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?
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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