Unfortunately, I’ve seen it before. A soon to be retiree has to make the decision to take a monthly pension or the lump sum annuity. He decides that he likes the flexibility that the lump sum option offers and decides to forego the monthly annuity. Once he gets the lump sum, he takes a distribution to pay off the remaining balance of the mortgage. Next, he takes out some more money to buy a car and help his daughter get through college. Another distribution to take care of those pesky credit cards and of course that dream vacation. He keeps telling himself that this will be the last big withdrawal that he needs, and once he gets these bills paid off he will be fine. Of course the bills keep building up and the distributions keep coming. In three short years the lump sum is drained and the once happy retiree is looking for a new job. This is the nightmare scenario for every retiree and certainly everyone who takes the lump sum pension. Obviously, you know that spending all of your lump sum in three years is a huge problem, but let me tell you another one that I see all the time.
In order to not make the same mistake as the example before, a retiree takes the lump sum and doesn’t touch it. Too nervous that if he does start taking withdrawals he will run out of money. He has plenty of money, but foregoes vacations, new hobbies and anything else that may require a distribution from his retirement savings. Congratulations, he’s not going to run out of money early. Unfortunately, he is also going to live a miserable retirement feeling like he doesn’t have the funds to be able to enjoy his new freedom. I’ve probably been in more meetings with clients encouraging them to take more out of their retirement savings than pleading with them to take less. I live in Michigan and many of my clients are engineers for the car companies. Engineers tend to be a little more conservative and more numbers dependent than other clients. This tends to give engineers an advantage in saving for retirement, but is also the same reason that they hate to see their life savings go down. Running out of money is absolutely the biggest problem in retirement, but not withdrawing enough (if you need the money) is absolutely an issue.
One of the biggest benefits of the lump sum is that it gives you a lot more flexibility. You are the one that decides how much you withdraw and when those withdrawals take place. For many people though this flexibility can also be the problem with the lump sum. The monthly pension option doesn’t give you any flexibility, you get a set amount each month for the rest of your life. The nice thing is that this gives you a baseline that you can spend each month. Between the monthly pension and social security you have a “forced” budget that you can feel comfortable spending and hopefully some additional savings to help fill in the gaps.
One last thing to consider is how comfortable would you be taking withdrawals from your retirement savings when the market drops? For example, let’s say that you need to withdraw $50,00 per year from your retirement savings to live comfortably and after the lump sum you have a $1 million account value. Now, let’s say that the stock market goes down 20% and your $1 million nest egg loses $200,000. Would you still feel comfortable taking out the $50,000 a year when your assets are heading lower because of a stock market correction? Sure this is hypothetical, but it is a common situation. Typically, we see a 20% market correction every 3 years or so. You will see a bunch of these corrections in retirement, and you need to feel comfortable still taking distributions even in a market correction. If you feel like a market drop may really hinder your distributions, you may want to consider the monthly pension.
Certainly, the monthly pension isn’t for everyone and I think the lump sum is appropriate for a lot of people. That being said, before taking the lump sum, ask yourself if you really feel comfortable with taking fairly significant distributions from your investments. Also, ask yourself if you feel comfortable seeing your assets decline and still taking distributions even in a market correction. If not, the monthly pension may be a better choice for you.