Should I Take the Pension Lump Sum or Annuity Income Stream?

[00:00:00] Intro: Hi, I’m Ed Slot and I’m Jeff Levine. And we’re two guys who just love to talk about retirement and taxes.

[00:00:06] Intro: Look, our mission is simple to educate you the saver so that you can make better decisions because better decisions on the whole lead to better outcomes.

[00:00:14] Intro: And here’s how we’re going to do that each week. Jeff and I will debate the pros and the cons of a particular retirement strategy or topic with the goal of helping you keep more of your hard earned money.

[00:00:26] Intro: Yeah, but we won’t know which side of the debate we’re taking until we flip a. Winner of the coin flip gets to pick which side of the debate they want to argue.

[00:00:33] Intro: And both of us will have to argue in favor of our respective positions, whether we agree with them or not.

[00:00:40] Intro: At the end of each debate, there’s going to be one clear winner. You a more informed saver who can hopefully apply the merits of each side of the debate to your own personal situation, to decide what’s best for you and your family.

[00:00:52] Intro: So here we go. Welcome to the great retirement debate.[00:01:00]

[00:01:01] Ed Slott: Hi everybody. And welcome to the great retirement debate. I’m Ed Slott, along with Jeff Levine and Jeff, what are we debating today?

[00:01:09] Jeff Levine: All right. So up for today, Ed, we’re gonna be discussing or debating. I should say whether someone should take their lump sum from a pension or whether they should take it out as an annuity option. And for today’s discussion, let’s not focus on whether a joint annuity or a single annuity based on a single life. Let’s just say, do you want a big pot of money or do you wanna take it out over your lifetime in guaranteed payments to last.

[00:01:36] Ed Slott: You mean like a pension? Like the company offers you a pension monthly’s payments or a lump sum all at once. That’s a big question, especially with lots of companies trying to de-risk and get rid of their, uh, pension obligations off their balance sheet.

[00:01:52] Jeff Levine: Well, hold on. Don’t go. Don’t go there yet. First we gotta flip. Maybe you don’t wanna make that argument, Ed..

[00:01:59] Ed Slott: All right. All right. Oh, [00:02:00] you did it already. I wanted the coin. I had an actual coin. All right.

[00:02:04] Jeff Levine: All right. You, you are the winner. So you get to pick, you wanna take the side of when you’re given the option, you should take the lump sum or do you wanna take the, this, the option of when you’re given that choice, you should try and take the pension.

[00:02:16] Ed Slott: And as we always say on these debates, this is for educational purposes to help you make the right decision. It doesn’t necessarily mean we agree with the side we’re taking. So I’ll take the side of the lump sum.

[00:02:29] Jeff Levine: All right. I’m going with the side of, uh, then I’m going with the side of annuity. Perfect. All right. So ed, let, let, let’s kick it off. I will defer to you. I will defer the coin toss if you will. Uh, and, and let you start, why would you say, take the lump sum?

[00:02:43] Ed Slott: Well, it’s a bird in hand, you know, when I’ve spoken to clients and I’ve had this discussion with people, just like the people, uh, listening today, uh, they say, no, I like, like to have my cash in the hand. You know, sometimes they don’t like their company, they don’t trust their company or don’t trust the viability [00:03:00] of the company. And they like to have that cash in hand, even though, actuarily, it may be less, they have the full payment, they can roll it over to an IRA and they know it’s in the bank, no matter what the future of the company might be.

[00:03:16] Jeff Levine: Well, that that’s a fair point, ed, but, but what is the number one concern that most people have when it comes to retirement?

[00:03:23] Ed Slott: Living too long and running outta money.

[00:03:26] Jeff Levine: All right. Well, when you take your money, it’s up to you to figure out and it’s up to the markets to handle, and it’s up to what stocks will do. It’s up to what bonds will do. If you go through a, a number of tough years, especially close to retirement, where sequence of return risk can kick in that could completely derail an otherwise sound retirement plan. Whereas if I have the ability to take a, a pension that is a guaranteed stream of income that I have for the rest of my life. And if I’m married, I can choose to take that over a spouse’s life or even over a younger beneficiary. Now [00:04:00] that may reduce my payments, but I can create guaranteed income for the life of myself, as well as other individuals I care about. And I don’t have to worry about what the markets will do. That’s on the company. I don’t have to worry about what, uh, bond rates are and what, you know, what interest rates do and how they impact my, my portfolio. I can leave that risk onto the company. And, and you even said, ed, like companies may want to get rid of this because they think it’s too good of a deal for the employee. Well, usually if the company thinks it’s too good of a deal for you, why would you give it back to the company?

[00:04:35] Ed Slott: Well, some people it’s true people, uh, like the idea on the one hand of guaranteed income for life, the money never runs out, but then I’ve spoken to people and they say, well, I’m retiring. I’d like to take an extra 50,000 or a hundred thousand and do this or that, or get a retirement home and do things. That won’t cut it on the monthly payment. Sometimes I need part of a lump sum. Maybe not all of it [00:05:00] and the rest they can invest on their own and maybe do annuities with their own advisor and create some of that stream of income or do other planning, but they have more freedom. And that’s what people like. Again, back to the bird in the hand, they can take the lump sum. It’s true what you said they could run outta money if it’s poorly invested, but that’s where you, uh, work with hopefully a financial advisor that can get you where you wanna go and limit the risk in the investments. If that’s what you’re worried or having, knowing you have other funds, you talked about sequence of returns risk, which means withdrawing when a market is in decline. Hopefully, if you’re making, if you’re looking to make this decision, do I take the lump sum, and it’s a very big decision now because lots of people are in transition, leaving companies. Do I take the lump sum or do I take monthly payments? You have to look at your own house and see if you have other funds that may carry you if the market goes down.

[00:05:56] Jeff Levine: That’s all fair, but I, I look and I say, what [00:06:00] happens when an individual wants to make sure that they don’t run out of money? What’s one of the best ways they can do that. And it is with a guaranteed stream of income, whether that’s through a pension or even through a, a private, uh, insurer’s annuity and not, you know, a true income style annuity, like a single premium immediate annuity or some other style of annuity where you make that payment and the insurance company now guarantees income for life. And I think it’s important to understand, uh, you know, for, for listeners to understand that if, if that’s the case, and you’re looking at these two options, your pension plan is almost always the cheaper annuity, if you will, right? Like there isn’t the need to spend dollars marketing for your pension plan. There aren’t all the, the distribution costs, etc. So when we compare what you could get on the open market with $1 of retirement savings and how much income for life that would buy with the same. That you could take with $1 of your [00:07:00] pension and see how much income for life that would buy, uh, most of the time, not always, but most of the time your pension will create a larger income stream. So you are, you’re in a situation where you’re already getting a really good deal on guaranteed income and let’s face it, another argument here that is probably discounted in a lot of, in a lot of places is the simplicity of this. You know, we’re talking about people who are going through retirement. And most of the time when we get to retirement, we need to simplify our lives. Uh, we are getting to the point in our lives where maybe cognitive ability begins to decline and, and we wanna spend our time doing things that are important to us. Not doing all these other things like figuring out how much stocks and bonds I should own and worrying about what the markets will do and not, it’s not just the, the fact that the markets go down. It’s not just the, what if, but even if things are good, there’s so many more decisions now that you need to make. How much [00:08:00] do you invest in different things? Which investments do you take? Do you have a Roth account or a traditional? All these decisions now piling on you at a time in your life when you’re trying to simplify things. I mean, it just, it sounds almost daunting to me, whereas the pension is nice and easy.

[00:08:15] Jeff Levine: It’s almost like when I worked, I just get my monthly check and I go do what I want with that money each month. And you know what it’s even better than working. Cause I don’t have to do anything to get it.

[00:08:25] Ed Slott: Okay. So somebody, uh, listening to this might sound, oh, that’s daunting, but you know what? When I’ve had people sitting in front of me and I’ve told them the same things they say, I still want the money. I want the big check. And anyway, and I’m gonna throw you a softball here. Okay. Uh, anyway, what if I’m taking the payments and many people have that choice, you said joint or one life or two life, obviously the longer you want the payments to go on the pension or what you call an annuity. The guarenteed payment, the the lower they will be. But, uh, so many people that choose that [00:09:00] tend to want the higher payment, which ends maybe at the first life, if you’re a married couple, for example. And then people say, what if I die three years in?

[00:09:08] Jeff Levine: Well, that’s good. I’ll take your lay up here. Yes, I’ll take your I’m gonna now slam dunk it. So if you have that, take the money and take a little extra and buy life insurance.

[00:09:16] Ed Slott: I knew you were gonna say that. That’s why I said I threw you a softball.

[00:09:19] Jeff Levine: Yeah. Well, I appreciate that. I I’ll give you back one, Ed. Uh, and, and that’s, you know, one of the things that you’ve said is that you should consider what would happen if the company goes belly up. The good news there, if you will. I guess it’s not really good news if your company goes belly up, but the, the nice part about that is the insurance that’s provided by your pension actually has insurance behind it in many cases and notably the P B G C, the pension benefit guarantee corporation guarantees, uh, up to certain amounts of monthly income.

[00:09:52] Jeff Levine: Even if your plan goes belly up. So. It’s fair.

[00:09:56] Ed Slott: Let me respond to that because that’s the softball bad [00:10:00] argument. Nobody, you just made your own argument against that. You don’t want complexity. You want simplicity who wants to deal with a pension benefit guarantee, Corp that at best after years of problems, they’ll give you a few cents on the dollar. If that happens. Again, I think a lot of people, even though actuarily they would do better with the monthly payments, given an average life expectancy, most people feel more comfortable taking control of their money, getting the lump sum, you know, getting that two, three, 400,000 out, putting it maybe in their IRA of the ability to convert it to a Roth IRA. And they feel they have control of their money and they don’t have to worry about these other things, including the company going belly up. Imagine telling somebody, well, now you’re gonna have to deal with a pension benefit guarantee Corp. They’re a government Corp oop, they’re short staffed. They’ll get back to you in three years and pay you 5 cents on the dollar.

[00:10:52] Jeff Levine: Yeah, we could put a link to the, uh, PBGC in our notes. Uh, our show notes. It’s worth noting that this year for 2022, [00:11:00] uh, if you’re taking basically a straight life annuity, right, and you’re a 67 year old, just to give people a sense of, of what those maximums are this year to be about $7,500 per month, which is pretty good. Although there are definitely some people who have income and pensions that are in excess of that. And with that, you would be effectively on your own. And if you had. Uh, a joint 50% survivor annuity for, so for two individuals that age, it’s closer to about 67, 6800 per month. So we’ll put a link to the, the PBGC benefits maximums in the show notes, and people can go check that out and see,

[00:11:34] Ed Slott: and we’ll hope nobody will ever have to go there.

[00:11:36] Jeff Levine: That’s right. I, I, yes, that’s a good point, Ed. Hopefully that is useless information for everyone, uh, for the rest of their lives. No doubt about it. Ed, anything else that like sticks out to you as a strong argument to make here in favor of, of taking this lump sum while you have that opportunity?

[00:11:54] Ed Slott: Again, the control and you actually, I wasn’t even thinking of it, but you actually made the better [00:12:00] argument, which I said a few minutes ago about the ability to convert it to a Roth once you roll it over to your IRA and this way you could do some Roth conversions, too.

[00:12:10] Jeff Levine: That’s fair. It’s a good point that we didn’t discuss. You do have not only more control over your investments, but over more control of when you pay those taxes…

[00:12:17] Ed Slott: and more control estate planning wise, even with the secure act and the 10 year rule, at least, you know, something, if you don’t spend it all, uh, you have some control over the beneficiaries that will get it for at least 10 years under the current tax rules.

[00:12:31] Jeff Levine: Yeah. Well, I’ll throw them out one more here for, for, for people thinking about leaving money to the next generation. And then you mentioned the secure act, that’s that law from 2019, that began to impact beneficiaries in 2020, where previously, you know, young individuals were able to, or anybody really, if you were named on a beneficiary form, could spread out the, the tax impact by spreading out the distributions from an inherited IRA or 401K or similar type of plan over the [00:13:00] course of their lifetime. Whereas now many of those individuals have to, to lock those distributions into just 10 years. So you may be compressing a multi-decade distribution schedule into just 10 years. And of course, taking out more income in each of those years can mean pushing yourself into a higher bracket phasing yourself out of credits and exemptions, etc. Well, interestingly enough, uh, now we don’t have final regulations ed, yet as we record here today. Um, but we do have proposed regulations. And if the final looks anything like the proposed that’s one other argument, actually in favor of the defined benefit plan for those looking to provide a, a lifetime income stream and a legacy to, to children or even grandchildren in the sense that with the secure act, many of those beneficiaries would have to take out everything over just 10 years. Whereas the rules only apply those that 10 year rule only applies to define contribution plans, define benefit plans. Like a pension plan actually are exempt. So you can effectively [00:14:00] replicate the stretch by taking the pension option and just choosing a younger beneficiary as the joint annuitant. In other words, the other individual with whom you take distributions out over a lifetime. So a lot of times people think like, well, I have to do it over myself and a spouse. It could be over you and a child or you and a grandchild. Yes. Payments will be much lower, but if you’re endgame…

[00:14:21] Ed Slott: That’s what I was just gonna say, that was my argument. To knock that down. The minute you add a beneficiary with all extended payout. There’s no free lunch. The longer the annuity payments go out. The lower each monthly payment will be a monthly distribution to you will be. And again, when I speak to clients and consumers, most of them want the larger check.

[00:14:42] Jeff Levine: That’s fair. That’s fair. Many, many, you know, just because you want something doesn’t mean it’s good for you. That’s part of why we’re here. I guess I’ll throw one more out to you. And that’s simply that, uh, when we’re looking at plans, a lot of times they’re based, you know, they’re based on actuarial tables and those actuarial tables [00:15:00] may consider all individuals of the same age effectively as equivalent and the unfortunate reality is that, you know, your socioeconomic status in life also determines a little bit of your longevity. If we look at individuals with higher incomes and higher net worth. They tend to have better access to healthcare facilities, the ability to pay. They’re not worried about going to the doctor and what the copay is, or, or able to afford whatever pills or treatment they may need. And so the, the life expectancy of someone with a, a higher income and higher net worth who is just by nature, more likely to have a pension is actually longer than the average life expectancy of the average person that age. So you’re kind of getting a benefit, uh, in, in, in those types of pension and look clearly, ed, obviously, if, if you know, you’re, you’re someone who’s not healthy taking a, a pension option over your lifetime probably is not a great idea, but to the, to the flip side of that, right? If there’s an opportunity here to, to [00:16:00] benefit from your higher net worth your higher income and that, um, actuarial push out of your life expectancy, the pension can be even that much more attractive. And that may be my, my final argument here on this one, Ed.

[00:16:14] Ed Slott: All right. You know, so you’re going back to the, actually the social security argument and social security is actually an annuity. It’s a big bet on whether you should take it early or late. We we’re going to do that on another one of these, uh, great retirement debates, but it’s the same issue. But I wonder if people had the option of getting the lump sum from social security instead of the monthly checks. I think a lot of them would take the lump sum, a bird in the hand, they like the cash up front. That’s my final word.

[00:16:44] Jeff Levine: All right. Fair enough. Well, let’s. Let’s just take a quick second, add to sum up some of the key points here that we talked about on, on both sides. So we said some of the key reasons to think about maybe taking your pension, uh, as a lump sum are that it gives you more [00:17:00] control. So control over your investments, control over your tax planning control over how you leave those assets to your heirs, a lot more control. And you’re also taking that away from the company, which could ultimately, you know, run out of money. The pension plan itself could run out of money. And while there is an insurance backing up, many of those plans, the PBGC, as we said, the pension benefit guarantee corporation there is that just adds to the, the mounds of complexity and could limit the amount that you’re actually entitled to from the plan. Whereas we said kind of some of the main benefits of this lifetime income is just that it’s guaranteed for life. As long as the plan can pay that out and you reduce your complexity, the investment decisions and all that are now on the company. And if you live a long lifetime, and that’s what most people are concerned about is outliving their money, right. They don’t wanna run out of money before they run out of life. They wanna make sure. That they have that income. That’s one of the reasons that, that, you know, the [00:18:00] primary reasons you might consider taking the annuity style or true pension option, monthly income or quarterly income, whatever that is, periodic payments over a lifetime.

[00:18:11] Ed Slott: All right. You know, one last thing I know, I said the last thing was the last thing, but since you said

[00:18:16] Jeff Levine: I will allow it, ed, go for it.

[00:18:18] Ed Slott: Since you said they like the lifetime, they want to, the income, they live a long time. They may get ill. I hear from people that say, you know, the opposite. The reason I want the lump sum is before I get too old and too ill, I may wanna take some of those chunks and enjoy it now, while I can, and that’s the second last word.

[00:18:36] Jeff Levine: All right. Fair enough. Well, ed, as you know, there are two sides to every coin, but your life and retirement decisions are too important to leave up to a coin flip. And that’s why one thing that you and I always agree on is making sure that you’re taking, talking through any big decision with a knowledgeable financial advisor or tax professional.

[00:18:56] Jeff Levine: So you can weigh the pros and the cons of those different decisions against [00:19:00] your specific goals and objectives. And if you’d like to continue the discussion with Ed and I we’d love to hear from you, you can reach out to Ed on Twitter using the handle at the Slott with two Ts @TheSlottReport, you can reach out to me using the handle @CPAPlanner, wanna tell us what we missed or other arguments pro or con uh, particular side. You tend to agree with more than another, or you just have a topic for another debate. We’d love to hear from you. So until then, thanks so much, Ed. It’s been fun and I will see you next time for the great time debate.

[00:19:33] Outro: Jeffrey Levine is chief planning officer for Buckingham wealth partners. This podcast is for informational and educational purposes only, and should not be construed as specific investment accounting, legal or tax advice. Certain information mentioned may be based on third party information, which may become outdated or otherwise superseded without notice.

[00:19:49] Outro: Third party information is deemed to be reliable, but it’s accuracy and completeness cannot be guaranteed. The topic discussed in corresponding arguments are those of the speakers and may not accurately reflect those of Buckingham wealth [00:20:00] partners.