When you terminate your employment from a company that has a defined benefit (“DB”) plan, you usually have an option to take a lump-sum payment or to leave the assets in the company’s plan and receive monthly payments for your lifetime (and your spouse.) More than 90% of employees opt for a lump-sum payout from their DB plan when given the choice. That could be a mistake.
• Investment Risk: If you are not able to earn more than the discount rate used to calculate the-lump sum payment during these turbulent investment markets, you made the wrong decision. Do you have the investment capability, savvy, or interest take on investment management? Can you deal with investment professionals who are more interested with commissions than your investment performance?
• Longevity Risk: If you are lucky to live longer than most people, you made the wrong decision. 50% of individuals will live longer than their life expectancy. Are you one of them? What will you do when the money runs out? Wouldn’t you rather have a guaranteed paycheck for the rest of your life (and your spouse’s life, if you elect it?)
The decision to take a lump-sum distribution or a lifetime annuity is not easy. It is probably the most important financial decision you will ever make. There are two reasons where taking a lump-sum distribution may be a good idea:
• Poor Health: The lump-sum factor is based on Americans your age that are of average health. If you are at a higher risk of death, taking the lump sum payment makes good sense.
• Company in Financial Stress:The Pension Benefit Guaranty Corporation insures DB plan benefits up to a dollar amount based on your age. At age 65, the 2012 maximum benefit is $4,653.41 per month. So, if you are concerned about your company’s viability and your monthly benefit is greater than $4,653.41, taking the lump-sum payment may be a good idea.
Unless you are in poor health or your company is in financial distress (and your monthly benefit is greater than $4,653.41), I would not take the lump-sum. Leave the investment risks and the longevity risks with your former company. To protect the monthly payments from the effects of inflation, I would recommend investing your remaining retirement assets in a balanced portfolio. This should help offset the impact of inflation on fixed monthly payments.