Retirement should be filled with freedom, leisure, travel, and time with our loved ones. However, it can also be filled with angst if we don’t properly plan for potentially 30+ years of expenses without the income from a job. Most people only retire once, which means you have no experience doing it and once your choices are made, there are no do-overs, so getting it right the first time is essential.
As retirement planners, one of the top questions we receive from our members and prospects is regarding the option that is offered by their pension plan at retirement. “Should I take the lump-sum or collect the monthly annuity payments that are guaranteed?” A decision that is so important and so final can only lead to anxiety, however, by arming yourself with information, you can make the decision that is best for you. Here are the benefits of each pension planning option:
- Sleep – The annuity option is traditionally the best option for your peace of mind. There is something very comforting about knowing you will get a monthly paycheck regularly for the rest of your life.
- Longevity – People today live longer. Medical advancements and healthier lifestyles have led to projections of most baby boomers living longer than they expect. The annuity option is a fantastic decision if you outlive your life expectancy.
- Safety & Security – Although nothing in life is guaranteed, the certainty of most annuity payments is very strong. Most annuities are backed by re-insurance companies (large companies that will be an additional back-up in the case of a default by the annuity provider) or the state. This leads to a very safe and secure cash stream in most cases.
- Loss of Cash – You may have a nice stream of income, but losing the lump-sum means losing large chunks of money potentially available for big-ticket purchases or emergencies. If your child needs to borrow $50,000 for a bridge loan to build a house, your annuity can’t help.
- Inflation – The silent killer of a robust annuity payment in early retirement is inflation. For those of you who skipped Econ 101, inflation is the gradual increase in prices over time. Most annuities today do not have a cost of living adjustment attached to them so a $3,000 monthly annuity payment today will be $3,000 in 25 years. That may seem like a decent chunk of change each month when your property taxes are $8,000 a year, but in 25 years when they gradually reach $25,000, you may be wondering where all of your money went.
- Estate Planning – The major downside of taking the annuity is the loss of your money. This means, with few exceptions, if you and your spouse are in the car for a nice Sunday drive the first year of your retirement and are killed in an accident, there will be nothing left for your heirs. The stream of cash dies with you and this can be very troubling when deciding to give up hundreds of thousands of dollars for a few thousand dollars a month.
When contemplating which pension planning decision is right for you, think about your values and beliefs. Is it more important to have safety and security or more money and access to it? Is inflation protection important to you or are you more worried about longevity? This is an important decision, but armed with the right information, you can decide what pension planning strategy will provide you with what you value most. Of course, if the decision seems too difficult, contact a good fee-only financial planner to help you make sense of it all.