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Showing posts with label annuities. Show all posts
Showing posts with label annuities. Show all posts

Protect Your Retirement (Fidelity)

Five ways to protect your retirement income

Five rules of thumb to help protect your savings and income—now and in the future.
 
If you’re nearing or in retirement, it’s important to think about protecting what you've saved and ensuring that your income needs are met now and in the future. Here are five rules of thumb to help manage the risks to your retirement income.

1. Plan for health care costs.

With longer life spans and medical costs that historically have risen faster than general inflation—particularly for long-term care—managing health care costs can be a critical challenge for retirees.
According to Fidelity’s annual retiree health care costs estimate, the average 65-year-old couple retiring in 2014 will need an estimated $220,000 to cover health care costs during their retirement, and that is just using average life expectancy data.1 Many people will live longer and have higher costs. And that cost doesn’t include long term care (LTC) expenses. 
According to the U.S. Department of Health and Human Services, about 70% of those age 65 and older will require some type of LTC services—either at home, in adult day care, in an assisted living facility, or in a traditional nursing home. The average private-pay cost of a nursing home is about $90,000 per year according to MetLife, and exceeds $100,000 in some states. Assisted living facilities average $3,477 per month. Hourly home care agency rates average $46 for a Medicare-certified home health aide and $19 for a licensed non-Medicare-certified home health aide. 
Consider: Purchase long-term-care insurance. The cost is based on age, so the earlier you purchase a policy, the lower the annual premiums, though the longer you’ll potentially be paying for them.
If you are still working and your employer offers a health savings account (HSA), you may want to take advantage of it. An HSA offers a triple-tax advantage: You can save pretax dollars, which can grow and be withdrawn state and federal tax free if used for qualified medical expenses—currently or in retirement.

2. Expect to live longer.

As medical advances continue, it's quite likely that today’s healthy 65-year-olds will live well into their 80s or even 90s. This means there's a real possibility that you may need 30 or more years of retirement income.
An American man who’s reached age 65 in good health has a 50% chance of living 20 more years, to age 85, and a 25% chance of living to 92. For a 65-year-old American woman, those odds rise to a 50% chance of living to age 88 and a one-in-four chance of living to 94. The odds that at least one member of a 65-year-old couple will live to 92 are 50%, and there’s a 25% chance at least one of them will reach age 97.2 And recent data suggest that longevity expectations may continue to increase.
Without some thoughtful planning, you could easily outlive your savings and have to rely solely on Social Security for your income. And with the average Social Security benefit being just over $1,294 a month, it likely won’t cover all your needs.3
Consider: To cover your income needs, particularly your essential expenses, you may want to use some of your retirement savings to purchase an annuity. It will help you create a simple and efficient stream of income payments that are guaranteed for as long as you (or you and your spouse) live.4

3. Be prepared for inflation.

Inflation can eat away at the purchasing power of your money over time. This affects your retirement income by increasing the future costs of goods and services, thereby reducing the purchasing power of your income. Even a relatively low inflation rate can have a significant impact on a retiree’s purchasing power. Our hypothetical example below shows that $50,000 today would be worth only $30,477 in 25 years, even with a relatively low (2%) inflation rate.
Consider: While many fixed income investments and retirement income sources will not keep up with inflation, some sources, such as Social Security, and certain pensions and annuities can help you contend with inflation automatically through annual cost-of-living adjustments or market-related performance. Investing in inflation-fighting securities, such as growth-oriented investments (e.g., individual stocks or stock mutual funds), Treasury Inflation-Protected Securities (TIPS), and commodities, may also make sense.

4. Position investments for growth.

A too-conservative investment strategy can be just as dangerous as a too-aggressive one. It exposes your portfolio to the erosive effects of inflation, limits the long-term upside potential that diversified stock investments can offer, and can diminish how long your money may last. On the other hand, being too aggressive can mean undue risk in down or volatile markets. A strategy that seeks to keep the growth potential for your investments without too much risk may be the answer.
The sample target asset mixes below show some asset allocation strategies that blend stocks, bonds, and short-term investments to achieve different levels of risk and return potential. With retirement likely to span 30 years or so, you’ll want to find a balance between risk and return potential. 
Consider: Create a diversified portfolio that includes a mix of stocks, bonds, and short-term investments, according to your risk tolerance, overall financial situation, and investment time horizon. Doing so may help you seek the growth you need without taking on more risk than you are comfortable with. Diversification and asset allocation do not ensure a profit or guarantee against loss.  Get help creating an appropriate investment strategy with our Planning & Guidance Center.

5. Don't withdraw too much from savings.

Spending your savings too rapidly can also put your retirement plan at risk. For this reason, we believe that retirees should consider using conservative withdrawal rates, particularly for any money needed for essential expenses.
A common rule of thumb is to use a withdrawal rate of 4% to 5%. Why? We examined historical inflation-adjusted asset returns for a hypothetical balanced investment portfolio of 50% stocks, 40% bonds, and 10% cash, to determine how long various withdrawal rates would have lasted. The chart to the right shows what we found: In 90% of historical markets, a 4% rate would have lasted for at least 30 years, while in 50% of the historical markets, a 4% rate would have been sustained for more than 40 years.
Consider: Keep your withdrawals as conservative as you can. Later on, if your expenses drop or your investment portfolio grows, you may be able to raise that rate.

In conclusion

After spending years building your retirement savings, switching to spending that money can be stressful. But it doesn't have to be that way if you take steps leading up to and during retirement to manage these five key risks to your retirement income, as outlined above.
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Lump Sum vs Pension - what is right for you? (Bloomberg)


You've Been Offered a Ton of Money. Should You Take It?

If a former employer tempts you with a lump sum for your pension, consider these four points before you jump.
 Suzanne Woolley
 WealthWatch
October 22, 2015 — 7:00 AM EDT

It's like the famous marshmallow tests done at Stanford University decades ago, when researchers gave some kids marshmallows and told them if they waited 15 minutes to eat them they'd get a second one.  The kids who delayed gratification went on to have better lives, judged by a variety of measures, than the kids who didn't.  
When it comes to your pension, you are the kid. The marshmallow is a big chunk of money.
The test: Within 30 to 90 days, choose to take your pension all at once, as a lump sum based on the present value of your future pension benefit, or wait and have the money trickle in on a monthly basis over the course of your retirement.
If you're lucky enough to have been in a traditional, defined-benefit pension plan at some point, it's a choice you may have to make in the next couple of months.
Before 2012, when legislative changes  made offering lump sums more attractive to companies, the offers weren't common. Activity revved up in 2013 and 2014, and there's been a dramatic uptick this year, said Matt McDaniel, who leads Mercer’s U.S. defined-benefits risk practice. The end of the year tends to be particularly busy, he said, with offers going out on Nov. 1 or Dec. 1.

Employers have a big financial motivation to offer lump sums. Pension costs are rising as workers live longer, and companies would love to get those long-term liabilities off their balance sheets. They'd also like to stop paying rising amounts to the Pension Benefit Guaranty Corp. (PBGC), a federal agency that functions as a backstop for pensions at insolvent companies. Since 2007, the PBGC's per-person flat premiums for single-employer pension plans have risen from $31 to $57. In 2016, they'll be $64.

The argument for accepting a lump sum offer is much, much weaker. As the General Accounting Office put it in a report issued in January, "participants potentially face a reduction in their retirement assets when they accept a lump sum offer." Yet about 40 to 60 percent of those offered lump sums take them, said McDaniel.

That may be because they don't have enough information to make a good decision. The GAO report notes that the 11 information packets from plan sponsors to plan participants it reviewed "consistently lacked key information needed to make an informed decision or were otherwise unclear."
Should you accept a lump sum offer? It depends on:

Your health 
If your close relatives tend to live into their hundreds, the lifetime annuity that a defined benefit pension plan provides is extremely valuable. If you have significant health problems, smoke, and close relatives died or had serious health problems fairly young, the benefit may not be as valuable. Statistically. To be frank.
The Social Security Administration's life expectancy calculator provides a longevity benchmark. It shows a life span of 84.4 for a man who is 65 today; for women it's 86.7. For a more nuanced estimate, David Littell, director of the retirement income planning program at the nonprofit American College of Financial Services, likes www.livingto100.com. (Helpful hint: Have your cholesterol numbers handy.)
Your alternatives
If you're tempted to take the lump sum and buy an annuity on your own, think twice. For starters, you won't get the lower institutional pricing your plan gets. And if you're a woman, you'll pay a higher price, because in your defined-benefit plan annuity pricing must be gender-neutral; outside of the plans, women pay more for annuities, because they live longer. (That same logic means women pay less for life insurance.) Then there's the task of vetting an annuity provider.
The best way to determine the value of a lump sum offer is to compare it with a commercially available product. You'll probably find that the lump sum isn't enough to buy an annuity outside of the pension plan that provides the same monthly benefit,  Littell said, particularly if your plan offers cost-of-living increases.
Littell went to immediateannuities.com, a consumer website that provides annuity quotes from major insurers, and looked for the lowest price on a deferred single-life annuity (with no death benefit) with a benefit of $500 a month and payments to start at age 65. The result: At age 50, it would take $51,000 for a woman to buy that annuity, compared with $47,500 for a man. A couple would pay $60,000.
If the woman is offered a lump sum of, say, $50,000, it might seem a wash. But if her company subsidizes early retirements and her plan includes features such as a cost-of-living adjustment, or if her lump sum offer is $40,000, that argues for staying in the plan.
Your investing expertise
If you've had long-term success in investing your own money, taking a lump sum may make sense. To earn a decent return, you'll probably have to leave the pension in equities for a few decades, which means coping with market swings.
"In times of volatility, like we had this summer, there's something to be said about that guaranteed check you know will show up in your mailbox every 30 days," said Matthew Sommer, director of retirement strategy for Janus Capital Group.
Also, an annuity's guaranteed income simplifies financial management, which is especially valuable later in life, when people are less likely to be capable of managing money.
Your cash needs
When the offer is between $10,000 and $50,000, the majority of people accepting it just cash it out, said McDaniel.3 That means paying income tax, and a 10 percent penalty if you cash out before age 59 1/2.
Cashing out early is a cardinal sin of personal finance. Tax-deferred investment vehicles let the earnings on money compound, year after year. Also, income from cashing out could push you into a higher tax bracket. 
Littell, who isn't a fan of the lump sum, points out that one good use of it would be to defer tapping Social Security until you're old enough to get the maximum benefit. And when the cash is in your investment account, you can leave it to children, other heirs, or charity.
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Strategies to Protect Your Retirement (Fidelity)

Grow and protect retirement principal

Two strategies for cautious investors to help balance growth with protection of principal.
 
Fear of loss is a powerful motivator, as the recent market selloff reminded us. But fear like greed is a dangerous sentiment for investors. In the wake of the financial crisis, many clung to the seeming safety of cash, only to miss out on a six-year bull rally. Beware of letting nervousness over the current volatility derail your long-term investment plan
“Money and investing are very emotional things,” says Tim Gannon, vice president of product management at Fidelity Investments Life Insurance Company. “Many people tend to approach investing the way they approach other personal and emotional parts of their lives—they try to protect themselves from potential loss.”
Excessive fear of loss—which behavioral economists call loss aversion—causes many investors to act counterproductively. For example, many investors who fled the markets during the worst of the 2008—2009 bear market still haven’t fully reinvested,3 so they missed most of the current six-year bull market. “There is a segment of the investor population that would like to hold stocks, and who need that growth potential, but are too afraid to take that step,” explains Tom Ewanich, vice president and actuary at Fidelity Investments Life Insurance Company. “They are afraid of the consequences of losing their money in a down market.”
It’s natural to want to protect yourself from loss. That said, most investors need exposure to certain asset classes, like stocks, for investment growth. A diversified portfolio of different asset classes—stocks, bonds, cash—is a time-tested approach to providing growth potential while managing volatility. But given the combination of volatility in both the stock and bond markets, some investors have instead opted for the sidelines to protect their investments. Fortunately, you don’t have to treat growth and protection as mutually exclusive. Certain strategies can help you benefit from market gains, while protecting you on the downside.

The fiction of market timing

Equities are volatile by nature. During the 10 years ending December 31, 2014, the S&P 500 lost 1% or more in about one out of every seven trading days.4 Avoiding the down days would be a great strategy. Trouble is, it’s highly unlikely. No one ever has successfully and consistently predicted stock market returns. In fact, the strategy of jumping in and out of the market, known as market timing, is one of the main reasons the average equity investor underperformed the S&P 500 by 4.2 percentage points per year over the past 20 years.5 Investors trying to time the market typically sell after their investments have lost money, and buy only after stocks have recovered—selling low and buying high.
Avoiding stocks altogether has major drawbacks, too. Stocks provide the potential growth nearly every long-term investor needs to stay ahead of inflation. With life expectancies on the rise, most retirement-focused investors have longer time horizons than they think—even after they enter retirement.
Cautious investors with long-term saving goals—those who will not need to access a portion of their assets for five to 10 years—may benefit from strategies that allow them to protect principal while exposing some of their assets to the stock market’s growth potential. If you fit that description, consider the following strategies: the anchor strategy or the protected accumulation strategy.

Anchor strategy

An anchor strategy involves dividing your portfolio into two parts, a conservative anchor and more growth-oriented investments. The anchor portion of your portfolio uses investments that offer a small return, such as certificates of deposit (CDs) or single-premium deferred annuities (SPDAs). These assets have a set lifespan, and the amount you invest is designed to grow back with interest on your original principal. This portion of your portfolio acts as your anchor, while your remaining assets are invested in more volatile, growth-oriented securities such as stock mutual funds or ETFs.
A true anchor strategy protects your entire starting principal. For example, say you have $100,000 in assets and a five-year investment period. You could invest $90,000 in a five-year CD yielding 2.25%. When that CD matures it will be worth $100,591—more or less your original principal—leaving you free to invest the remaining $10,000 in stocks without risking any of your principal. “The anchor strategy can remove the negative outcomes cautious investors fear,” Ewanich says. “Even if the markets fall, your anchor makes sure you at least have what you started out with. Keep in mind, though, that inflation can erode the purchasing power of your original investment over time and that this strategy generates taxes each year in a taxable account.”
Gannon points out, “Interest rates are so low today that you will either need to commit more to the anchor portion of your plan or go with longer-duration products to get a higher yield.” In higher interest rate environments, the anchor strategy might become a more attractive option.

Protected accumulation strategy

The protected accumulation strategy takes advantage of principal protection features—commonly referred to as guaranteed minimum accumulation benefit (GMAB) riders—on variable annuities. Your assets are invested in a portfolio that typically has a larger equity position than the 10% stake outlined in the anchor strategy above. For a fee, the GMAB rider guarantees that at the end of the annuity’s investment period—typically 10 years—you’ll have at least the same asset value you started with. The main benefit over the anchor strategy is that more of your assets are likely to be exposed to growth. Based on current market conditions, you might have equity stocks represent 10--15% of your anchor strategy, compared with the GMAB holding 60% or more in equities. “The GMAB doesn’t guarantee growth but it provides a way for you to expose more of your assets to real growth potential,” Gannon says. Recognize that a similar investment portfolio held outside the annuity would have higher returns in up markets without the cost of the guarantee, though you would sacrifice the protection (see chart below).
Another potential benefit is that most GMAB riders let you reset the level of principal protection each year if your investments have grown in value. If you do lock in a higher balance, the investment period resets and your balance is guaranteed for another 10 years. It is possible that your fee may increase if you elect this option and annuity features will vary by the issuing company.
For example, say you originally invested $100,000 in a variable annuity with a GMAB rider. After the first year, the annuity’s underlying investments grew to a value of $105,000. Locking in that new balance guaranteed that you would have at least $105,000, regardless of how the markets performed after a new 10-year period. If the underlying investments lost value in that first year, you could be comforted by the knowledge that your original $100,000 was guaranteed.

Making a choice

Determining which strategy may make more sense for you will depend on a number of factors, including your investing goal, fees on your investments, your time horizon, and your tolerance for risk. First consider if you might be better off investing in a diversified portfolio, because either of these strategies (anchor or protected accumulation) may limit your upside growth potential—and the diversified portfolio may offer a greater long-term benefit. But for those who are just not comfortable exposing their investments to stocks without some kind of loss protection, one of these approaches might be worth considering.
You also need to consider when you will need access to these assets, because both strategies might penalize early withdrawals. For instance, redeeming a CD before it matures typically means forfeiting some or all of the interest earned, while variable annuities may levy a surrender charge representing a percentage of the account value. So if your goal is less than 10 years away, the protected accumulation strategy is not a good fit. “You want to make sure you invest only the money you need for that specific goal,” Ewanich says.
The anchor strategy is generally considered the more conservative of the two strategies, as it has less potential for growth than the protected accumulation strategy. That said, investors who are more comfortable with some volatility in their portfolio could adapt the anchor strategy by protecting only a portion of their principal. That approach would free up more assets for growth in the equity portion of the strategy in exchange for a lesser degree of principal protection.
Also consider the cost of each plan. You can assemble a very low-cost combination of CDs and stock funds. However, the protected accumulation strategy can carry fees of more than 2.5% annually, which will lessen the potential return on your investments. While both strategies are designed to protect principal, that principal will lose purchasing power over the applicable investment horizon.
The decision may well come down to your investor personality. With your principal protected from loss, would you gain the confidence to invest more aggressively than you are today? The protected accumulation strategy requires little action from you aside from your initial investment and an annual decision whether to lock in any growth. The anchor strategy requires that you invest the assets that are left over after establishing your anchor. Those may or may not be decisions you’re interested in making. “All these factors hit on the same point,” Gannon says. “What kind of investor are you? What are you going to be most comfortable with? And, most importantly, what will let you sleep better at night?”

 1. S&P Dow Jones Indices; three-year average annual return through April 2, 2015.

2. Strategic Insight Simfund Federal Reserve Bank.
3. The New York Times, May 2012.
4. S&P Dow Jones Indices.
5. DALBAR2014.
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How to Pay Less Taxes on your RMDs (Required Minimum Distributions from IRA) and what is a QLAC? by Natalie Choate

Age 70 1/2: Think Through Your RMD Choices

Buying a qualified longevity annuity and tactically timing the first RMD could reduce the tax hit.

Natalie Choate, 05/08/2015
In 2015, we are looking at planning ideas for different life stages. This month: The year the IRA owner reaches age 70 1/2. 
The year the IRA owner reaches age 70 1/2 is his or her first "distribution year." It's the first year for which there is a required distribution. Unlike with later years, however, the IRA owner gets a one-time special break in the age 70 1/2 year: The minimum distribution for that year is not required to be taken until April 1 of the following year. In all other years for which there is a required minimum distribution, or RMD, it must be taken by Dec. 31 of the distribution year. 
If the client's income is still "too high," and he or she doesn't want or need to take the RMD to pay living expenses, continue to look for ways to reduce the RMD, such as rolling into an employer plan if still working, Roth conversions, or purchasing a qualified longevity annuity (QLAC), discussed below. (This tactic could also be used in years prior to the age 70 1/2 year.) 
Buy a QLAC?A longevity annuity is an annuity contract that does not start paying you until you reach age 85. It eventually pays you a life income, but the income does not start until that later age, meaning that your investment (if made when you are many years younger than 85) has many years to accumulate and grow, so the income you eventually get will be larger. The purpose is to insure against "living too long"--outliving your income. 
Normally such delayed annuities are not "legal" investments for IRAs, because the minimum distribution rules require IRA-owned annuities to start paying out no later than age 70 1/2. 
But the IRS has made an exception to permit IRAs to purchase "qualified" longevity annuities (QLACs) with up to $125,000 of the IRA balance, or 25% of the IRA owner's total IRA balance if less. When the QLAC is purchased, the purchase price and value of the QLAC cease to be counted as part of the IRA balance for purposes of computing the IRA's annual RMD, beginning the year after the year of the purchase.
Suki Example: Suki is turning age 70 1/2 and age 71 in 2015. She plans to keep working (and therefore expects to continue to be in a high tax bracket) for at least another five years. Her projections show she will have a comfortable income even after retirement, though if she lives to a very old age, it could become questionable. She finds a QLAC that will pay her a good income starting at age 85, in about 15 years. She buys it inside her IRA for $125,000. By removing $125,000 from her account value "base" in 2015, this move will reduce her next year's IRA RMD (i.e., 2016) by $4,883, saving her about $1,900 of income taxes that year. Equivalent savings will accrue each year thereafter until the QLAC starts paying out. If the contract makes sense for her, the tax savings is a nice little bonus. Of course her income (and taxes) will go up when she reaches age 85 and starts collecting on the QLAC, but she won't be working then (she figures), so she won't mind the taxable income as much. 
You can also buy a QLAC in your IRA earlier or later than the year you reach age 70 1/2. The earlier you buy it, the longer your $125,000 investment has to accumulate and thus reduce your RMDs pre-age 85 by an even larger amount. The longer you wait to buy it, the less of a good deal it is and the less value it has for reducing RMDs. 
Take the RMD This Year or Next Year?Since you have a choice, which is better? Take the age 70 1/2 year RMD in the age 70 1/2 year? Or postpone it until the age 71 1/2 year? Despite a magazine article that said "never postpone the first year's RMD!" this is actually something that needs to be decided on a case-by-case basis. 
In a few cases, the choice will be easy. 
Don't postpone the first year's RMD if…Someone who needs the age 70 1/2 year distribution to pay immediate living expenses will obviously not postpone. A person who is in a more or less steady income tax bracket, but whose RMDs are large enough that bunching two of them into one year would push him into a higher bracket in the age 71 1/2 year, should presumably not postpone. Postponement will not be possible if the participant desires to do a rollover or conversion from the plan in 2015: The RMD must be distributed before the account can distribute money for a rollover or conversion. 
Do postpone the first year's RMD if… Someone is still working and earning a high income, but plans to retire later in the age 70 1/2 year, so expects to have a substantially lower income next year. Someone who is leaving his entire IRA to charity will probably postpone, since if he happens to die before taking the RMD that is just a little more money that will go the charity at his death income tax-free. Anyone who wants to maximize the amount of the IRA that will pass to her beneficiaries upon death should postpone taking the RMD as long as possible, in case he or she dies prior to the postponed distribution deadline. 
The close cases…For others, the choice is not so easy. A client who expects to be in the same bracket next year as this year might decide based on personal preference: "Jack" takes his RMD early in his age 70 1/2 year, to "get it over with." His sister "Jill" postpones because, even though it looks like her bracket will be just as high next year as it is this year, you never know--she might get lucky and be really poor next year after all, making postponement profitable. 
The person who thinks that postponing is always a good idea because you defer the taxes a little longer should remember that postponing actually increases the amount of the second year's RMD … because the age 70 1/2 year RMD that you did not take in the age 70 1/2 year is still part of the account balance at the end of the year! 
One thing is sure: Postponing the RMD to the age 71 1/2 year creates complications. If the first year's RMD is postponed, two RMDs are required in the second year, and the two RMDs in the second year will have different deadlines, be based on different account balances, and use different divisors! 
Bernie Example: Bernie turns age 70 1/2 in 2015, so 2015 is the first distribution year for his IRA. To calculate the 2015 RMD, he uses the 2014 year-end account balance and the Uniform Lifetime Table divisor for the age he attains on his 2015 birthday, which will be 70 if he was born before July 1, or 71 if he was born after June 30. He can take the 2015 RMD at any time from Jan. 1, 2015, through April 1, 2016. There will then beanother RMD for the year 2016, which must be taken between Jan. 1, 2016, and Dec. 31, 2016. The 2016 RMD will be based on the Dec. 31, 2015, account balance and will use the Uniform Lifetime Table factor applicable for the age he attains on his 2016 birthday. 


Resources: See Natalie Choate's book Life and Death Planning for Retirement Benefits(7th ed. 2011) for full details on the required beginning date and the first distribution year. The book is available as a paperbound "real" book at http://www.ataxplan.com/ or in an electronic (online) edition by subscription athttp://www.retirementbenefitsplanning.com/.
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Which is better, lump sum or pension (Fidelity)

Lump sum or monthly pension?

What you need to know about monthly and lump sum pension offers.
 
Faced with mounting pension costs and greater volatility, companies are increasingly offering their current and former employees a critical choice: Take a lump sum now or hold on to their pension.
“Companies are offering these buyouts as a way to shrink the size of their pension plans, which ultimately reduces the impact of that pension plan on the company’s financials,” says John Beck, senior vice president for benefits consulting at Fidelity Investments. “From an employee’s perspective, the decision comes down to a trade-off between an income stream and a pile of money that’s made available to him or her today.”
Pension buyouts can be offered to any current or former employee of a firm. You may be already receiving benefits as a retiree with an accrued (vested) benefit, or you may have a vested benefit from a former employer, or your current company may be offering you a pension lump sum buyout long before you retire.
Whatever the case, here’s how a pension lump sum offer typically works: Your employer issues a notice that by a certain date, eligible employees must decide whether to exchange a monthly benefit payment in the future for a one-time lump sum. If you opt for the lump sum, you’ll receive a check from the company’s pension fund for that amount, and the company’s pension (or defined benefit) obligation to you will end. Alternatively, if you opt to keep your monthly benefits, nothing will change, except the option to take a lump sum will be removed.
Some employers are also considering buying annuities for those who do not opt for the lump sum offer. In this case, your benefits will not change, except that the insurance company’s name will be on the checks you receive in retirement, and the guaranteed income will be provided by the insurance company.1 (As with offering lump sums, companies that switch to an annuity provided by an insurance company can remove the pension liability from their books.)
The process is relatively simple, but the decision about which option to take can be complex. Here are the pros and cons of each option:

Keeping the monthly payment

Pension plans typically provide a payment of a set amount every month from your retirement date through the rest of your life. You may also choose to receive lifetime payments that continue to your spouse after you die.
These monthly payments do have drawbacks, however:
  • If you’re not working for the company making the offer, your benefit amount typically will not increase between now and your retirement date. During retirement, your life annuity payments typically do not come with inflation protection, so your monthly benefits are likely to lose purchasing power over time. An annual inflation rate of 3%, the average since 1926, will cut the value of your benefit in half in 24 years.
  • Taking your pension benefit as a life annuity means you may not have access to enough money to fund a large, unexpected expense.
  • Your ability to collect your payments depends in part on your company’s ability to make them. If your company retains the pension and can’t make the payments, a federal agency called the Pension Benefit Guaranty Corporation (PBGC) will pay a portion of them up to a legally defined limit. The maximum benefit guaranteed by the PBGC in 2014 is $4,943 per month for most people retiring at age 65. The monthly guarantee is lower for retirees before age 65 and larger for retirees age 65 or older. If responsibility for your payments shifts to an insurance company, it will be the insurance company and not the pension plan that is responsible for your guarantees.2

Taking the lump sum

A lump sum may seem attractive: You give up the right to receive future monthly benefit payments in exchange for a large cash payment now—typically, the actuarial net present value of your age-65 benefit, discounted to today. Taking the money up front gives you flexibility: You can invest it yourself, and if you have assets remaining at your death, you can leave them to your heirs.
However, keep in mind the following cautionary factors:
  • You are responsible for making the funds last throughout your retirement.
  • Your investments may be subject to market fluctuation, which could increase or reduce the value of your assets and the income you can generate from them.
  • If you don’t roll the proceeds directly into an IRA or an employer qualified plan like a 401(k) or an 403(b), the distribution will be taxed as ordinary income and may push you into a higher tax bracket. If you take the distribution before age 59½, you may also owe a 10% early withdrawal tax penalty.
  • You can use some or all of the lump sum to purchase annuity—typically, an immediate
    annuity—which could provide a monthly income stream as well as inflation protection or other features. But as an individual buyer, you may not be able to negotiate as good a deal with the insurance provider as the benefit you would have received by taking the pension plan annuity, so the annuity may or may not replicate the monthly pension payment you would have received from your employer. You also need to select your annuity provider carefully, paying special attention to a company's credit ratings, and make sure you read and understand the terms and conditions of the annuity.

Making your choice

Whether it’s best to take a lump sum or keep your pension depends on your personal circumstances. You’ll need to assess a number of factors, including those mentioned above and the following:
  • Your retirement income and essential expenses. Guaranteed income, like Social Security, a pension, and fixed annuities, simply means something you can count on every month or year and that doesn’t vary with market and investment returns. If your guaranteed retirement income (including your income from the pension plan) and your essential expenses, such as food, housing, and health insurance, are roughly equivalent, the best choice may be to keep the monthly payments, because they play a critical role in meeting your essential retirement income needs. If your guaranteed income exceeds your essential expenses, you might consider taking the lump sum: You can use a portion of it to cover your monthly expenses, and invest the rest for growth.

    These comparisons may be relatively easy if you’re already retired, but developing an accurate picture of your retirement income and expenses can be difficult if you’re still working. Beware of the temptation to use the lump sum to pay down credit card debt or handle other current expenses—and not just because of the large tax bill you’re likely to face. “Lump sum distributions come from a pool of money that is developed specifically for retirement,” explains Beck. “To access those funds for another reason puts the quality of your retirement at risk.”
  • Longevity. Both your monthly benefits payment and the lump sum amount were calculated using actuarial calculations that take into account your current age, mortality tables, and interest rates set forth by the IRS. But these estimates don’t take into account your personal health history or the longevity of your parents, grandparents, or siblings. If you expect to have an above-average life span, you may want the predictability of regular payments. Having a payment stream that is guaranteed to last throughout your lifetime can be comforting. However, if you expect to have a shorter-than-average life span because of personal reasons or your family medical history, the lump sum could be more beneficial.
  • Wealth transfer plans. After you’ve considered retirement income and expenses, and have planned an adequate cushion for inflation, longevity, and investment risk, it’s appropriate to take wealth transfer plans into consideration. With pension plans, you often don’t have the ability to transfer the benefit to children or grandchildren. If wealth transfer is an important factor, a lump sum may be a better option.

Moving forward

A pension buyout should be evaluated within the context of your overal retirement picture. If you are presented with this option, consult an expert who can give you unbiased advice about your choices. Finally, be aware that more corporations continue to consider discharging their pension obligations, so it’s a good idea to stay in touch with old employers. “If you’ve left a pension behind at a former employer, sometime in the coming years you’re very likely to be offered a lump sum,” says Beck. “Keep your former employer’s administrator up to date on your current address, because you can miss this opportunity if your employer can’t find you.”

Next steps

  • First and foremost, make sure you know whether you have any pension benefit at your current or former employers, and keep your contact information with those companies up to date. You cannot even consider an offer if you don’t know it exists.
  • Second, make sure you have a plan for retirement. If you understand your needs, you will be better prepared to understand which option is right for you if you do receive a lump sum offer. Because these offers usually have a limited window for election, it will be more difficult to make an educated and informed decision without knowing, in advance, your total retirement financial picture. Using Fidelity Income Strategy Evaluator® (login required) and Retirement Income Planner can get you started.
  • If you decide to take a lump sum in lieu of monthly pension payments, you may want to consider rolling it over to an IRA. A direct rollover from your employer's plan to your IRA provider (trustee to trustee) will not be subject to immediate taxation and may be the best way to preserve the tax-deferred status of this money. You should consult your tax adviser.
If you do receive an offer, review it with a trusted financial adviser. Everyone’s circumstances are different. What is right for your friend, neighbor, coworker, or relative may not be right for you.
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