Taking Your Retirement Benefits

Part 1: The Defined Benefit Plan

You’ve finally reached that magical day: retirement. You have a fixed and final retirement sum in your account. Now the question is, “What’s the best way to take my money?” And the answer is a very definite and firm, “It depends.” Realistically, it depends on two things: 1) the type of pension plan that you have, and 2) the system you choose for taking your money out. In this article, we’ll focus on defined benefit retirement plans, which include most corporate pensions.

The defined benefit plan is the classic pension plan. You receive a taxable monthly income for the rest of your life. Corporate pensions are usually always a fixed monthly amount, which virtually guarantees the perpetual erosion away of your money’s purchasing power. Government pensions, on the other hand, often come with an annual cost-of-living adjustment which may or may not keep par with inflation.

Before you receive your first benefit check, you may have two choices to make. The first involves whether the pension will cover you alone or your spouse along with you. If you choose coverage for your lifetime only you’ll receive a larger monthly check. But once you die, the pension stops and your spouse gets nothing. If your spouse doesn’t need your pension then that won’t be a problem. However, if your spouse will depend on that money, then it should cover both of your lives. Although not as big, a two-life pension (joint and survivor) will still provide much-needed benefits for your spouse.

The second choice you’ll need to make is whether to take your pension in a lump sum or as a monthly income. Many times, monthly payments are your only choice; some employers, however, offer the option of lump sums. If your company is somewhat shaky financially, then take the lump sum, unless your pension is fully guaranteed by the Pension Benefit Guaranty Corporation (PBGC). Some other suggestions follow to help you decide which choice may be best for you.

If you’ll depend heavily on your retirement money, take the monthly pension. Even though it’s wearing away by inflation, the payment will last for life. If you take the lump sum and invest it, you may not be able to make it last.

If you’re an inexperienced investor, take the monthly pension. A financial planner might be able to show you, on paper, that you could get a higher income by investing the lump sum…assuming he’s right. But what if he isn’t? What if the planner’s investments fail? If you’re not experienced, it’s unlikely that you’ll know whether you’re getting good advice or not. And with investments, sometimes even good advice doesn’t work out.

If you’re a good investor, consider taking the lump sum. But before you do, ask your company what discount rate of interest they’re using to determine the size of your lump sum. This is extremely important. In order to match what you would get from the company, you’ll have to invest the lump sum at that same rate for the rest of your life. To improve your income, you’ll have to invest it a higher rate. So unless you’re absolutely sure that you can do better than the discount rate, go with the monthly pension.

If you have other sources of income, take the lump sum. You can roll it into a tax-deferred IRA and let it accumulate for your older age, giving you some protection against inflation.

If you have enough money not to need an additional income stream, take the lump sum, roll it into an IRA and leave it for your children.

If you’re in very poor health and don’t expect to live very long, take the lump sum. You can use it for larger payments if they become necessary because it won’t have to cover a full life expectancy.

One more thing – be sure to check the size of your pension if it’s integrated with Social Security. This means that it’s partly reduced by the size of your Social Security benefit. When making that reduction, companies estimate what your Social Security benefit will be. If they estimate too high, you’ll end up being paid too little on your pension.

In Part 2 we’ll look at the choices available with defined contribution plans.

blog comments powered by Disqus