Deciding between a lump sum vs. monthly pension

Lump sum vs. monthly pensions

Low interest rates mean a higher lump sum— but don’t let that be your deciding factor

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Q: I would like to have some basic information on how to choose between a lump sum payment from an employer pension plan or receiving monthly payments from the pension. What should I consider when trying to make a decision?

—Ruth

A: A Defined Benefit Pension Plan as Ruth is describing provides for a lifetime monthly income. The pension administrator will typically offer an exit to this plan called the commuted (lump sum) value. This is a one-time decision that can’t be reversed.

The commuted value calculates to a higher amount when interest rates are low, which explains why commuting is becoming a more popular choice these days.

Here are some pros and cons to consider to help you make this important decision.

Pension Lifetime Monthly Benefit Commuted Pension (Lump sum)
A guaranteed income for life.  No concern about investment volatility or running out of funds. Not guaranteed to last for life. Investment volatility could impact investment growth. Must be disciplined in investment approach.
Better positioned for a long lifetime A better option if you have reason to believe your lifespan will be shorter than the average.
The simple no-nonsense choice This choice has investment decisions and monitoring but provides more lifestyle flexibility
Tax is spread equally over your lifetime The lump sum (commuted) value may have provisions to shelter some of the amount from current year tax but a significant amount will be immediately taxed.
100% taxable income for life Once the initial tax bill is behind you, the resulting amount can be reinvested and only the growth will be subject to tax.
Do not have the option to adjust the pension benefit amount. Withdrawal from investments can be matched to inflation or other lifestyle needs.
No residual value (leftover) value to your estate There could be funds left over as an inheritance if you die earlier than expected.
Can spend right up to the last dollar. Need to leave a buffer amount of approx 5% to allow for an investment downturn.
Need to have 2 years of safe, liquid funds in case of a market downturn.
Short term goals cannot rob funds from long-term goals Short term goals CAN rob funds from long-term goals
Fully protected from creditors Partially protected from creditors.

To commute or not to commute? It comes down to how long you expect to live and how much control over the assets you need or want to have. Consult with a professional to help you with this key financial decision.

Tom Feigs is a Certified Financial Planner at Money Coaches Canada

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