A client recently told me that he was planning on taking the lump sum pension because he heard from Dave Ramsey this is the best option. Are you kidding me?! You are making one of the biggest financial decisions of your life based on a four paragraph article by Dave Ramsey? I know the guy is THE financial guru, but he doesn’t know your personal financial situation. And this is coming from me, just another guy that spews financial advice online. Still, here is why I wouldn’t base your pension decision on Dave Ramsey’s advice.
Taking your lumps
Here is the link to the Dave Ramsey article about taking the lump sum pension: Taking Your Lumps. A few excerpts from the post:
Mark in Texas used to work for a company that had a pension plan. It’s still in place. He’s being offered a lump sum payout, or he can opt to receive a monthly annuity of $264 until death when he reaches the age of 67. He’s 54 now. Which is the best alternative?
I’ll tell you, 95% of the time, you’d be right to roll it into an IRA in good growth -stock mutual funds that have a long track record. You are going to come out ahead that way…
The other advantage, in addition to making more than 7% over a long period of time, I think, is that when you die, the pension dies with you. The IRA does not die with you. It goes to your heirs, so you get to pass that lump sum on. It’s almost always better to take the lump sum as long as you don’t spend it.
Wait, more than a 7% rate of return?
Yes, if you know that you can earn more than a 7% rate of return on your lump sum, go ahead and take the lump sum. Unfortunately, this isn’t as easy as it sounds. Actually, it doesn’t even sound that easy. Sure, the stock market has returned quite a bit more than 7% over the long-term, but individual investors have done quite a bit worse than this number. Over the long term, investors have barely cracked 5%, and this is while the market has nearly doubled that return. Give me a 7% rate of return and I’ll take the lump sum all day long, unfortunately I’m not sure that this is so realistic.
Invest it all in a growth mutual fund?
Let’s say that you are the average employee, you retire and get a lump sum payout that equals hundreds of thousands or even millions of dollars. Now, you take that huge sum of money and put it all into a highly volatile growth mutual fund? How comfortable will your retirement be when you see this gigantic lump sum fluctuating by tens of thousands of dollars each day. I know you need to take on risk with your investing but a more balanced approach to your lump sum is the better option for most of us. Putting a large lump sum, and the bulk of many people’s retirement, into a growth mutual fund is crazy.
The biggest issue isn’t that you will spend all of your lump sum
He mentions that as long as you “don’t spend it all”, you will be much better off with the lump sum. My biggest problem with most retirees is not that they will spend too much, rather they don’t spend enough when they take the lump sum. The retirees I mainly work with are petrified that they will spend down the lump sum too quickly and as a result don’t actually take big enough distributions. The result is not exhausting the lump sum too quickly, it is that they aren’t living as comfortable of a retirement as they could if they took the monthly pension. The lump sum generates a higher income for your kids when you die, the monthly pension maximizes your income while you are living.
95% if people should take the lump sum?
My biggest disagreement with the article, and there are plenty, is that 95% of people should take the lump sum. Sure, there are reasons why a lump sum makes sense, which I write about more in this article. There is no way that taking your pension as a lump sum is advisable for nearly everyone. I would actually go the other way and say that 95% of people should take the monthly pension. Dave Ramsey talks about the fact that “when you die, the pension dies with you.” Again, if your goal is to maximize your kids inheritance, yes, the lump sum makes the most sense typically. However, maximizing your kids inheritance is not the main goal of most retirees. Your goal is to maximize your income and enjoyment, and in my opinion, the monthly pension does this better than the lump sum.
However, I probably do agree with him in this situation
I believe that most people are better off taking the monthly pension, however in certain situations I do think the lump sum is the better option. One of those situations is when you retire/leave a company, but go to work elsewhere and don’t need the money now. In that situation you can take the lump sum and invest it until you actually need the money. As much as I don’t agree with most of Dave Ramsey’s points, I do agree that they lump sum is probably better in this situation.
The pension lump sum decision is one of the biggest financial decisions you will make. The decision is a little more complicated than “95% of the time you should take the lump sum”. There is no right answer for everyone. I tend to think that the monthly pension makes sense because you have a guaranteed monthly payment that you can rely on. However, I can also see the benefit of taking the lump sum and the flexibility that it gives you. Analyze your situation, work with a financial advisor, and determine what makes the most sense given your situation and comfort level. Most importantly, don’t make one of the biggest financial decisions you have, based on some general advice from a couple of guys on the internet.
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