As retirement nears for your clients, they might receive the offer to choose between a retirement pension that is paid regularly throughout retirement, or a lump sum paid once. Here is what you should know to help your clients make the best choice.
The Lump Sum
If they opt to take the lump sum, they will have more flexibility in several areas.With the lump sum, they control how much they withdraw each month. So they can withdraw a set amount each month, but can also withdraw more if they need to make a large or unexpected payment. The lump sum also allows your client total control over where they invest it. Any “extra” money from this lump sum also becomes part of your client’s estate, giving them the option of leaving it to heirs or charitable organizations.
The downside of investing the funds themselves is that they risk losing money if the stocks drop suddenly. They’re also responsible for making sure that the lump sum lasts for 25 years or more. This is where the importance of working out a cash-flow scenario comes into play. If they choose the lump sum, make sure they roll it directly into a 401(k) or other qualified plan to avoid being bumped into a higher tax bracket.
Pension payments have a built in “budget” of sorts, in the sense your client is only paid a certain amount per month, much the same way they were paid throughout their career. According to Clark Howard, if the monthly pension offer is 6 percent or more of the lump sum, then it might be better to stick with the pension. But if it’s less that 6 percent, it’s just as well to take the lump sum and invest it.
Your clients will also will owe federal taxes on every pension payment, and most of the time pension payments don’t have inflation protection. If your client has a spouse or children, remaining pension payments cannot be paid out to heirs.
At the end of the day, whether your client chooses to stick with the pension or take the lump sum is going to be very dependent on their individual situation. Prepare yourself to guide your clients through this process by making sure you are up to date with the latest best practices in pension, IRA and retirement planning.