Managing Your Pension in Retirement

Bob French, CFA

by Bob French, CFA

November 6, 2015

Managing your pension in retirementIf you’re lucky enough to have a pension coming in retirement, you’ll most likely have two options for dealing with it. While the details differ with each pension, there are two general options:

  1. Take your pension as a lump sum, which you can then manage however you want; or
  2. Take it as an annuity that will pay out over a designated timeframe.

Deciding between an annuity and a lump sum may be complicated, depending on your particular pension, but often the choice boils down to two factors: the stability of receiving an annuity check in the mail, and what you can do with the lump sum your pension offers.

Annuity Pros and Cons

Knowing a check will show up at your door every month can provide a sense of security. For some people, this gives important financial peace of mind that allows them to focus on enjoying retirement. In deciding if this is the right course for you, consider these questions:

  • Will your spouse continue receiving payments if they live longer than you?
  • Will the payments be adjusted for inflation, or will it pay the same amount forever?
  • Will you get payments for life, or for a certain number of years?

Make sure you understand the answers to all these questions before deciding whether or not to take the annuity.

The stability of the annuity option has a downside. In many cases, though not all, the lump sum will actually be worth slightly more than the annuity offered, from a purely financial perspective. This is because you are paying for the stability of receiving monthly checks over time. The organization that is responsible for the annuity is taking on investment risk, and has to provide these stable payments, so they need to be compensated. It’s the same thing with a bank – they pay lower interest on their deposits than they get back on loans.

Lump Sum Pros and Cons

You’ll want to think about a couple of things when you’re considering the lump sum option:

  • How disciplined are you going to be with this money? Will you be able to keep it invested?
  • How much risk are you willing to take on? Taking the lump sum means accepting more investment risk, even if you just invest everything in bonds.
  • How much flexibility are you comfortable with in your income? If you are willing to spend less when investment returns are poor, then you can make the lump sum last much longer.

Taking the lump sum means you are accepting more responsibility for your own retirement. This means you can end up with more resources throughout retirement, but it also means you don’t have the stability you get from knowing there’s a check coming every month.

Every plan handles this trade-off differently, and there are always details that may make your decision more complicated. Do your research before you do anything – especially as this is often a decision that you cannot reverse.

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