The “job-for-life” idea isn’t too popular these days. Mergers and acquisitions, in addition to business restructurings, are responsible for many lay-offs. Millennials are changing jobs every 4-5 years. Some do it for a higher salary; some others seek to climb the ladder faster.
Then, many workers share a point in common; after quitting or being laid-off, they have to make the decision between keeping their pension plan and taking a lump sum payment and invest it on their own.
This is not an easy decision to take. In fact, it is a very important one as it will affect your retirement plan. Since I’ve been working as a certified financial planner for a decade, I used my experience to highlight the most common reasons people decide to take the pension or the commuted value.
But First, 3 Questions to Ask Your Employer
A few weeks after you are no longer employed, you will receive what I call your “pension booklet”. This document will explain your pension details and possible options upon your employment leave. Unfortunately, a few parts of this document may not be as clear as you want them to be. Here are the top 3 questions you want to ask your previous employer before making any decisions:
Is my pension fully funded?
Many people think their pension is like a deal sealed in stone. Unfortunately, the guaranty you will receive your paycheck at retirement is as good as how your employer manages this money. If the company runs into financial difficulties, nothing is certain anymore. Talk to some GM (NYSE:GM) retirees about it!
Is my pension protected from inflation?
Or in more technical words, is your pension indexed? And, don’t go for the short “yeah, sure” answer. Some pensions aren’t indexed and some others are. However, there are several sub-rules to indexation. For example, the amount received monthly could be growing by 1% each year. This is considered an indexation, but it will definitely not match the real inflation rate over a long period of time.
What happens when I die?
You worked your entire life to build this pension; what happens if you die at the age of 67? Is the remaining goes to your surviving spouse? Is the full amount used? If you don’t have a spouse, will your heirs receive anything? How is this being calculated?
Once you have gathered all the information, you are now ready to take an enlightened decision. Here are the most common reasons to keep your pension…. Or taking the lump sum!
5 Reasons to Keep Your Pension
01 You expect to live longer than the average life expectancy
One of the main benefits of keeping your pension is definitely the fact you will receive a paycheck as long as you live. Therefore, if you live up to 98, you will never survive your capital! Unfortunately, there aren’t many ways to know what your life expectancy is. Let’s just say that if you have many family members that had reached 90+, you may join them in this select club.
02 You have a hard time going through market volatility
If the latest market drops of 2015 and 2016 made you uncomfortable, you might not want having additional money invested in the market. I doubt it’s your case since you are a Seeking Alpha reader, but it is one of the most common reasons why people chose the pension over the commuted value.
03 Your pension is fully indexed to match the inflation
If your pension grows at the same rate the inflation does, there is no room for uncertainty in regards to your retirement plan. If it had been my case, I might as well have considered the pension when I quit my job.
04 You do not want to bother about withdrawal strategies
There is a fun aspect of simplicity if you keep your pension. You don’t have to decide anything, the paycheck comes in each month, and you have nothing to do. If you decide to manage your money, you will have to follow an investment plan and draft a withdrawing process.
05 You do not wish to invest your money in an all-time high market
If you are currently in this situation, you may not want to risk your retirement over an overvalued market. I personally think it’s not a good reason, but many think we are about to suffer from a market crash. In this case, I guess the pension would be a wise decision.
6 Reasons to Take the Lump Sum
Now that I’ve highlighted the most common reason to take the pension, I will share with you the reason one could decide to take the lump sum payment.
01 You want to remain in control of your money
A very interesting aspect of the lump sum is the control you have over your money. You not only decide how to invest it but also when and how much you withdraw. For example, if you would like to withdraw money to finance special projects like a trip to Europe, you will be able to do so once you are retired. You will not be stuck with a fixed monthly deposit. Please take note that if you withdraw more money in the first year of retirement, it will greatly affect the rest of your retirement.
02 You love investing
If you are like me, you love investing. Managing your lump sum amount is more than taking care of your retirement; it’s a hobby, it’s a passion. Plus, there is a good chance you can do better than what your employer is promising in terms of return.
03 The future value of the lump sum amount is larger than the pension value at retirement
During low interest rate environments like this one, the lump sum value is often higher than what it normally should be. This is because this amount is in fact the present value of what your pension will be worth in the future. Since interest rates are very low, it greatly affects the discount rate to calculate your commuted value. In order to know which option is the most profitable, you can ask a Certified Financial Planner or run the numbers on your computer. You can learn how to calculate various scenarios through Excel in this article.
04 You want to leave something behind once you pass away
Keep in mind that each pension plan is different, and this is always a case by case scenario. However, most pension plans aren’t very generous with the surviving spouse and even less with other heirs (in the case you don’t have a spouse). It’s important to review the specifics with HR, but most of the time, the lump sum is better if you want to leave something behind.
05 Your employer’s financial situation is shaky
As I mentioned at the beginning of this article, if your employer doesn’t show stellar financial metrics, you might want to pull out your money from it. You can ask HR what the status of the pension plan is. Many pension funds are underfunded since 2008. You don’t want to stick with one of them.
The Best Advice; Run Numbers with a Certified Financial Planner
As you can see, there are various factors that can influence your decision. Depending on the pension details and on the individual, both options could be good. In order to help you out, I’ve created a decision grid you can use to make up your mind. You can check it here.
However, the best thing you can do is definitely to meet with a CFP as he will help you understand all possible options, and he will have software to run multiple scenarios with you.
I recently quit my job after 13 years working in the financial industry. This week, I’ve received my check of $108,000, and I’ll be creating a live portfolio at Dividend Growth Rocks, my Seeking Alpha service.
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Additional disclosure: The opinions and the strategies of the author are not intended to ever be a recommendation to buy or sell a security. The strategy the author uses has worked for him and it is for you to decide if it could benefit your financial future. Please remember to do your own research and know your risk tolerance.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.