“Should I take my pension in monthly payments, or roll the lump sum over to an IRA?” It’s a common question you may get from retiring clients, but choosing one option over the other could reap (or cost) a client hundreds of thousands of dollars. It’s your job to weigh the differences.
Out of Control
Once the client submits the request to receive the monthly pension payments, there is no turning back. He or she can’t change the time and beneficiary calculation options down the road, and it’s virtually impossible to get an “advance” on future payments.
That could be a problem in several instances, including a need to cover a large emergency expense, the desire to help out a family member, or the emergence of a more attractive investment opportunity.
Depending on the available pension payment options, an earlier-than-expected demise of the pension beneficiary could mean little or no money left for survivors, family members or charities.
A lump sum rolled over, however, would likely have a decent remaining balance that could be dispersed according to the client’s wishes, in the event of her untimely passing.
Mystery Money
Then there is the issue of how the money left in the pension plan will be invested. Other than an occasional snapshot, plan participants will have no idea as to how and where the funds are allocated.
Since the portfolio has to be managed on behalf of thousands of recipients, plus other interested parties, it’s a safe bet that the pension plan’s managers will have to make decisions that may go against what individual clients would like done with their portion of the money.
You can probably tailor a portfolio that is better aligned with the client’s needs and risk tolerance. You certainly can design and manage one that is much more flexible and transparent than if it were left in the pension.
Overly Optimistic?
Pension fund administrators are usually required to report how close the plan’s assets are to meeting its expected future obligations. A number approaching 100 percent will certainly calm a client worried about the pension plan’s viability. But the examination of the plan’s strength shouldn’t stop there.
Check on the projected future annual rate of return that the plan uses to determine its sustainability. Chances are the figure is close to 7 percent or more, a number that may be overly confident, especially with prices of many asset classes at or near all-time highs.
That targeted return looks even less likely when you examine the general asset allocation of the portfolio and see that it likely contains a large portion of conservative bonds and short-term investments that won’t come close to making the returns necessary to keep the plan in good standing.
And if a shortfall in returns (or contributions) materializes or the pension recipients live longer than expected, the company may understandably choose to sacrifice payments to retirees, rather than pass the pain on to employees, lenders and shareholders.
DIY Option
Clients who like the idea of “guaranteed” monthly income but don’t want to use the present pension can look instead to rolling the lump sum into an immediate annuity.
You can get a quick, anonymous, hypothetical quote at www.immediateannuities.com, and even add the same age- and time-based options offered by many pension plans.
When the results from an immediate annuity option inevitably show a lower payment amount than what the pension offers, you may want to ask the clients why an insurance company competing for the business still isn’t willing (or able) to offer as much as the pension plan is promising.
No Tax Maneuvers
A pension payment is generally going to be fully taxable as ordinary income. But if the funds are instead rolled over into an IRA, the client has several opportunities to reduce his income tax bill each year.
He can take just enough to keep him under a particular federal income tax bracket. Or, he can roll over some (or all) of the account into a Roth IRA, paying the taxes now to hopefully reduce what he pays down the road.
Another option is to take nothing at all and avoid the taxes completely for the time being. The client will likely have to take required minimum distributions after reaching age 70½, but those won’t greatly exceed what a pension payment might otherwise be.
Social Security
Clients will be happy to know they already have some retirement income coming—Social Security. Although the long-term viability of the program is a source of contention, Social Security is stronger and more sustainable than any similar retirement income program overseen by a private enterprise.
Duplicating Social Security retirement income with regular pension payments is an especially unfortunate decision if the clients are then left with little else in liquid and investable assets.
Why They Still Might Want It
There are two questions you can ask of a client who is still on the fence: “Do you think the pension is going to exist indefinitely, or at least as long as you need and want the income?” And, “When it comes to investing and managing the money for your specific goals and situation, do you think the people in charge of the pension can do a better job of that than I can?”
If the answer to either (or both) of those questions is “yes,” you and the client might be better off if he takes the monthly payments.
Kevin McKinley is principal/owner of McKinley Money LLC, an independent registered investment advisor.