Defined benefit workers pensions may be offered the chance to recover a one-off sum, lump sum payment in lieu of monthly retirement benefits for life.
Making this decision involves evaluating several factors, including the lump sum amount, the amount of monthly payments and the age of the beneficiary at the time of the offer. Other factors to consider include the beneficiary’s health, whether the pension will pay benefits to a surviving spouse, and the beneficiary’s level of financial literacy, self-discipline and need for financial flexibility. Faced with a choice like this, a Financial Advisor can help you evaluate your options and make an informed decision.
Lump sum or monthly payments
A pension recipient who is offered $250,000 in one lump sum instead of $2,750 in monthly payments for life can start by calculating the potential cumulative value of the monthly payments. To do this, they must estimate how long they are likely to live.
According to Social Security mortality tables, a 60-year-old man has an average life expectancy of around 20 years. If the pension begins to be paid at age 65 and continues to be paid until the beneficiary dies in 15 years at age 80, they will receive approximately 180 monthly payments for a total of $495,000.
If the beneficiary opts instead for the lump sum amount, he or she can start investing it immediately at age 60. When he retires five years later, he can start making monthly withdrawals of $2,750. For the $250,000 to last until age 80, his investments would need to generate an average annual return of at least 5.9%.
Now suppose the pension recipient is a 55-year-old woman and her monthly payments will start at age 65. According to the Social Security Administration, she can expect to live to age 83. higher value, totaling $594,000. However, because the lump sum would be invested for a longer period before she begins withdrawals, her investments only need to grow at an average rate of 4.84% per year for the money to last until at 83 years old.
In these two scenarios, the return required for the lump sum payment to at least match the value of the monthly payments is not unreasonable. It is possible that a well-managed portfolio will exceed these average returns, making the value of the lump sum payment option greater than the monthly payments.
As you can see, decisions like this often require calculations and assumptions. A Financial Advisor can help you do the math and evaluate your options.
other considerations
In reality, choosing between a lump sum or a monthly benefit will likely be a bit more complicated than these simplified scenarios. For example, many pensions have a survivor benefit that will pay all or part of the retiree’s benefits to his or her surviving spouse after the retiree’s death. If a spouse survives the original pension recipient, this can significantly increase the value of the monthly benefit option.
Ultimately, of course, longevity is not assured. If a monthly benefit recipient dies earlier than expected, it reduces the value of the monthly benefit. If they live longer than expected, that increases the value. For this reason, details about the recipient’s health may be important considerations. A healthy person with a family history of living older than average might place a higher value on monthly payments.
Inflation And returns on investment are two other unpredictable factors. Although an average annual return of 7% may be considered a reasonable expectation based on historical investment records, there can be no assurance that future performance will match this figure. Likewise, if inflation rises, this will reduce the purchasing power of a monthly benefit, unless the pension has a cost of living adjustment. Investing a lump sum offers the opportunity to earn returns that could help overcome the erosion of purchasing power caused by a period of rapid inflation.
Security is a major concern when it comes to paying for retirement. Pensions are guaranteed, but not investment returns. A beneficiary who lacks the financial knowledge to invest a lump sum wisely might be better off with a monthly benefit. Likewise, it is possible for someone who earns a large sum of money to spend it frivolously rather than investing it wisely to pay for living expenses in retirement.
While a lump sum may be inherently riskier, it also provides flexibility that can be an advantage in certain situations. For example, if a person has significant debt, it may make more sense to take the lump sum and pay off what is owed rather than continuing to service the debt while receiving monthly benefits.
If you are faced with a similar decision or scenario, consider discussing it with a Financial Advisor First of all.
Conclusion
When faced with a choice between receiving a lump sum or receiving monthly pension payments, key factors to consider include the age of the pension recipient at the time the offer is made, life expectancy of the beneficiary, the amount of the lump sum and the amount of the monthly payment. payment. Other factors to consider include details about the pension, including whether it offers spousal benefits or adjustments for inflation.
Retirement Planning Tips
A financial advisor can bring objectivity, experience and insight to the task of weighing the choice between monthly retirement benefits and a lump sum. Find a financier the advisor should not be difficult. The free SmartAsset tool connects you with up to three financial advisors in your area, and you can survey your advisors for free to decide which one is best for you. If you are ready to find an advisor who can help you achieve your financial goals, start now.
SmartAsset ROI and Growth Calculator offers a quick, easy and free way to see how much your portfolio could be worth in the future. This can be useful if you receive a lump sum pension and wish to reinvest it in the stock market over several years.
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