Retiring: Pension or Lump Sum?

When people retire, many face the biggest financial decision of their lives. Do they keep their pension and its monthly payments or do they take the lump sum? The pension provides security and peace of mind, but having the lump sum would really be nice, too. Which should you choose? Here’s a simple analogy that might make that decision easier. Steve, age 65, is retiring after 30 years of working for the phone company. He logs on to the company benefits website and sees that he has a decision to make. He can get a lump sum payment from his pension of $300,000 or he can instead get $1,817.94 a month guaranteed for the rest of his life.

Steve likes the thought of getting a onetime $300,000 check, but his wife likes the security of a monthly guaranteed payment. What should he do?

First, Steve (and you) need to understand the underlying concepts involved in this decision. Either way, you have to have monthly income to live on. Think of that monthly check as 10 gallons of milk. You have the choice of being guaranteed that you will receive 10 gallons of milk a month for the rest of your life or, you can take the cow that produces that milk instead.

For a moment, let’s look at it from the side of the one guaranteeing that monthly supply of milk. They own the cow and know it should produce 13 gallons of milk each month. (Don’t laugh farmers, I’m a city boy!) In that situation, would they guarantee someone 13 gallons a month? Of course not.

They have the responsibility to care for and manage the cow. If they don’t do that right, she (I do know that much…) may not produce as much milk. Plus, they have to keep some of the milk for themselves, or it’s not worth doing in the first place.

To decide what stream of milk to guarantee, they start with what they know the cow will conservatively produce. Then they subtract out the amount of milk they want to keep, and they see that they should have 10 gallons left over each month. Thus, they guarantee to deliver 10 gallons a month to you. It’s the same with the insurance company; they won’t give you all the ‘milk’ the ‘cow’ produces.

Of course they own more than one cow, but they aren’t going to put themselves in a position where they regularly have to take the milk from another cow to make their guaranteed delivery to you. In the same way, do you think an insurance company is going to guarantee you so much in monthly payments that it might force them to take money from somewhere else?

What if Steve decides to ‘keep his cow’ instead of receiving the guaranteed monthly stream of milk? First, he and his wife get all the milk. They might even breed the cow to get a calf. Second, if Steve dies, his wife continues to get milk. Third, the cow can then be passed on to their children when they both have passed away. Fourth, if there’s an emergency and push comes to shove, they can sell the cow and use the money for other things. None of these advantages exist if all you get is the guaranteed stream of milk.

With ownership comes responsibility, though. The cow has to be cared for so its milk production doesn’t decrease. The cow has to be protected so it doesn’t run off or get stolen. If (like me) you know nothing about caring for a cow, then you will need to hire someone else to do it for you. And that hired hand might be more concerned about his or her paycheck than your milk supply. Certainly the amount of milk each month will fluctuate. By owning the cow, though, you receive some milk and have the cow to boot.

Hopefully, this analogy will allow you to better understand the decision you face. Receiving a lump sum allows you to maintain control and maximize your returns. But if you know nothing about investing, you may be a sheep waiting to get fleeced! Don’t believe everything you hear and research every financial decision before you make it. Feel free to contact me for help.

Nationally-syndicated financial columnist and Certified Financial Planner® Jeffrey Voudrie provides personal, in-depth money management services and advice to select private clients throughout the USA. He’ll answer your financial question – FREE at www.guardingyourwealth.com.

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