subject: Know How To Choose Between A Monthly Pension And Taking A Lump Sum [print this page] One major decision 'about-to-be' retirees must make is whether or not to take their pension as a lifetime series of monthly payments or as a lump sum. Don't worry. You can make a confident decision if you take a methodical approach. And here's how to go about doing that.
Let's assume your company will give you the option of taking a monthly pension or a lump sum. Which should you take? Here's the approach to make that decision...
The essential question you must ask yourself is: "Do I need all of that monthly payment for my essential retirement income?"
The two alternatives for an answer:
1. Yes, I need practically all of each payment for my essential income requirement, or
2. No, I need about half or less of each payment for my essential income requirement.
*Steps to determine if your answer is Yes or No:
Firstly, you must determine your essential monthly retirement income requirement. This is the income you need to cover your monthly expenses. So, add up your monthly expenses - utilities, rent/mortgage, food, clothing, car expenses, typical entertainment expenses, etc. Include any long term payments such as for long term care insurance and real estate taxes so you have a true average monthly expense during the year. That average monthly expense becomes your essential monthly retirement income.
Your next step is to find other readily available income sources that can contribute to paying your essential retirement income. Begin by checking your Social Security monthly benefits due you. Add to this a conservative estimate for annual earnings from your savings. Stick to income only from your saving's earnings so your principal remains untouched each year.
You can include about half of the proposed lump sum in this estimate. That's because you should have some savings that you don't need to rely on for income. You'll need to preserve savings for emergency, special vacations, and a legacy for your kids. Divide by twelve to get your monthly investment earnings. Does their total almost cover your essential monthly income requirement?
If it doesn't, you haven't much for extra income so your answer to the essential income requirement question is 'Yes, I need the pension income'. So, you need the assurance of a lifetime income that only a pension payout or annuity can give you. Either take your company's monthly pension payout, or purchase a 'better' paying immediate annuity with the lump sum.
Alternatively, if your available sources of retirement income exceed your essential retirement income, you can answer 'No, I don't need the pension income' - as alternative 2. In that case you can take the lump sum for the flexibility it offers you as extra income and savings.
Two considerations that come into play now for the use of your lump sum are:
1. How much do you wish to leave as a legacy for children or charity?
2. How well can you manage your savings including your lump sum for generating an income to cover your essential income requirement?
If you're able to manage your savings to generate whatever remaining income is needed, you're in good shape. Be sure to invest whatever you won't use to generate your annual income in solid growth funds to offset inflation effects. Managing your savings includes preserving or increasing their value each year so you never run out of income and wish to maintain their value as a legacy.
If you think you can't easily manage your savings to generate that extra retirement income, use at least a portion of that lump sum to purchase an immediate annuity to handle that extra income you need from savings. Again, invest the difference in solid growth stocks for future emergencies, and legacy reasons.
