Retirement Options: Lump Sum Versus Pension

When preparing for retirement, you may be faced with a decision that will launch you into the next chapter of your life: your company retirement plan may offer a lump sum or pension option upon retirement. Choosing the right option can seem like a daunting decision with no perfect answer, but it serves as a great opportunity to begin thinking about your retirement goals. Both options have their advantages, and it is up to you to determine which benefits you prefer more during retirement.

Lump Sum Options

On one hand, choosing a lump sum option gives you the benefits of flexibility, potential protection against inflation, the possibility to leave behind an inheritance, and investment diversification. A lump sum allows you to dictate when and how much income you withdraw from your account, in consideration of any negative tax consequences that can occur from such actions. Retirement can throw many surprises your way and being able to control the amount of income you withdraw from your account can help mitigate such challenges along the way.

Receiving a lump sum at retirement allows you to be invested in stock markets, which can provide for inflation protection of your assets in the long run. Keeping up with inflation ensures that the purchasing power of your retirement account does not become diluted in the years to come. Depending on your retirement goals, you may wish to leave assets behind to children, other family members, or a charity. With a pension option, the income stream ends after you or your beneficiary passes away. A lump sum, however, has the benefit of growing and potentially never being completely drained after retirement. This account can then be passed on to any of the aforementioned beneficiaries.

Despite the pros, there are, however, cons that are associated with the lump sum option. Lump sums are subject to market risk as well as a non-guaranteed income stream. If the lump sum distribution is the majority of your retirement nest egg, you are vulnerable to market conditions. This can be hedged through a more conservative strategy, but there exists the risk of losing money during retirement. In comparison with the pension option, you also are not guaranteed a monthly income. The lump sum option also does not provide immediate income, because investment earnings can take time to accumulate.

Pension Options

On the other hand, choosing the pension option has the benefit of serving as a guaranteed income source, is very simplistic, and is a quick income source during retirement. This option is appealing from a psychological aspect for many people. A pension offers an alternative to receiving a paycheck during your career, which can reduce anxiety for many people who are accustomed to receiving a reliable paycheck.

Many pensions, unfortunately, do not come with a cost of living adjustment. This means that the purchasing power of your pension may deteriorate over time if inflation rates increase. A more extreme circumstance is that if the company were to go under, your pension benefit would be reduced. Fortunately, there exists the Pension Benefit Guaranty Corporation, which allows for a partial continuation of pension payments if such an event were to occur.

A pension is also very simple to manage. There is no market risk or worry about the value of your retirement account decreasing, and income is guaranteed, given that a specific amount of funds is deposited into your account each month. Cons that are associated with pensions include the previously mentioned inflation risk, the fact that they are not very flexible, and the fact that the payments end upon you and/or your beneficiary passing away. Having a fixed income source can be very convenient for some, but if a major life expense occurs and you do not have accessible funds, this can be a problem. With the pension option ultimately having an end date, there are no assets from this decision that can be passed on to children or other family members. If your ultimate goal is to leave money behind, this detail could be a deterrent.

As I mentioned at the beginning of this article, the decision as to whether to choose a lump sum or pension is reliant upon your own goals during retirement. If you are someone who prefers a flexible benefit that allows for inflation protection, an inheritance possibility, and can handle the ups and downs of daily market movements, then the lump sum may be the best choice for you. If you are someone who likes the idea of a simple and guaranteed income source throughout retirement, no matter the market conditions, then perhaps the pension is your best option.

To make an informed decision about your retirement options, meet with Financial Consulate. One of our trusted financial advisors will walk through both options with you and help determine which option makes the most sense for you. Contact us today to get started.

Financial Consulate aims to help lessen the worry and burden of wealth management and enhance financial wellness so our clients can pursue relationships and true fulfillment. Choose the professionals at Financial Consulate as your Certified Financial Planners™ (CFP®) to take advantage of our educational, ethical approach to financial planning. Our services are comprehensive, including tax planning, investment planning, retirement planning, estate planning, and more. We operate completely independently and offer fee-only services to keep your vision in line with our recommendations at all times. While we have offices in Hunt Valley, Maryland, Fernandina Beach, Florida, and Gettysburg, Pennsylvania, we serve clients across the nation. To begin your partnership with a trustworthy wealth advisor, please contact Financial Consulate today.