Q&A: What to consider before taking a lump sum

Dear Liz: I had a pension from a previous employer that was going to pay me $759 per month at 65. They offered me a lump-sum buyout about five years ago of around $65,000. I ran the numbers and decided that was definitely not enough money and declined.

Then last year they upped the offer and the new lump sum amount was $125,000. I ran the numbers again and this time decided to grab the money and roll it into an IRA. I’m 63 and plan to retire at 70. I can hopefully grow that $125,000 to $250,000 by that time, which would give me that much more to live on, plus it gives me more discretion on using that money than just getting the monthly payment the pension would have paid me.

After reading one of your latest columns, I am now questioning whether I made the right decision to take the lump sum.

Answer: There are a number of good reasons for opting for a lump sum versus an annuity. For example, people with large pensions may not be fully protected by the Pension Benefit Guaranty Corp. if their pension fund fails. Others may need more flexibility than an annuity offers.
But a pension is typically money that’s guaranteed for life, in good markets and bad. If you’re choosing the lump sum just because you think you can earn better returns, you need to consider how you’ll protect yourself and your spouse from fraud, bad decisions and bad markets.

Bull markets can lull people into thinking they’re good investors, but markets can go down and stay down for extended periods. That poses a special risk to retirees, who are at increased risk of running out of money when they draw from a shrinking pool of investments. Even a short bear market can cause problems, while an extended one can be disastrous.

You’ll also want to consider how you’ll manage when your cognitive abilities begin to decline. Our financial decision-making abilities peak in our 50s, but our confidence in our abilities tends to remain high even as our cognition slips. That can lead to bad investment decisions and increased vulnerability to fraud.

Finally, consider your spouse. If you die first, will your spouse be comfortable managing these investments? If not, is there someone in place who can help?

A fee-only financial planner could discuss these issues with you and help you create a plan to deal with them.

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