Q&A: Pension: to lump or not to lump

Dear Liz: I’m 67 and I’m going to retire later this year. My wife is already retired, and our kids are grown and on their own. I have a 401(k) that I’ve contributed to for most of my working years, and a small traditional IRA. I also have a grandfathered pension plan through my employer. I’m leaning toward taking the pension benefits as a lump sum and rolling it directly to either my 401(k), which my company allows, or my IRA. Would you recommend using the 401(k) to receive the pension rollover? Or would the IRA be the better choice?

Answer: Before you decide where to put the lump sum, please reconsider taking a lump sum in the first place.

Pensions are normally taken as a stream of monthly payments that last for the rest of your lives. (You may be offered a “single life only” option that ends when you die, but that could leave your wife without enough to live on, so the “joint and survivor” option is typically better.) You can’t outlive this money, fraudsters can’t steal it and you won’t lose it to bad markets or bad investment decisions. Most pensions are protected by the Pension Benefit Guaranty Corp., so even if the plan goes broke, your payments will continue.

Contrast that with the lump sum. Theoretically, you may be able to invest the money and get a better return than what you would get from the annuity option (the monthly payments). But that’s far from guaranteed, and one misstep could leave you far worse off.

There are a few situations where taking a lump sum may be smart. If the pension plan is woefully underfunded, and your benefit would not be entirely protected by the PBGC, you could take the lump sum and either invest it or buy an immediate annuity that would replicate those guaranteed monthly payments.

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  1. Robert A Groden says

    Too superficial an answer. I took lump sum; breakeven is 3.5% IRR and the PBGC would not fully cover in event of bankruptcy. No inflation clause either. If you invest conservatively, 50/50 or 60/40 you should beat the hurdle rate over time. There is more to this analysis than Ms. Weston replies to.

    • Liz Weston says

      Definitely, which is why it’s important to discuss your options with a fiduciary financial planner. If the lump sum is the better option, then the planner can help with other decisions, such as how best to protect this money from fraud, bad investments and bad markets as you age. Even if you’re a good investor now, that might always be the case. If you’re married, you also need to consider how equipped your spouse is to handle these investments should you die first.