If you’re planning to retire soon from your job and have a defined-benefit pension plan through the company you work for, you will be faced with the decision to either:
a) Accept the traditional, lifetime monthly payments or…
b) Take a lump-sum distribution, ‘cash’ payout of your pension.
The lump sum cash payout sure is tempting! Your pension commuted value could be 500k, 800k, or even 1 million dollars or more. Think of all the things you could do with that type of cash!
But like any choices you make for retirement, there are pros and cons. Let’s review some of them:
Lump-Sum Pension Payment
A “lump-sum distribution” is a one-time payment from your pension administrator. Here are some points to consider:
- You gain access to a large sum of money right away.
- Lump-sum payment gives you more control and flexibility over your money, allowing you to spend or invest it how you see fit.
- The amount you withdraw from investments can changed based on your retirement lifestyle needs.
- The lump sum amount you receive, after taxes are deducted, can be reinvested.
- If you die earlier than expected, there could be funds left over to be used as inheritance with your estate.
- Once you and your spouse die, the pension payments might stop if you are on a regular pension payout. However, with the lump-sum distribution option you could name a beneficiary to receive any money that is left after you and your spouse are gone.
There are some negative aspects to the lump-sum distribution option:
- Income from pensions is taxable, and in Canada it is a big tax ‘haircut’ when you take the lump-sum cash. A significant amount will be immediately taxed, typically hundreds of thousands of dollars.
- The biggest risk is that your pension is no longer guaranteed to last for life because investment volatility could impact growth.
- You’re only partially protected from creditors.
- The lump sum amount you receive requires careful asset management to ensure you have enough to live on for the rest of your life. When you are in retirement, you don’t have the luxury of riding the ups and downs of the financial market. If there is a slump in the economy, or a recession, it can greatly impact your investments which would impact how much you have to pay yourself monthly to live off of.
- Flexibility is great, but can also be a negative. With a lot of money being accessible to suddenly spend, it can invite overspending, and once you’ve spent the money it is gone for good. A 2017 study of retirees revealed that 21% of retirement plan participants who took a lump sum depleted it in only 5.5 years on average.
- Your health insurance coverage may be affected if you take the lump-sum payout. Some companies that continue health coverage to their retired employees stop coverage if an employee takes the lump sum payout. If this is happens to you, you’ll need to take into account the cost of paying monthly for health insurance coverage from the amount you withdraw each month from your investments.
Regular Pension Payments
A regular pension payment (also referred to as a Lifetime Monthly Benefit) is when you retire and decide to receive a set monthly payment for life. In some cases, depending on your plan, this can continue after you pass away and payments are sent monthly to your spouse until he/she passes.
- Pension payments are made for the rest of your life, no matter how long you live, and can at times continue after death with your spouse.
- With a regular pension check, it is harder to splurge or overspend on items that you might later regret.
- You get guaranteed income for life.
- Tax is spread equally over your lifetime (stable predictability)
- No concern about running out of funds
- No concern about investment volatility
- Fully protected from creditors
Some dis-advantages are:
- Being 100% taxable income for your lifetime
- You can’t adjust the pension benefit amount
- If you and your spouse die earlier than expected, there is nothing left over that could be used as inheritance
As you can see, there are pros and cons to both options. It comes down to how long you expect to live and how much control you want over your assets.
Let us analyze your multiple income streams in retirement. We’ll make sure to minimize your income tax.
Retirement planning is about budget and taxes. You address your spending. We address tax minimization.
Consult with a professional to help you with this key financial decision.
Bruce Youngblud, CFP, CIM