Annuity or Lump Sum Payment? (Part I)

For me, the choice was easy. My defined benefit pension plan didn’t allow for lump sum payments, so the only question I needed to answer was the form of the annuity. My defined contribution pension plan didn’t allow an annuity, so lump sum it was. In this discussion I will use generalities regarding taking a lump sum from a defined benefit pension plan.

Lump sums are determined based on the defined benefit otherwise payable, interest rates and mortality assumptions. The law defines minimum and maximum lump sums; the pension plan itself contains the rules for determining your specific lump sum. I could regale you with atrocities plan sponsors and financial advisors perpetrated on plan participants in the bad old days; but the law was changed and those abuses are no more.

If you are going to die the day after you receive the distribution, taking a lump sum is a great idea for your estate. Clearly, if your expected mortality is significantly worse than assumed in determining the lump sum you are better off taking the cash now.

If you don’t expect to get personally acquainted with the grim reaper in the near future, then a lump sum is not a clear winner—even with historically low interest rates. Before the next post, I want you to think about what risk you should be trying to mitigate. (Here’s a hint: it’s not about dying too soon.)

The next blog will explore the risk that should be paramount in your decision-making and what that means.

~ Jim