How to Decide If A Pension Lump Sum Makes Sense

Getting ready to retire can be a strangely stressful time, even for folks who objectively have done everything right in regard to saving and investing.

I see this a lot, particularly when it comes to pensions. Over the decades of working, a pension is just something in the background. It’s growing, of course, but the employee doesn’t need to do anything about it.

All those stress-free years seem to come to an end when retirement is a few months away. The employee starts to get emails and letters from human resources — well-meaning communications I am sure — pointing out their options, albeit draped in off-putting legalese.

Take a pension lump sum? Reinvest in an IRA? Stay in the plan? Oh, boy, here comes the stress.

The thing is, the “right” answer has less to do with the amount of money in the plan than with who will need the money and for what purpose. That’s when having a strong financial advisor in your corner is a tremendous asset.

Here are the fundamental issues to take into account when presented with a pension-plan decision as you leave work:

Door No. 1: Take the money

We know that one in three pension plan participants take a lump sum and never look back. One presumes they have a good reason for doing so.

A lump-sum withdrawal is not a terrible idea, for instance, if you need money for a serious and significant purpose. A chronic or life-threatening illness might be a reason. Certainly, the flexibility of cash is welcome in those scenarios. You might use a portion now and gift the rest to loved ones while you are still alive.

It also makes sense to take money out if you know for a fact that your income needs are more than met, say you inherit significant other investments. Why not buy a second home or finance a few round-the-world trips?

Door No. 2: Leave it there

Is your pension plan large, well-funded and widely respected? Is steady income compelling to you? Leave the money in the plan. There are a lot of great pension plans, private and public, all over the country.

You are just not going to find the purchasing power and seriousness of purpose of a pension plan at a run-of-the-mill, ​commission-driven stock brokerage. Quite the opposite!

However, if you believe your plan is mismanaged or the company or government entity behind it is in trouble, time to get educated. A failing pension plan will be backed up by the federal government, but that’s like saying it’s okay that your house is on fire because your town has shiny new fire trucks. Consider your options carefully.

Door No. 3: Take it, but reinvest it

I’m a financial advisor, so you would expect me to advocate taking the lump sum and putting the money into an IRA. Let’s play devil’s advocate first, though. Can you find reasonably priced advice with fiduciary-level oversight? Can you avoid emotional decisions and allow a portfolio to flourish over time, as your pension would inside a well-run plan?

If so, an IRA invested in a well-designed retirement portfolio gets you the best of both worlds: tax advantages and control over your retirement. Paired with a fiduciary retirement investment advisor, your pension money can produce income and outpace inflation for years to come. If you are under 70 and plan to work some more, an IRA can be a great, tax-friendly alternative.

One caveat: Do not take money from a pension plan if it is “non-qualified.” You could be liable for taxes on the spot. A qualified pension, however, can be rolled into an IRA, just like money from an old 401(k) plan.

What’s the right answer for you? It’s hard to say without understanding your personal financial background, your other sources of income and your goals. A solid advisor with planning chops can get you on track and help you make the most of your decades of hard work, while minimizing risk and taxes along the way.

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