Pension plans are becoming less and less common in the private sector, though the public sector still uses them regularly. If you have a pension, you’ll likely have to make a decision whether to opt for monthly pension payouts or one lump sum payment. Both options have their pros and cons, and there are several important factors to consider before making your choice. These considerations include your financial situation, other retirement savings, expected retirement costs and more. If you have questions about how the specifics of your situation should inform your decision, consider speaking with a financial advisor.
Pros and Cons of Monthly Pension Payouts
Monthly payouts are a great option for retirees for a few reasons. First, receiving a regular payout each month helps you stick to your budget in retirement. This is because they work similar to traditional checks that you earn from a job. As a result, it should be easier to keep your retirement spending under control, hopefully ensuring you meet your financial obligations each month.
Some pension plans will adjust their monthly payouts for inflation. This obviously isn’t a benefit that single, lump sum payouts can match.
Pension plans with a monthly payout are a great source of security in retirement, as they typically continue until death. In some cases, they are even transferable to a spouse. Because of this, there’s little risk of running out of money in retirement.
One major drawback of this payout option is that when you die, your monthly pension payments may stop. That means you could wind up leaving a lot less cash to your children, grandchildren and other beneficiaries. Again, they may transfer to a spouse, but this isn’t a guarantee. Be sure to check with your plan administrator to see if benefits continue after death so you and your family can plan your estate accordingly.
While it’s unlikely, you could lose your pension if your former company goes bankrupt and you elect monthly payouts. However, most pensions are insured by the federal government, so don’t harp on this too much.
Pros and Cons of Lump Sum Pension Payouts
A lump sum payout is the more exciting option of the two. After all, getting a huge influx of cash into your account upon retirement would make anyone jump for joy. But keep in mind that a lump sum pension payout makes it easier to overspend in retirement. That new car or luxurious vacation may not seem like such a splurge when you’re looking at a six- or seven-figure bank account.
There are a few drawbacks of the lump sum payout option. A lump sum is finite, while monthly pension payments continue at least until your death. This means that you’ll have to be significantly more diligent about how you manage your lump sum payment. Plus, with life expectancies on the rise, who’s to say that a lump sum will actually last you through retirement or beyond?
On the upside, receiving a lump sum payout gives you the freedom to spend what you need in retirement, when you need it. This includes both expected and unexpected costs, like housing and healthcare. For example, if you have a serious health condition and need around-the-clock care, your lump sum would come in handy.
Another positive of a lump sum payout is you’ll be able to invest your money exactly how you want. On the other hand, monthly payments might hamstring your investment capabilities. Try looking into financial advisors who can help you invest the money and set up regular withdrawals.
If you plan your investments and withdrawals right, you’ll also be able to leave the rest of your lump sum to your children, grandchildren, relatives and other beneficiaries. This can help set your mind at ease throughout retirement, knowing that your family is well cared for after you’re gone.
Regardless of how much cash you have in retirement, it’s always wise to set up and stick to a workable monthly budget. Living frugally in retirement could entail any of the following:
- Planning for healthcare costs
- Moving to an area with a lower cost of living
- Cutting excess costs like going out to dinner or cable
- Rethinking a life insurance policy
Example of Your Potential Pension Payout
Let’s say you’re opting for monthly pension payments. Every pension plan has different terms. However, most will use the average of your three highest years of compensation as a start for your payout calculations.
Once this number is clear, it’s multiplied by the percentage factor for your plan. You then multiply the subsequent number by the amount of years you were employed at the company. The product of that calculation equals your annual pension payout. To see how that’s split up over each month, divide your annual pension payout by 12.
The table below illustrates how you can figure out what your pension will pay you on a monthly basis. For reference, this example assumes that you worked for your employer for 30 years, that your plan uses your three highest years of compensation for calculations and that your plan’s percentage factor is 1.50%. Check it out here:
Example of How to Calculate Monthly Pension Payouts
|Top 3 Years of Compensation||$50,000 + $53,000 + $56,000 = $159,000|
|Average Compensation||$159,000 ÷ 3 = $53,000|
|Plan’s Percentage Factor||$53,000 x 1.50% = $795|
|Annual Pension Amount||$795 x 30 years = $23,850|
|Monthly Pension Amount||$23,850 ÷ 12 months = $1,987.50|
Determining the size of your potential lump sum pension payment is a much more personal process. For the most part, these payments come from what you would receive as a monthly benefit and current interest rates.
More specifically, lump sum payments are always less than what you would receive in total monthly payments if you reach your life expectancy. When it comes to interest rates, the lower rates currently are, the larger your lump sum will be. Speak to your employer for more information about what you could be in line to receive.
Lump Sum vs. Monthly Payouts: Which Is Best for You?
The answer to this conundrum isn’t black and white. The choice between lump sum and monthly pension payouts depends on many factors. Principal among these include your spending style, whether you have a spouse or other dependents, whether you have a health condition that may limit your life expectancy and the financial health of your former employer.
If you think you have a long life ahead of you or if you’re most comfortable budgeting a regular income, you’re better off with the lifetime monthly payments. If you think the lump sum amount will wind up being larger than lifetime monthly payments, or if you’d like the flexibility to spend and invest as you see fit, then go with the lump sum.
Retirement is one of the most complex financial endeavors to plan for, so take your time. Involve your family in discussions regarding your pension payout decision. Consider your ultimate financial goals for retirement, the current status of your health and any long-term conditions that may affect your life expectancy.
Similar to any financial decision, your final choice should rely entirely on the specifics of your situation. For many people, the decision to take a lump sum or monthly payments depends on how much they have saved for retirement in other places. If you have plenty of other money in an IRA or Roth IRA, having controlled payments every month may be the better way to go. But if your pension account is the main contributor to your retirement income, then a lump sum could be preferable.
Tips to Help You Plan for Retirement
- Consider working with a financial advisor to help with your retirement plan. An advisor can help you decide between the monthly benefit and the lump sum, as well as how to invest your assets. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Although it would be difficult to live off of Social Security alone, these extra payments can really help. To figure out about how much you could receive from the federal government, stop by SmartAsset’s Social Security calculator. If you have a government pension coming your way, it’s possible your Social Security benefit will shrink.
Photo credit: ©iStock.com/clubfoto, ©iStock.com/OlyaSolodenko, ©iStock.com/fizkes