delta pilot how he/she feels about that. Take a look at the PBGC maximum benefits showing benefit reductions by age.

Here's the bottom line: There are pros and cons for both annuitization and lump sum distribution. You should consider all options in order to arrive at a prudent decision. Steve brings up some excellent points in his commentary, but we'll have to agree to disagree on the issue of giving serious consideration to a lump sum distribution, if available."

-Respectfully, John Carl. President, Retirement Learning Center
So now you have the pros and cons of the lump sum vs annuity decision, considering John's comments above, my prior post, and the longer article on my website.

I agree with John; you should carefully consider all options in your decision. This is one of the most important decisions you'll make regarding your retirement, and you can't change your mind once your decision is implemented. If you choose the lump sum payment, you must consider how you will use that lump sum to generate lifetime retirement income, no matter how long you live and no matter what happens in the economy. This is a significant challenge, and that's why I addressed it in my post last Monday and here today.

More on CBS MoneyWatch
Pension Plan Lump Sum Payments: Why You Should Avoid Them
IRAs and 401k: 3 Ways to Generate Retirement Income
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    For more than 35 years, consulting actuary Steve Vernon helped large employers design and manage their retirement programs. Now he's a Research Scholar for the Stanford Center on Longevity, where he helps collect, direct, and disseminate research that will improve the financial security of seniors. He also delivers retirement planning workshops and has authored Money for Life: Turn Your IRA and 401(k) Into a Lifetime Retirement Paycheck and Recession-Proof Your Retirement Years.

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